Food Processing Offers Financial Rewards, Risks

The author is an NDSU information specialist, and freelance writer.

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Prairie Grains is the
official publication of
the Minnesota
Association of
Wheat Growers,
North Dakota Grain
Growers Association,
South Dakota Wheat,
Inc., and the
Minnesota Barley
Growers Association.

Nonetheless, investing in value-added co-ops involves both risk and reward. Therefore, experienced shareholders and others with ties to these co-ops say potential investors need to assess many factors before literally putting their money on the processing line.

On the plus side, there’s the obvious: Investing in processing co-ops creates an opportunity for farmers and ranchers to enhance the profitability of their agricultural enterprises.

In 1994, the cooperative sector of the U.S. economy grew by 8.1 percent, and revenues of the top 100 co-ops approached $98 billion, says the National Cooperative Bank (NCB), Washington, D.C. Overall, 45 of the top-100 co-ops were farmer-owned.

Holding down 1994’s number one and two spots, respectively, were Farmland Industries, Kansas City, Mo. ($6.7 billion in sales), and Harvest States Cooperative, St. Paul ($3.8 billion).

Other processing co-ops included Ocean Spray Cranberries Inc., Middleboro, Mass., $1.2 billion; Sunkist Growers Inc., Van Nuys, Calif., $967 million; American Crystal Sugar Company, Moorhead, MN, $563 million; California Almond Growers Exchange, Sacramento, $562 million; and Citrus World Inc., Lake Wales, Fla., $308 million.

"It’s criminal how much money farmers have left on the table by not being involved in processing," says Don Senechal, a consultant with Senechal, Jorgenson, Hale & Company, the Danvers, Mass., firm which developed feasibility studies for many of the ag processing ventures in this region, including Dakota Growers Pasta Company, Carrington, N.D., and the North American Bison Cooperative, New Rockford, N.D.

The gamble: downside potential

Also pointing out the downside, Senechal says, "That money is at risk, and you invest the money because you expect to get a better return there than from the alternative investments that you can make."

Downside potential is not limited to start-up processing ventures. One case in point involves Minnesota Corn Processors (MCP), Marshall, MN.

Begun in the early 1980s, the co-op’s successes in ethanol and fructose production resulted in recent expansions to its original plant, as well as construction of a new facility in Columbus, Mo.

However, MCP’s delivery contract with shareholders is based on market prices, and the co-op also procures corn from outside sources. As a result, a management decision not to hedge in a short-crop year contributed to a substantial loss, which shareholders must now recoup on a per-share basis.```

"I’m glad I made the investment, even so," says Tom Runholt, an original MCP shareholder from Marshall. "The risk, obviously, is that the investment can be lost, or a good share of the investment can be lost, and in tough times, you may receive less than market value for your crop, as a result of being a member. But those periods will be short, and long term, you have something that offsets the loss of farm program protection. You have an additional income stream from that value-added processing."

For start-up processing co-ops, one risk factor for investors to consider is the equity base, says Francis "Butch" Buschette, another MCP shareholder from Renville, Minn. Buschette has invested in several other processing cooperatives, including the Renville-based Southern Minnesota Beet Sugar Cooperative and ValAdCo, a hog breeding operation started in 1993 by corn producers.

At the onset, ValAdCo experienced some cost overruns on construction, and with an equity base of 30 percent, Buschette says the co-op had little financial "wiggle room." As a result of that experience, he says start-up processing ventures should begin operation with a 50-percent equity base as a minimum.

Evaluate risks like a lender

Overall, producers thinking about investing in a start-up processing co-op should evaluate the same risk areas that a lender would, says Lee Estenson, vice president and lending team manager with the St. Paul Bank of Cooperatives. Those areas include marketing, management and facility design.

"Probably the most important is the marketing side," says Estenson. "Is there an opportunity to enter the market, and is there room to get into it profitably? Granted, there’s no such thing as a guarantee, but you’ve got to have some of the strategic advantages to do it profitably."

From a management perspective, the board members, the professional managers and any hired consultants must have both experience and credibility. It’s critical for a start-up co-op to hire a top-caliber management team, so the farmer-based board of directors can focus more on policy, and not day-to-day operations.

With respect to technology, Estenson says lenders typically conduct a facility review, if a plant is involved, to see whether and how co-op organizers plan to utilize technological breakthroughs and advancements. He explains, "We would like to see technology that’s on the cutting edge but not over the edge, in terms of proven commercial viability."

When deciding whether to invest in a processing co-op, Estenson says producers should "boil the numbers down" from the prospectus and business plan to a per-unit basis, and then decide what return they feel they’ll need, in relation to the risk.

While each investor will have a different "hurdle rate," he says per-unit returns should range at least between 10-15 percent over time.

"It’s not going to come back to you the first year or the second year. You’ve got to look at it for the long run," concludes Estenson.

Other important considerations involve profit distribution and anticipated growth rate, says Bruce Anderson, director of the Cooperative Enterprise Program at Cornell University in Ithaca, N.Y.

One problem facing value-added processing co-ops is that the overall food-products industry is mature, although there are individual sectors within the industry where growth is still occurring.

"You’ve got to grow in order to keep spreading your fixed costs over time," says Anderson. "So, I usually recommend that a co-op be growing at least twice the rate of inflation."

Anderson discourages producers from making investment decisions involving start-up ventures based on the stock appreciation of other processing co-ops. One reason is that a co-op’s stock value is supported by expectations of future performance as much as it is by current earnings.

"(Stock appreciation) can happen, and does happen, but that should not be the primary reason for joining a cooperative. The primary reason should (be to receive) the full economic value for whatever the product is," says Frank Hunt II, board chairman of Citrus World Inc., a federated co-op comprised of 12 other Florida-based co-ops and businesses representing more than 1,000 growers.

Learn from other ventures

Founded in 1933, Citrus World only began marketing its own branded, not-from-concentrate product in recent years. Hunt says food trends indicate that a growing number of consumers are willing to pay more for a convenient, high-quality product. In fact, many consumers today feel making orange juice from frozen concentrate takes too much time.

A recent Wall Street Journal report credits clever advertising and aggressive discounting for Citrus World’s success in the not-from-concentrate market. The farmer-owned co-op now commands nearly a 30-percent share of that market, with its Florida’s Natural brand outselling Minute Maid Premium Choice, marketed by Coca-Cola Co.

Today, Ocean Spray processes about 80 percent of the North American cranberry crop. However, the success of this producer-owned cooperative has come at the expense of another.

"The Eatmore cranberry label and the cooperative basically disappeared because the growers decided they wanted to belong to Ocean Spray," says Craige Scott, Ocean Spray board chairman. "Ocean Spray was able to build a market for its processed goods and also sell fresh fruit."

Since moving beyond fresh fruit to cranberry sauce, the Ocean Spray product line evolved into juice and then into blended drinks. The co-op now operates a citrus division and owns more than 40 trademarked brands.

"We have spent just tremendous amounts of money in developing markets and developing new products. It takes years to get new products made, but when we do it, our success rate is far greater than the people we compete against," says Scott. "We make sure that we do it right the first time, if at all possible. That kind of dedication and expertise on the marketing and the manufacturing side is part of what’s really made this thing work. The

other is that the growers have allowed their management to be at the cutting edge of the manufacturing process."

Shareholder commitment is a key factor in the success of a processing co-op, says Ken "Doc" Throlson, a veterinarian-turned-rancher who is board chairman of the North American Bison Cooperative. From the onset, shareholders should fully understand the co-op’s management and marketing philosophies and be supportive of those positions, especially those relating to product quality.

Making another point, Throlson says, "for me to invest in a co-op other than the niche one we have here, I would be very insistent that we hire professional people to do the marketing."

Organizers of the bison co-op decided to construct their plant so as to meet the certification standards necessary for exporting bison products, in order to take advantage of domestic and international markets. After about only two years, the co-op is doubling the capacity of its facility.

Likewise, Dakota Growers Pasta Company is in the midst of an expansion project that will double its milling and processing capacities. Management expertise, plant design, shareholder commitment, marketing strategy and logistics are all reasons this co-op has enjoyed success early on, says board member Eugene Nicolas, a durum farmer from Cando, N.D.

And there’s another reason: product procurement. Nicholas says nearly 40 percent of the co-op’s operating expenses go toward raw product. At Dakota Growers, the procurement committee is comprised of durum growers, who are well versed in seasonal price fluctuations and who also have firsthand knowledge of crop condition.

That second factor is a distinct advantage for Dakota Growers as compared to corporations, whose buyers must rely on second-hand information for making purchase decisions.

January 1997