Introduction

The expanding degree of investment prompted RIRDC to undertake rigorous analysis of eight relatively well-known industries. The result is a three-stage model of production by agricultural consultants Hassall and Associates which will provide entrants with better knowledge of industry requirements than previously.

Each of the eight – Cashews, Coffee, Geraldton Wax flower production, Lychee, Olive, Peppermint, Tea tree and Walnuts - achieved a positive return, although they varied from marginal to very favourable.

Of these, Tea tree Oil, Walnuts and Olives have the potential as best performers, returning strong results in financial indicators; benefit cost ratio, net present value and internal rate of return.

The analyses in this report are based on industry information and assumptions which were applicable at the time of the analysis. They are also analyses of hypothetical new ventures.

The Model

A concentrated model acts as a pointer to investment, by research proponents like RIRDC and private investors. For current industry it highlights possible areas of improvement according to fundamentals of investment and associated data levels.

As an investment tool it is a strong indicator, not a crystal ball. The final stage, requiring specifics like site selection and enterprise size, must be undertaken by individual investors.

Hassalls drew on an array of current investment methodologies from within and outside agriculture to formulate the model. The adoption of methodologies from Research and Development Corporations, Government Agencies and Corporations, Agribusiness, Venture Capital industry and the Banking and Finance industry created a package of high level performance indicators suitable for evaluation of new industries.

The research found three distinct stages which most successful projects had to pass before being implemented:

• Concept (stage one)

• Feasibility (stage two)

• Investment (stage three)

A characteristic of the stage three evaluation is that the project is site-specific. This requires a location be determined and the project be fully scoped in terms of land area and enterprise size.

The whole industry research is restricted to the more general stage one and two to build a sound basis for investment decisions and generate responses from research undertaken in industry, identifying areas of required research and development.

Stage 1

The results are likely to be interdependent. For example, a prospect might require further research in order to determine whether fundamentals are in place, or the fundamentals might be so positive that the absence of certain data is irrelevant.

Although a degree of judgement is necessary, the methodology can act validly as a decision support tool. Financial analysis is only a component of this process, albeit an important one.

To simplify the model enterprises are divided into two types – crop and livestock – which is estimated to cover 85 per cent of new and emerging industries.

The model calculates the unit gross margin and net margin for the enterprise for a typical steady-state year, using fundamental inputs and outputs (see table 1).

The sensitivity of these margins to changes in the main parameters is automatically computed to provide a guide to the relative importance of the various data categories. For instance, it would be counter-productive to spend time and resources improving the confidence limits of costs of common machinery, if the farm-gate price or market strength have similar confidence limits, as the viability of most enterprises is more sensitive to market demand than to investment inputs.

If the financial worth is insufficient, or there is an identified lack of data, the enterprise should not move to stage two. New investigations and research will need to be completed, whether on the input or output (market) sides.
 

Table 1: Checklist of Fundamentals
 

	Crop Enterprises	Livestock Enterprises
Investment Inputs
Field investigations	Survey, soil, agronomic, farm planning	Survey; vegetation investigations; farm planning
Land	Assumes suitable area of land; soils; topography; access	Assumes suitable area; fencing, soils (if grazing); access
Buildings	Suitable sheds, storage	Suitable buildings, protection
Stock	Seed stock	Suitable and sufficient breeding pairs
Machinery	Tractor, plough, irrigation, etc	As required (milking etc)
Establishment	Fencing, landforming; access structures	Fencing; protection; watering; feeding; access structures
Processing	Drying, oil extraction, winemaking	Shearing; tanning etc
Distribution	Packing facilities; bulk silos; transporters, reefer trucks	Packing facilities; transporters, reefer trucks
Markets	Established or prospective	Established or prospective
Permits	Permits, licences, industry memberships	Permits, licences, industry memberships
Working Capital	Normally value of one season’s recurrent inputs	Normally value of one season’s recurrent inputs
Recurrent inputs
Seed/Stock	Seed, rootstock cuttings	Access to replenishment stock
Irrigation/water	Irrigation if necessary	Watering: habitat for some
Soil preparation	Tilling, stubble burning	Only for grazing
Fertilisers	Phosphates, urea etc	Only for grazing
Chemicals	Herbicides, pesticides	Pesticides
Crop protection	Trellises; covers; shade	Silage; grains; many others
Harvesting	Crop harvesting	Shearing; milking
Maintenance	Fencing; banks, structures	Fencing; pens, structures
Disposal	Disposal of unused products	Disposal of unused products
Permits	Annual permit, licence, industry levy renewals	Annual permit, licence, industry levy renewals
Yield
Primary yield	Unit yield of primary crop	Unit yield of primary product
By-product yield	Unit yield of each by-product	Unit yield of each by-product
Demand
Demand value	Unit farm-gate price, or market price minus transport & handling	Unit farm-gate price, or market price minus transport & handling
Quantified demand	Size of accessible market	Size of accessible market
Price elasticity	Impact of new supply on market prices	Impact of new supply on market prices
Projected demand	Market outlook	Market outlook

Stage 2

Enterprises moving onto stage two of the analysis undergo a more rigorous analysis especially in implementation timing and scope.

Its single objective is to identify prospects which are worthy of commercial advancement. The comprehensive assessment leads to a green light and stage three, or termination.

In reality prospects are rarely terminated, as other stakeholders will re-evaluate a prospect based on new information, advanced technology, market shifts, changes in assumptions or sheer determination to make it commercial.

The stage two model is structured around a horizontal cash-flow layout, with annual timesteps and a maximum evaluation of 20 years. (The analyst needs to decide on the most appropriate evaluation period for the enterprise, but 20 years is commonly considered the maximum period.)

In the financial analysis results, the model delivers three indicators; net present value (npv), internal rate of return (irr) and benefit cost ratio (bcr).

A key to this analysis is the 7% discount rate. This can be considered as the cost of capital minus inflation and sets the base point for the IRR which should be greater than the discount rate in a positive investment.

A subjective assessment is made according to industry performance indicators.

The possible outcomes of stage two analysis are:
 

• Termination of the opportunity if its feasibility is judged to be inferior; or

• Documentation of the opportunity for investigation to invest and implement, i.e. take to stage three.

Table 2: Results
 

Enterprise	Benefit Cost Ratio @ 7%	Internal Rate of Return	Breakeven on cumulative basis after
Cashews	1.19	12%	14 years
Coffee	1.12	10%	16 years
Geraldton Wax flowers	1.06	10%	18 years
Lychee	1.36	16%	13 years
Olive production for oil	1.46	14%	12 years
Peppermint oil	1.30	13%	13 years
Tea tree oil	2.02	44%	5 years
Walnut	1.54	12%	15 years

Table 3: Threshold analysis results:

Net present value of the enterprise equals zero when
 

Enterprise	Yield/Price decreases by %	Investment expenditure  increases by %	Recurrent inputs increase by %
Cashews	16	46	31
Coffee	11	35	18
Geraldton Wax flowers	5	31	6
Lychee	27	151	45
Olive production for oil	32	109	74
Peppermint oil	23	63	49
Tea tree oil	50	318	140
Walnut	35	78	143

Table 4: Industry performance indicators
 

Performance Indicator	Condition	Embedded Comment
Net present value (NPV)	>10% of investment inputs 0-10% of investment inputs <0	Very Favourable Outcome Favourable Outcome Unfavourable Outcome
Internal rate of return	>1.5 x required rate of return 1-1.5 x required rate of return < required rate of return	Very Favourable Outcome Favourable Outcome Unfavourable Outcome
Benefit cost ratio	>1.5 1-1.5 <1	Very Favourable Outcome Favourable Outcome Unfavourable Outcome

Stage 3

The objective is often to maximise commercial return of an already proven concept by finessing parameters like the exact timing and structuring of the enterprise, financial and tax structuring aspects, and the management structuring.

As these parameters are unique to a specific context, they cannot usefully be explored outside the generic or developmental methodology.

Other considerations should always be made. In the report Hassalls identify four other areas potential investors should consider:
 

• Agronomic Analysis – central to an enterprise’s performance and an essential input into financial analysis.

• Market Analysis – frequently a weak link in the financial appraisal. Where target markets are small or immature, price elasticities must be fully investigated.

• Risk Assessment – risk plays an important role in the prospect of new enterprises. Generic risks like political change to export market exposure must be subjectively assessed as part of the generic industry, but only in stage three analysis can specific risks be identified and analysed to any degree of precision.

• Personal Assessment of Proponents – the confidence with which new and emerging enterprises can be evaluated will to some degree depend on the personal reputation and past performance of the proponents, over and above all over subjective considerations.

Summary of results

The format is demonstrated by the sample analysis below, which should be used in conjunction with the individual industry results that follow.

Results for each industry were verified as being reasonable by the recognised industry representative.

Readers should note that each of the analyses in this report is based on industry information and assumptions which were applicable at the time of the analysis. They are also analyses of hypothetical new ventures. Personal investigations should always be made, specific analyses undertaken and specific advice sought before investment in any new venture.
 

Interpreting the results from a sample analysis
 

Description:		Prospective industry							Comments
Analyst:
Date:
Key Assumptions:
xxxx	Enterprise scale							100 hectares		xxxx
xxxx	Geographic location							Aust.		xxxx
xxxx	Initial investment							$ 1,717,300		Outlay required to get into business
xxxx	Typical recurrent input costs							$ 282,780		Annual cost of labour, materials, equipment, etc
xxxx	Key yield factors						xxxx				xxxx
xxxx	Farm gate (or other) prices							$ 4.00 per unit		xxxx
xxxx	Discount rate							7%		Can be considered as the cost of capital minus inflation
xxxx	Inflation rate (if any)							n/a		xxxx
xxxx	Analysis period							20 yrs		xxxx
Present Value @ 7% over 20 years:
xxxx	Investment inputs							$ 1,790,480		Present values allow for the time value of money
xxxx	Recurrent inputs							$ 2,170,885		" "
xxxx	Revenues							$ 5,888,888		" "
xxxx	Residual values							$ 219,070		" "
Net Present Value of Enterprise @ 7% over 20 years								$ 1,810,020		" "
Financial Analysis Results:
xxxx	Return on recurrent inputs							223% static state		For a typical year only - usually an optimistic result
xxxx	Return on investment and recurrent inputs							70% static state		xxxx
xxxx	Internal Rate of Return							14%		Should be greater than discount rate (above)
xxxx	Benefit Cost Ratio @ 7%							1.57		Greater than one if benefits exceed costs
Breakeven on cumulative discounted basis after								13 years		No "dividend" from the business up to this point
Threshold Analysis Results:
Net Present Value of Enterprise equals ZERO when...								xxxx		ie: long-term breakeven
xxxx	Yield / Prices decreases by (%)							31%		xxxx
xxxx	Investment Expenditure increases by (%)							101%		xxxx
Major Risks to Financial Viability:
xxxx	Loss of crop due to climate variations							xxxx		xxxx
xxxx	International prices and volume of domestic supply							xxxx		xxxx

 

Cashews rank third in world production of edible tree nuts with a current world production of about 700,000 t nut-in-shell (NIS). Australia currently imports A$26-30m (wholesale value) of cashew kernel annually; a local industry would provide import replacement and create export opportunities for sale of NIS, raw kernel and value-added products.

The Australian cashew industry is currently at an embryonic stage, with one major plantation in north Queensland and two plantations in the Northern Territory. To expand, the Australian industry needs high-yielding (>4 t/ha NIS) selections and management practices to achieve and sustain such high yields. Plantings of at least 500 ha in single or cooperative plantations may be required to (i) establish a brand name in the local/international market, and (ii) minimise the unit costs associated with production and the overseas processing of Australian cashews.
 
 

World coffee trade is worth $A24 billion annually. Australia’s industry died in the early 1900’s as labour costs increased, but new machine-harvesting can reduce harvesting costs by one tenth making it viable again. There is however a limit to the protected, frost-free land available for premium coffee.

Freshness, a lower caffeine content and a `pesticide free' or `organically grown' image are attractive qualities of Australian Arabica coffee. There is also interest overseas in the mild, medium-acidity, `stomach-friendly', specialty coffees which are being produced. The challenge is to produce enough consistent quality coffee to take advantage of these market opportunities.

Coffee is free of major pests and diseases, and can be grown near urban areas.

Geraldton wax is Australia’s leading commercial wildflower. It has reached the top 20 plant species in terms of volume sold in Europe, and is on the brink of achieving ‘commodity’ status in the international cut and potted flower market.

However, Australian exports of Geraldton wax are less than 10% of world total production, and world production of floricultural plants of Australian origin constitutes only about 1% of world production of all flori-cultural products. Site selection and preparation are important.

Care should be taken to plant on higher ground or on slopes that allow free air drainage to minimise frost risk. Pest and disease control form a part not only of the production and management system but also of harvesting and processing.

Harvested material must be free of insects, spiders, snails and other minor pests that may constitute a quarantine problem. Root diseases can also be a major problem. The economics of production are very much an enterprise level issue, varying widely on the basis of scale of production, range of products and cost of market access. Market access costs are minimal for a road-side operation but increase to as much as five times the production cost for European and eastern seaboard USA markets.

The major portion of trade is through established market channels, through local agents to freight forwarders to import agents, auctions and onto the retailer. In this long market chain two thirds of the auction price go to pay costs external to Australia.

The largest producers of lychees are China, Thailand and Taiwan. Major Australian commercial plantings started in the 1970s and currently there are about 450 growers of lychee with an annual production of 3000t worth $15m. Production has steadily increased over the past eight years.

Lychee are difficult to grow and yield consistently. Trees take three to five years to come into production, and will not yield substantial crops until year six or eight. They require regular chemical control measures for pests and suffer heavy losses to birds and fruit bats if not netted.

The fruit ripen only on the tree and have a very short self life without refrigeration. Australia has an advantage in the international market because it produces fruit during the northern hemisphere `off season' including the lucrative Christmas and Chinese New Year festivities. Demand for high quality product far exceeds Australia's ability to supply. There are also opportunities in the domestic market, although some promotion and retail/consumer education are required.

Olives, particularly for oil production, have the potential to become a substantial horticultural industry based on existing domestic demand and the development of export markets in Asia. Nevertheless, locally produced olive oil must be able to compete against other vegetables oils with similar chemical characteristics and alternatives, including imported olive oils, which are cheaper.

Olive markets are dominated by Spain, Italy, Greece and Tunisia which account for 85% of oil production. The time from planting to first harvest is variety dependent and also dependent on management techniques. Most olive varieties though will take at least 4-5 years and even longer if not cared for properly.

A major advantage of olives is that they are relatively pest and disease free in Australia.

Olives have traditionally been harvested by hand but for an economically viable large-scale operation mechanical harvesters are essential. The two major establishment costs are the trees and irrigation system.

Peppermint oil is obtained from the leaves of the perennial herb, Mentha piperita. Oil is extracted by steam distillation and is generally followed by rectification and fractionation before use. Its major end-uses are in toothpaste and mouthwashes, chewing gum and food flavourings.

World production is more than 4000 t/year, with the USA accounting for 90% of this. The increase in world-wide demand is 5% a year, predominantly as a result of Asian market expansion.

The environmental conditions under which peppermint is grown are critical to the quality of the oil produced and limit the areas suitable in Australia to Tasmania and Victoria. Production has been under way in both these regions for many years and is currently expanding in the Victorian region. Production techniques are based on U.S. practices and require a high level of capital input and expertise to produce a saleable product.

Several species of Melaleuca can be used to produce Australian tea tree oil, but most plantations use Melaleuca alternifolia. The industry originally harvested trees growing naturally in bush areas, but plantations were established when the demand for oil exceeded the capacity of bush production.

The first successful plantations were established in the mid-1980s and the shift from bush to plantation production created a need for new technology to address cultural issues such as establishment, and weed and insect control. Australian tea tree oil is marketed as a natural antiseptic and antifungal agent.

The production of oil has increased from a base level obtained from bush stands of about 12 t/year to 180-220 t in 1996-97. Concurrently, the farm-gate price of oil increased from $15/kg to $45-55/kg.

Walnut production is attractive to many because it is highly mechanised, orchards require low maintenance, are productive for at least 40 years and once harvested, the nuts will keep for two years.

Many parts of southern Australia have a Mediterranean-type climate ideally suited to the growing of walnuts. Irrigation areas which currently support a highly productive deciduous fruit industry could also support a profitable industry.

Compared with the USA, Australia has the advantages of fewer pests and disease of walnuts, clean air and water, and a reduced threat from the urbanisation of agricultural land.

The Australian walnut industry is small, producing only 110 t annually and yet we imported 382 t in-shell and 2115 t of shelled nuts in 1995-96, conservatively valued at $1m and $10m respectively.