Posted by d.o.g. on June 1, 2010
Larger (heavier) abalones are worth more, so assigning the same value to abalones regardless of weight is not appropriate.
Also, the market value rises faster than linearly i.e. an abalone that weighs twice as much is worth more than twice as much in market value. So computing value by total weight doesn't work either.
Usually the abalones are sold at specific stages/weights, so it's more common to value them based on the quantity in each weight band, with a different per-weight value in each band.
The fundamental problem with abalone farming and indeed any long-lived agricultural business like timber, cattle or tobacco leaf production is that at any given time, there is a huge amount of capital at risk, while only a small part of the total value can be realized at any one time.
For abalone, it typically takes 5-7 years to reach full maturity and optimum market value. If the abalone are sold earlier, not only is the weight lower, the per-weight value received is also lower, so the IRR is lower. This has to be balanced against the negative cashflow throughout the growing period. As a result, the business owner must choose between cash flow and ultimate value.
The financial statements use fair value accounting which books estimated changes in market value as revenue. While this may comply with accounting rules, it is total nonsense from a cash flow perspective because none of the so-called fair value profits can actually be converted into cash. Only when the actual goods are sold and cash received will the company know what their real profits are.
The problem of negative cash flow is exacerbated when a company is growing, because more and more capital is tied up in the business. Thus, initial success can turn into eventual failure if the company is not able to obtain sufficient amounts of money at a reasonable cost to meet its working capital needs. More problematic is the poor market visibility: because each company only sees current market output, it believes the market is undersupplied, so it expands at a furious pace. Eventually all the new production hits the market at the same time, and prices crash.
There is a huge amount of pricing risk in abalone. Traditionally, demand has outstripped supply, resulting in very high per-weight prices. These prices have enticed many players to go into abalone aquaculture, to the extent that the market price of abalone has already begun to fall. Those who purchased abalone in Singapore during Chinese New Year should have noticed that prices were meaningfully lower this year versus last year.
Furthermore, market prices are spot prices reflecting current supply - they don't reflect the much larger future supply that is coming up. Oceanus is far from being the only abalone producer out there.
IMHO it would not be surprising if within the next 5-10 years, abalone becomes a commonly available food, available year-round at affordable prices. Good for consumers, not so good for producers.
For further reading, here's the 2008/2009 annual report of the Tasmanian Abalone Council:
www.tasabalone.com.au/documents/2...Report.pdf
In particular page 21 (Quota Holder Sub-Council Report) quotes Peter Cook, a keynote speaker at the 2009 International Abalone Symposium, as saying:
"Higher market prices of the past 10-15 years have been the engine powering farm expansions; however a “perfect storm” is currently driving market prices down 30% or more. A devastating combination of (1) a 400% increase in farm production in the past 9 years (much occurring in the last 3 years) and (2) the world economic downturn and (3) continual lack of development of “home markets” resulting in over 98% of the world’s farmed abalone marketed to Asia Pacific countries. Premium species are driving the Chinese market, with production and demand in China being a dominant factor but, unfortunately, not necessarily impacting overall world demand as many people expected”.
In other words:
1. Past abalone prices were very high;
2. Farms ramped up production; and
3. There is now oversupply.
This oversupply situation probably explains Oceanus' attempts to set up abalone restaurants and create a captive offtake channel. Unfortunately restaurants have their own issues as Oceanus is finding out.
And of course we have the other problem of biological assets - since abalones are living things, they can die from disease, stress, pollution etc. Insurance is often costly or simply unavailable. Even when insurance is available at a reasonable cost, and is actually claimed and paid, the company is reimbursed for its inventory losses, but not for market share losses. By the time it rebuilds production capacity years later, its old customers would have already turned to other suppliers.
Investors in Oceanus should think very hard about:
a. access to working capital;
b. abalone pricing; and
c. a "black swan" type event killing the abalone inventory.
That should inform their view as to its true value as a business, and its merits as an investment.