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Troubled Times Ahead For Scales?

Long term readers will know that I’m a big fan of Scales (NZX:SCL). I like the management, the share price (up until today), the balance of land ownership with a business extracting value from that land, and the fact that the product is never going to go out of fashion (food).

However it is a farming business, and it’s therefore subject to the ebbs and flows of the industry. Weather, disease and other factors are annual risks that can cause fluctuations in the share price.

While I had factored recent logistical issues (which caused a drop in sales) into my share price calculations for this stock, there have recently been some new developments that I had not considered / foreseen, which I believe will effect the share price going forward.

Specifically, the industry is expecting to have trouble importing workers to harvest the crop and prune the trees (I know they complain about this every year, but this time I think it’s different because of Covid19).

A little bit of research suggests that tree pruning should occur now, and picking at Mr Apple (the subsidiary owned by Scales) will need to start in February.

This will be a problem because the crop will not be harvested, and costs will increase as Scales will have to pay more to entice New Zealanders to harvest them.

Upon reading this, a thoughtful person might make a connection with the job losses due to covid19 and assume that NZ has enough free labour to do these jobs, especially when they pay $25-$27ph. Unfortunately history shows that New Zealanders simply aren’t willing to fill these jobs as the unemployment benefit is more attractive and people are unwilling to move for the work.

It is my hope that the foreign people who worked in the ailing NZ tourism and hospitality sectors would be willing to work as pickers while their industries recover. I suspect that the uptake on this won’t be sufficient to fill the required number of jobs, but I assume that it will be enough to get by without Scales having to raise capital. I say this because the company delivered a normal dividend in June, which suggests either a lack of foresight from management (unlikely), a miscalculation of the effect of Covid19 (possible but improbable) or that they planned to struggle though, treating it as a BAU problem (as it’s difficult to get seasonal workers each year).

What Are SCL Shares Worth?

Well, it is a difficult question to answer. I’m going to have to make some assumptions.

According to an article from Stuff, Jacinda may relax border restrictions for skilled workers, but Nick Bibby (Business Manager of agricultural worker supply company Thornhill) says this will be too late. He infers that Jacinda is holding them to ransom (a “bribe” as he puts it) in exchange for being reelected, if as he says, pickers can be considered “skilled labor”. Implicitly, the current government does not intend to fix this particular labour problem, and I assume that it will be too late for any other government post election. There will certainly be some labour for this work, but costs will be higher. Frustrating as it is (because there’s no need to have this problem), there could most certainly be a problem harvesting apples for Scales.

I think the assumption that I will make is that they won’t have to raise capital and therefore there will be no shareholder dilution. I’m also going to assume that the economy is not going to be hot going into the next year, and that there will be a subdued share market. Because of this, I will assume that the opportunity cost of buying shares in SCL is high. In fact, to put a value on this, I will assume that SCL will return nothing in the coming year. Consequently they will need to return 8% minimum for a year in the share price to have any value. As I’ve previously valued SCL at about $5, this would place them at about $4.60.

However, if I was to value them on the same terms of growth that I had previously valued them, they would be worth less than this.

The valuation is pretty subjective based on your required ROI, labour cost (and supply) expectations, but either way I think it’s clear that there is potential downside for this stock in the coming year.

If the market takes a short term view (which I expect that it likely will, at least at some momentary point) then the potential downside could be significant. In that scenario there could be a major buying opportunity within the coming 6 months or so.

Personally I’ll be holding my current position and looking to top up if there’s a major crash in the price that goes below what I think they’re worth at that time (which will depend on my other opportunities and the state of the company’s financials and guidance).

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