Sydney, Australia: Agribusiness, like other sectors of Australian manufacturing, is facing rising processing costs in Australia. This is particularly true for the Australian cotton industry. Industry leaders believe there is the potential for major crisis in the industry as it accommodates the resources boom. In August this year, cost pressures caused Bluescope Steel to announce a shutdown one of the nation's three remaining blast furnaces, resulting in the loss of at least 1,000 jobs and an expected AU$1bn deficit in one year.
PKF Corporate Advisory Principal, Margaux Beauchamp has warned the Australian cotton industry of the inevitable rise in the cost of ginning. “The current cost of ginning is simply not sustainable as the current return on equity (estimated at -0.4%) means the industry will have difficulty attracting capital and there is unlikely to be the optimum reinvestment ”, Margaux commented.
The poor profitability of the Australian ginning industry is the result of ginners having absorbed cost increases over the last ten years as the cotton farming sector struggled due to the low level of production caused by the drought. The fortunes of the farming sector have since changed, but this hasn’t been reflected in ginning prices.
“It’s imperative the price charged per bale for ginning is increased to ensure the sustainability of the ginning industry, an essential component of the Australian cotton industry,” Ms Beauchamp said.
The ginning industry provides an excellent example of the pressures affecting many businesses within the Australian agriculture industry, with business owners facing economic pressures in three key areas.
Retaining and attracting skilled employees is proving increasingly difficult, with many moving to the mining industry for lucrative salaries. It is essential to attract and retain skilled staff to operate gins to maximise output, particularly given the prediction of another bumper cotton crop in 2012.
Energy is one of the ginning industry’s most expensive operating costs and significantly impacts bottom line profitability. Electricity costs have increased nearly 89 per cent over the past 10 years and have risen another 6.6 per cent since 1 July 2011. In addition, the cost of gas, which is used to dry the lint cotton, has doubled.
Finally, the cost of materials has also risen sharply. This grouped with the rising cost of machine maintenance, council rates and bale wrapping materials has caused a decline in profit for the ginning industry.
The indicative ginning financials in the table below highlights the significant changes in profitability over the past 10 years.
Exhibit 1: Comparison of revenue, expenses and profit for Australian ginning industry (2001 v 2011)
* All dollar figures are AUD. Throughput is assumed to be constant at 120,000 bales per annum.
Source: PKF industry data
“In order to return the ginning sector to the level of profitability of ten years ago, the fee per bale needs to increase from the current price of around $56 per bale to $88 per bale – an increase of 57 per cent. Based on our projections for the next season, this would result in the cotton industry absorbing additional costs of $144m in 2012,” Ms Beauchamp said.
Despite the anticipated increase in the cost of ginning, Ms Beauchamp believes the overall future of the Australian cotton industry is positive, with the possibility Australia will produce as many as five million bales next season. This is a major turnaround for an industry that produced only 585,150 bales in 2008 due to the impact of the drought.
Exhibit 2: Australian Cotton Production 2001-2012F
Concerns about cotton supply saw the global cotton price peak at AU$1,050 per bale during the last financial year. It is currently around AU$500 per bale, a level consistent with the long term trend. The price drop reflects a decline in fibre demand due to global economic uncertainty and the expected increase in global cotton supply. World cotton stocks are expected to increase from 45.22million tons at the end of FY2011 to 54.96million tons at the end of FY2012.
Looking forward, China is expected to provide a floor in the global market at around US$500 per bale until at least March 2012, with the Chinese Government stepping into the market as it seeks to buy around 13million tons of cotton. While the purchase of cotton by China will boost the market, the actual price received by Australian cotton growers will continue to be influenced by the Australian dollar.
Strong market conditions and record cotton crops in Australia have placed the industry in a strong position. The Australian cotton industry is the world’s top performer in terms of high-cotton yields which is a reflection of good management practices and the use of high-yield crop varieties developed specifically for Australian conditions. Growers , ginners, and marketers however need to work in partnership to ensure the long term viability of the industry.
These cost pressures are not just affecting Australia’s cotton industry, they are being felt across the agricultural sector. Our two-speed economy and the impact of the resources boom means that successful Australian agricultural producers will need to account for these inevitable increases in processing costs to remain successful.