Ann: AHF to produce Organic Infant Formula with Australian Milk, page-180

So many posts from so many seemingly well-informed new posters, some of them traders, some speculators, some groupies and some fundamentalists it seems and even some of the AHF old hands as well warning of empty promises of past and potential history repeating itself (I tend to be in this camp). So here is my 2 cents...1.818 cents actually the rest is GST.

All I can say on the freshly found excitement is to play the current new found market liquidity for all your worth but I hope you aren't left holding when the music stops. It has had two days of trading since the announcement and I would hazard a guess the excitement is abating as the peak price is coming off the top of 25 cents that occurred in the first trading period after the announcement. Chart whisperers will have a greater opinion than I on the short term but I can't see it punching through much more than what has been achieved since the announcement unless a new catalyst is presented to the market, for example a new 5%er comes along or a possible take-over offer from somewhere or an actual strategy announcement from the company.

In regards this latest announcement, I like their ideas and look forward to (a) what their actual strategy is, and (b) their reporting of its progress in the subsequent 24 - 36 months to get it started. The announcement was clever but lacking in company specific details which indicates history may well repeat itself again. For those that may have forgotten the some of the past strategies and initiatives;
1. Farm aggregation - the initiative died at 6 farms - 5 milkers and 1 feeder. For those interested there are two other well-known dairy farm aggregators besides the Moxley / Perich tie-up in NSW (ASX: 'FNP') and they are Ace Farming and Warrakirri so this idea was neither new nor differentiating for them.
2. Vertical integration - The last time they announced a new strategy was the go vertical call and the acquisition of CDC (Camperdown Dairy Company) from Aussie Farmers Direct and a price premium was paid for a joint ownership (with ODFC) processing plant on a half demolished lot under a lease in Camperdown and a declining product-to-market low margin base. This has subsequently been compounded by the seller of the processing plant going into administration (Aussie Farmers Direct) and although small, leaving AHF with a small accounts payable exposure of sub-$100k. On top of this is the declining throughput of raw milk at the plant possibly due to poor milk supply from their owned farms and possibly the cost of buying raw milk from the wholesale market. The ripple effect is reflected in the accounts, check that out for yourself both the quarterly cash-flows and the last two annual reports.
3. Attempted joint arrangement with Lian He for export of fresh milk to China which got a suspension and that market acquiesced even though they announced after the suspensions a new wonderful deal with Lian He - not sure the current status of the export licence or the new initiative, but either way the initiative is inactive and provided no tangible earnings for AHF and certainly not sustainble.
4. Attempted joint arrangement with Lencia for the distribution of AHF produced milk products - never to be heard of or spoken about again.
5. Various channel type agreements for a range of products to some rather large domestic retail names, including Woolworths, that were vague loose and never follow through with measurements and results reporting to shareholders.
6. Various other initiatives far to sensitive to announce to market but enough to announce "something old, something new, something borrowed, something blue" to keep shareholders in animated suspension. Some of those are still pending disclosure of further details.
7. The shift from Holstein and Fresian cows to include Jersey cows to try and improve the quality for a range of new products and uplift the kg/ms - not their finest hour as they threw out to market, via social media channels rather than a planned campaign launch, the free range milk and jersey milk on the back of the farm based initiative. Go boutique and go niche was a catch cry for some time...along with free range happy cows.
8. As past shareholders had enough and tolerance wore down then there were rumblings in the background of a rising and the company rushed a private placement capital raise of questionable means last year for $5m (~37m shares) to stave off a rumoured Board spill on the back of a second strike at the AGM. The one strategic initiative to date that had been successful, their self preservation.

Just a word from the past, the expression "joint venture" was used very liberally by AHF in general announcements and meeting commentaries the past but the Annual Reports will actually disclose they have no joint ventures during the same periods. Loose language or a typographical error, you decide.

The one strategic imperative that should provide a guiding light they seem to continually completely miss and that is "scale". Putting cost efficiencies, product flexibility and market presence aside without any scale there is no export opportunity. Current production of 17m litres of raw milk does not afford scale by any means, Even if it is a high kg/ms and the milk solids are weighted towards protein rather than fat the net result of powder available for blending and canning would be somewhat less than what many think. Assuming the current dairy cows mix will be the same mix for the producers of the organic milk in the future the conversion factor for kg/ms could be closer to 7 than 8.5 yielding usable milk solids of around 2.4 million kg. To then take this and rebalance in favour of whey and reduce the fat would further reduce this to about 2.2 million kgs for blending and canning. And the undisclosed details that cost time and funds and require various inputs from other non-dairy suppliers to make up the Infant Formula whatever one they use or come up with.....net result is no matter what the retail value of their 17m litres can be converted to it is unlikely they have the capital structure, capability or appetite to succeed and the sheer lack of 'scale' will deny them certain domestic and export markets.

As for maintaining a sustainable business whilst they gear up and transition to the "organic Infant Formula" world I can't see it being easy, cheap or funded by existing cash-flow so it will need to be capital (equity or debt) funded unless they can do something else in the interim to improve this situation the new found strategy will test it even further. Transitioning from conventional dairy farming to organic dairy farming is neither a light task nor a quick one. Processing raw milk derived from organic farms into a consumer acceptable Infant Powder has a number of large steps in between (e.g. casein & whey rebalancing and also fortification let alone who will do the formula development) and these seem to have been glossed over by many not even taking into account the sales channels to get to market (a well serviced market by the way).

From here on it it will be about confidence and trust....do you trust the current board and management team to deliver upon the latest announcement? Holders and believers of the past don't as the performance and delivery of promises has been apocryphal to say the least. Perhaps they have changed their stripes to spots and will come good but no significant change to the board, no change to the management team and no change to the significant holders (ex-TAU now JCC - Jimmy Crow listed on the NSX) doesn't bode well for a successful outcome in future times no matter how enticing some key emotionally driven market wordsmithing in an announcement appears.

There is so much happening on the dairy market right now that one would have though they would be capitalising on under-performing acquisitions to grow the business rather than spouting off about yet another venture on the back of a populist strategy that has done well for a few other ASX-listers but for AHF will not yield for at least 3-4 years from now at best. In the organic space the largest organic dairy processor of a gross national output of organic milk of about 40m litres per annum right now is ODFC (Organic Dairy Farms Co-operative) and they have a small plant in Geelong, they have somewhere just north of about 50% of the total market. Where will the organic milk market be in 3-4 years when AHF says "We are here!". And what alliances will be forged between now and then as BEGA, WHA, possibly BAL in Tasmania) and others move to secure locally sourced organic milks from ODFC or elsewhere for their own purposes whilst AHF plays catch-up with re-engineering their current farms over the next 30 odd months.

For example, right now there is the MGC plant at Koroit up for possible sale (with caveats that some many be aware of) and that would give AHF scale if they figured out how to fund it, acquire it and how to run it profitably...scale by the way is around 1.0 billion litres of raw milk processed annually. This plant has the ability to process organic if required without materially impacting other operations and dairy product outputs. This deal alone would possibly provide a better return on capital than taking the boutique, unique approach they seem to be pursuing.

The region of Victoria (SW Victoria) that AHF operates in produces a tad over 2.0b litres of milk per annum and there is well over 3.0 billion litres of reasonably new dairy processing capacity hungry for milk supply and AHF want to build a new plant in the midst of the region for something delicious in years to come??? Another market based opportunity would perhaps a smarter approach and that would be to see if they could open discussions with Viplus (southern Gippsland region) to accelerate their aspirations for Infant Formula and the chinese export market even though Viplus had some glitches in the past it would be better than the path they have alluded to in the announcement and Viplus has a key differentiator, it already has CDNA approval and is operating as an IF producer and has a chinese backer tucked away in the background.

On to the account then shall we, hidden in the accounts is an array of colourful and wonderful accounting treatments that only serious forensics will be able to dig out but suffice to say it has been called out in the past and much of it is still hidden and in existence. The corporate structure of AHF is not particularly clean as it is that of a stapled unit, meaning there is an ordinary share and a stapled unit in a related trust. The Trust essentially owns the farms (somewhat questionable) and is managed by a related party, the Responsible Entity. Go have a peek at the names on the Board of each entity to satisfy yourself there is good robust transparency and independence and also see if you can following both the inter-company/trust charging that occurs including the secondary ripple effect of fee recovery from such a complex corporate structure.

I don't believe any of the independent initial financiers or backers are still in AHF including those that were convinced by Bell Potter to share in their own placement (not their finest hour backing this one they now admit). The current share register makes for interesting reading as well if a longer term punt is your game.

Anyone want any more or do you all want to just argue the semantics of the share price now and in 5 minutes time? Lets give it some relativity...to history. AHF announced the acquisition of CDC ( a tangible initiative) and price smartly hopped its way from 15 cents to 59 cents in a matter of a week equating to ~293% increase and in the last two days the latest announcement of no real substance we have seen the price hop from 11 cents to a high of 25 cents equating to ~127%. How much further do you see it going given it hasn't tested new highs today? Will history repeat itself and the relative share price hit another 293% increase to ~43 cents or will it come back and rest in the mid to late teens or will it just pass on through 43 cents to the wild beyond? Look to the market capitalisation rather than the share price for a guide I suspect.

Right now it is a tradeable sub-investment grade punt and many past long term holders are very grateful for the new entrants for alleviating some long held angst and discomfort and may the future not deliver a repeat of the past for the new folks. Make me wonder if this company is not more scared of success than it scared of failure.