You Can’t Blame the Government for SPC

government
Reddit

We’ll try and ignore markets for today…they need a little time to themselves. Are they happy about strong rear view mirror economic growth in the US, or worried about the Fed’s continued taper and its effect on emerging markets? 

They don’t really know, but it seems like the Aussie market can’t get excited about too much these days. We’re clearly on the emerging markets side of the fence in the eyes of foreign investors. Our proximity to China now looks detrimental, rather than beneficial.

You might think this is another bearish sign for commodities, but don’t be disheartened. These events could just be setting up gold and commodities as a tremendous long term buy this year. We won’t go into it now, but check you inbox this weekend for details.

Today we’re going to leave this confused market to work things out for itself. It needs some time alone. Instead, we’ll ask the question: Is it government’s role to protect jobs?

We ask because the issue of handing fruit processer SPC Ardmona a lazy $50 million to keep its Shepparton based plant running has become a major talking point. If you’re not aware, owner Coca Cola Amatil [ASX: CCL] has asked the State and Federal Governments to chip in $25 million each to modernise its Shepparton fruit processing plant. CCL will invest $90 million.   

Why won’t CCL put in the whole amount? Because it’s return on invested capital won’t make the investment worthwhile. Only $50 million in ‘free’ government money will reward shareholders enough for the ‘risk’ they are taking.
 
The Federal government yesterday rejected the request, a decision that has drawn plenty of criticism from parts of the mainstream media, and obviously, unions. Why it’s not CCL copping the brunt of the criticism is strange.

Maybe it’s because people instinctively realise profit seeking organisations won’t invest money when they know the returns are sub-standard. Which is why they turn to the government. Apparently the government has a bottomless pit of money and can provide subsidies when there are jobs on the line.

We don’t think it’s the government’s role to subsidise every (or any) inefficient plant or factory in Australia. But where it becomes tricky is when you’re dealing with the actions of other governments, or industries that are not regulated in the same way as Australia’s. 

Then you get arguments of ‘cheap imports’, ‘not a level playing field’ etc. But it is what it is. The market is clearly voting by buying products that are cheaper than SPC’s. The regulations, whatever they are, that dictate SPC’s production clearly do not add enough value in the eyes of the consumer to make them switch to a higher priced product. Fruit is a commodity…and when it’s in a can it’s pretty much all the same…so price wins out.

We reckon the over-arching problem is prolonged underinvestment by CCL. From memory CCL bought SPC around 10 years ago. It paid a decent price, but the fruit processor has struggled ever since. A stronger dollar and rising labour costs since that time no doubt contributed to its woes.

If the return from the initial investment was low, CCL would not have rushed to invest more to improve productivity. It’s likely that CCL simply used the business as a cash cow, running it for cash flow while avoiding additional capital expenditures that would have only generated a below average return.

Don’t forget, CCL is a highly profitable company…any capital it had to invest was much better off going into the main soft drink distribution business.

But it obviously got to a point where CCL had left a major capital upgrade too long. And after doing some due diligence, they realised they needed to invest nearly $150 million to get the place in order.

‘That’s a lot of money,’ the board says.

‘But if we don’t invest now, things will continue to deteriorate…we’ll have to walk away and write off our investment; shareholders won’t like that,’ says management.

‘Well, ask the government to chip in,’ says the board, ‘they won’t want to see jobs in the areas go. Actually, ask state and federal government, we’ll get both to chip in.’ 

That’s all speculation on our behalf, of course. But it makes sense to us.

Look, we like to blame the government for a lot of things, $10 pints being one of them. But you can’t blame the government on this one. It’s not their job to keep people in jobs. It’s their job to provide a good environment for business to grow and employ workers.

And in this case, we think CCL has managed the business poorly. They failed to invest and take some short term pain to improve productivity. They were beholden to the share market, who would’ve pushed their share price lower on news of any major capital expenditure.

But if you really want to go back to the source of the blame, give Ben Bernanke a call. His QE policy helped set off a boom in China, which set off a terms of trade boom in Australia. This pushed our currency and wage rates to record levels and made things like locally produced canned fruit pretty expensive.

See what easy money does? It enriches the bankers at the expense of the workers.

But the good news is that the dollar is coming back down. Meaning canned fruit import prices will get more expensive. It’s all thanks to China, which is slowing and will slow much more rapidly than most people think this year.

And because the rest of the world views Australia as an appendage to China, such a slowdown will see our currency continue to fall against the majors like the US dollar and the euro.

As we said yesterday, news from China will be pretty quiet for the next few days, as everyone is on holiday. That’s probably why gold took a beating overnight. There’s no one around in China to buy the hedge fund selling-induced dip…making the short sellers’ profits that much easier to collect.

But no news is not good news on the China front. That being the case, we’ll leave you with something to ponder for the weekend. It’s what investment bank BNP Paribas, calls ‘perhaps the most dangerous misconception concerning the Chinese economy‘.

From Alphaville:

…(it’s) ‘the self-limiting argument that, because the Chinese authorities have been able to exert an impressive degree of control over cyclical volatility for many years, this will necessarily continue to be the case. This argument manages to conflate bad economics, poor history and unsound logic. The key lesson of the global financial crisis is that long periods of stability actually sow the seeds for bouts of future instability: the greater the apparent degree of control and stability, the greater the build-up of hidden vulnerabilities.

Regards,

Greg Canavan+
for The Daily Reckoning Australia

Join The Daily Reckoning on Google+

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
Reddit

Leave a Reply

17 Comments on "You Can’t Blame the Government for SPC"

Notify of
avatar
Sort by:   newest | oldest | most voted
Rob CA
Guest
Yes the government can’t afford to chip in funds to keep SPC going or Ford or Holden because they need to keep the money pay for government departments that produce nothing but more and more regulations that in turn make more and more businesses unprofitable. In the meantime the unions and the Fair Work Act set wages and conditions that make a business unprofitable on top of government generated electricity and water charges, payroll tax, workcover, superannuation (which will go up in puff of smoke in the end), Fringe Benefits Tax, GST, nonsensicble workplace health and safety regulations etc. Finally… Read more »
Rob CA
Guest
Yes the government can’t afford to chip in funds to keep SPC going or Ford or Holden because they need to keep the money pay for government departments that produce nothing but more and more regulations that in turn make more and more businesses unprofitable. In the meantime the unions and the Fair Work Act set wages and conditions that make a business unprofitable on top of government generated electricity and water charges, payroll tax, workcover, superannuation (which will go up in puff of smoke in the end), Fringe Benefits Tax, GST, nonsensicble workplace health and safety regulations etc. Finally… Read more »
Jason
Guest
Australia being China’s little toadying dachshund was always going to end up with detrimental effects. China will inevitably go down the same path as Japan, who Australia grovelled too in the 1980s, and the rest of Asia will follow, and that path is-subreplacement fertility/aging population and population decline, and all this before the issue of oil production declining. As for the ‘old’ arguments about level playing fields and cheap imports, they are valid. Australia is being undercut, Australia is being sold off, yet racist Asia banned Australians from buying land or companies over there. Maybee the demographic crash isn’t such… Read more »
Jason
Guest
Australia being China’s little toadying dachshund was always going to end up with detrimental effects. China will inevitably go down the same path as Japan, who Australia grovelled too in the 1980s, and the rest of Asia will follow, and that path is-subreplacement fertility/aging population and population decline, and all this before the issue of oil production declining. As for the ‘old’ arguments about level playing fields and cheap imports, they are valid. Australia is being undercut, Australia is being sold off, yet racist Asia banned Australians from buying land or companies over there. Maybee the demographic crash isn’t such… Read more »
slewie the pi-rat
Guest

Ode to SPC/Owed 2 CCL

faustian food-chain frothily frolicking
fat-free food in fructose funk
mandarin oranges screaming: EAT ME!
feeling lucky are we, punk?

slewie the pi-rat
Guest

Ode to SPC/Owed 2 CCL

faustian food-chain frothily frolicking
fat-free food in fructose funk
mandarin oranges screaming: EAT ME!
feeling lucky are we, punk?

Jimmy
Guest

Get off the crack Slewie.

Jimmy
Guest

Get off the crack Slewie.

Jim
Guest

Good article Greg !!!

shortchanged
Guest
No..No.. stay on ‘it’ Slewie, you make my day. During my 47 years in Australia, innumerable companies pushed out the begging bowl, then 6 or so months down the track upped sticks and went back home, usually to the US. Good on you Mr Abbott, stick to your guns, and call the bluff of these ‘bully boy’ companies if they can’t make a go of it, then they shouldn’t be in business. As for the decline, it’s world wide, Australia can’t expect to evade the consequences forever. I say this although the A$ to £ is ruining my opulent (Yeah,… Read more »
shortchanged
Guest
No..No.. stay on ‘it’ Slewie, you make my day. During my 47 years in Australia, innumerable companies pushed out the begging bowl, then 6 or so months down the track upped sticks and went back home, usually to the US. Good on you Mr Abbott, stick to your guns, and call the bluff of these ‘bully boy’ companies if they can’t make a go of it, then they shouldn’t be in business. As for the decline, it’s world wide, Australia can’t expect to evade the consequences forever. I say this although the A$ to £ is ruining my opulent (Yeah,… Read more »
ram
Guest

It doesn’t help that the process of “canning” is obsolete for most items. There are better ways of preserving and packaging food these days. Subscribe to a “Food Technology” magazine and be amazed at what is out there.

ram
Guest

It doesn’t help that the process of “canning” is obsolete for most items. There are better ways of preserving and packaging food these days. Subscribe to a “Food Technology” magazine and be amazed at what is out there.

garry
Guest
Look, we like to blame the government for a lot of things, $10 pints being one of them. But you can’t blame the government on this one. It’s not their job to keep people in jobs. It’s their job to provide a good environment for business to grow and employ workers. “”” Yes indeed. Then why in the hell haven’t they been doing something about the blatant dumping that’s been going on for years. Tins of food for instance, as SPC say, are landed here for less than the cost of production in the country of origin. A really great… Read more »
shortchanged
Guest

To DR.

All posts are in twice, in twice, is that me, or do you have a problem, have a problem. ???

wpDiscuz
Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au