Chairman's report

 

By the Chairman & Chief Executive Officer

Introduction

The Directors are pleased to present the fourth annual report to shareholders for Rural Equities Limited (REL). An after tax surplus of $2.4 million is recorded for the year ended 30 June 2007. This compares with $10.5 million last year. Understandably rural land values did not show the same steady increases seen over the last five years and remained generally firm. Dairy incomes lifted following an increased payout from Fonterra, however, sheep and beef farmers had a difficult year with continuing low farm product prices. Farm profitability in all sectors came under pressure from rapidly rising farm input and operating costs.

The company’s investment holding in the New Zealand Rural Property Trust (NZRPT) increased from 53.9% to 54.2% of the total units on issue during the year. This resulted from the issue of units in accordance with the NZRPT management contract. NZRPT is an accounting subsidiary of REL with the consolidated financial statements reflecting this.

As noted in the Annual Report last year, the REL - Pacific Equity Trust was formed as part of a key strategy to expand the funds management aspect of the business. REL’s wholly owned subsidiary, REL - Trust Management Limited, holds the management contract for the REL - Pacific Equity Trust. Acceptable investment returns and the development of an investment portfolio have been achieved in the first year of operation in a variable investment environment.

Financial Overview

In the Statement of Financial Performance the Group results include the financial returns from NZRPT as well as those from REL, the parent company. The figures for REL are also shown separately as the Parent. Operating Revenue includes both income and expenses from NZRPT farms and forest which are adjusted for minority interests after the calculation of the after tax surplus. This year management fees of $201,000 relating to the operation of the REL - Pacific Equity Trust are included for the first time.

The Group Net Surplus therefore includes REL’s share of NZRPT’s current year surplus, as well as the growth in the value of the REL - Pacific Equity Trust and the operating surplus from REL of $798,000 (last year $1.096 million). The interest expense incurred by REL was a significant cost again this year and results from the interest cost of the accumulated bank debt which was has been incurred to purchase units in NZRPT and fund the investment in the REL - Pacific Equity Trust. Other Group expenses are at a similar level to last year.

Although revaluation movements relating to the increased value of farm properties owned by NZRPT are much lower than last year, they are still a significant contributor to the after tax surplus for the year of $2.4 million. REL’s share of NZRPT’s revaluation movements was $1.8 million this year compared with $9.9 million in the previous year. This is the main reason for the after tax surplus reducing to $2.4 million.

From the Statement of Financial Position, Total Group Equity has increased by $3.6 million to $148.8 million. The solid result for the year is pleasing considering the difficult year experienced throughout the rural sector. The move to expand the funds management aspect of the business has made a contribution to income and is expected to grow to be a significant source of income for REL in the future.

Dividend Policy

Directors have decided that no dividend will be paid. Revenue returns from rural property investment are low, and taking this into account as well as the debt carried by REL, Directors reaffirm that they do not expect dividends will be paid in the foreseeable future. Rural Equities Limited

REL – Pacific Equity Trust

In early July 2006 REL expanded its funds management business with the formation of the REL - Pacific Equity Trust. This Trust was established following the issue of a Private Placement Memorandum to take advantage of equity investment opportunities, principally in New Zealand and Australia. Initial investment capital was $19 million of which $4 million was contributed by REL which therefore has an interest in, as well as the contract to manage, the REL - Pacific Equity Trust. This $4 million investment by REL was funded by additional bank debt. This Trust has now accumulated an investment portfolio of listed and unlisted securities which Directors believe represent good fundamental value with sound long term prospects.

Impact of Adopting New Zealand Equivalents to International Financial Reporting Standards (NZ IFRS)

REL plans to adopt NZ IFRS for the accounting period ending 30 June 2008. As some of the requirements of NZ IFRS are still to be finalised, the likely changes to our accounting policies from its adoption have not been fully assessed. The main areas of impact on REL from the adoption of NZ IFRS identified to date are; deferred taxation, property carrying values and financial instruments. At this stage the best estimate of the impact of these three items, based on the 30 June 2007 financial statements, would be an increase in Parent Company shareholders equity of approximately $1.6 million. The actual impact of adopting NZ IFRS may change from this estimate and the variation may be material. Full disclosure will be made and information provided in the 2008 Annual Report.

Directors

In accordance with the Company’s constitution Brian Martin and Gerald Weenink retire by rotation at the Annual Meeting. Gerald Weenink has decided to retire and therefore not to seek re-election. Gerald has had various roles in the Group’s businesses over the past 17 years. His contribution over that period has been highly valued. In particular his input to NZRPT, especially during the period of restructure, was fundamental to its success. We wish him well for the future.

Outlook

Directors believe the outlook for the rural sector and the dairy industry in particular looks very encouraging. Strong world demand for dairy products is translating into markedly higher returns for dairy farmers. World grain prices have lifted dramatically in response to increasing consumption and use for animal feed and biofuels. Higher grain prices are resulting in higher global food prices, and the benefits are already flowing to the dairy industry in New Zealand, and should also flow through in due course to the wider rural sector.

Fonterra has recently announced an improved forecast milk solids payout for the 2007/8 season of $6.40 per kilogram of milk solids, up from $4.46 paid last season. Farm product prices for sheep meat, beef and wool are also expected to show improvement. The actual quantum of the benefit to farmers and REL will ultimately depend on the sustainability of prices and the strength of the New Zealand dollar, and while the outlook is currently positive it needs to be noted that product prices and currency have both been historically volatile and difficult to predict.

Management of the REL - Pacific Equity Trust and the addition of other funds management opportunities will add a further dimension to the Group. REL is also pursuing funds management administration opportunities and would like to grow that aspect of the business without direct investment. A contribution is expected from these initiatives in the new financial year.

REL is in a strong position to benefit from the expected upturn in the rural sector through its investment in NZRPT which owns a high quality portfolio of 30 rural properties.

Sir Selwyn Cushing Brian Burrough

CHAIRMAN CHIEF EXECUTIVE OFFICER