King Salmon passes FMA sniff test despite only hinting at challenges in Sounds

New Zealand King Salmon's prospectus didn't make detailed mention of the proposal to relocate up to six of its farms to areas of the Marlborough Sounds where such commercial activities are currently prohibited, even though a cabinet paper indicates its future prosperity depends on such a move.

Primary Industries Minister Nathan Guy released details of the proposal last week, seeking public comment on plans to shift farms to areas that have faster water flow and away from residences. The advantages include reducing the adverse environmental impact of the waste and feed that drop from such farms, while the stronger currents offer the company the ability to increase production without expanding its footprint.

Mr Guy's plan would see him regulate to change the Marlborough Sounds Resource Management Plan to allow fish farms in new areas of the Sounds. If he succeeds, King Salmon gains access to lucrative new sites. But if he fails the company would be forced to scale back production at existing sites to comply with environmental standards for the quality of the benthic zone – the lower portion of a waterway including sediment – that were agreed in 2014, according to a cabinet report. Staying commercially viable "is not possible at the existing sites," the report says.

King Salmon shares have fallen since Mr Guy's January 26 announcement amid concern the proposal will run into opposition and become a protracted process, although the peak-to-trough decline was a less-than-devastating 6.5 percent and the shares have recovered some ground to trade at $1.34. The shares sold in the company's initial public offering last October at $1.12 when the company raised more than $70 million, of which about $45 million was for Direct Capital to exit the company. The bulk of the $30 million of new capital was used to repay bank debt and shareholder loans, and cover offer costs. Just $8.2 million was earmarked to directly fund growth, contributing to new farm development.

When the company originally applied for a zoning change to make salmon farming a discretionary activity at eight sites in the Sounds it was referred to a board of inquiry which rejected five of the sites. It ended up battling the Environmental Defence Society all the way to the Supreme Court, which upheld resource consents for three farms but ruled out a fourth on the basis of protecting "outstanding landscapes."

As EDS chief Gary Taylor says, it "overturned 25 years of jurisprudence away from a balanced approach where you assessed a competing menu of issues in favour of an environmental bottom line" that included avoiding adverse effects on sites of outstanding natural landscape on the coast. At least two of the proposed new sites fall into that category, Mr Taylor says.

Already, Mr Guy's plan has been labelled "an arrogant captain's call" by the Green Party. "There is an obvious alternative option, and that is for King Salmon to simply reduce the number of fish and amount of feed that it uses on existing sites," environment spokesperson Eugenie Sage said. "The only reason this isn't the major option being considered by the minister is because it will cut into King Salmon's profits."

Investors were unfazed by the passing references in the prospectus to the potential changes underway. The product disclosure statement (PDS) has a paragraph in its growth strategy section that says the government and the Marlborough District Council are working together on the implementation of best practice guidelines for salmon farming in the Marlborough Sounds.

"A possible outcome of this could be a process to swap some existing low-flow sea farm consents for water space with improved characteristics and at which compliance with best practice guidelines can be more easily achieved," the document says. Further back in the prospectus, in the risk section, King Salmon notes that its operations are subject to resource consents and other regulatory requirements that "may change from time to time."

"Community acceptance of our business is also important, as community groups and others could put pressure on central or local government to restrict our existing access to water if they oppose our operations," it said. "The likelihood of us losing access to our existing water sources is considered low but, if we did, the impact could be severe depending on whether the loss affected all or only some of our facilities."

A third reference, under the heading Growth Opportunities Risk on page 73, says the three consents obtained in December 2014 would over time allow the company to double production but after that, it would need access to additional water. Such sites were "rare" and "difficult to obtain " It was in active discussions about its options including water space swaps. "If we are unable to secure new water sources, we may be unable to meet our longer-term growth aspirations."

Was that enough to alert investors to the potentially big changes and challenges bearing down on the company including potential curbs on existing farms and earnings and a round of public consultation on an industry that has divided public opinion? The Financial Markets Authority says yes.

"The risk of losing existing water access is disclosed in the key information summary of the PDS and expanded in greater detail in the risk section on page 71," the FMA said in a emailed statement. "The directors express the view that the water space swaps could be a potential growth opportunity on page 38. On these grounds we have no reason to believe at this stage that the disclosure wasn't sufficient in the PDS."

King Salmon also says it provided adequate disclosure. But the disclosures don't make clear how advanced the plans were. Maps attached to the cabinet paper from the Ministry for Primary Industries that show potential relocation sites are dated November 11 last year, just seven weeks after the prospectus was made public.

"It is material if they were to switch some of these sites into the Tory Channel," said Sam Trethewey, a portfolio manager at Milford Asset Management. "That's where the really lucrative locations are. Higher flows equal higher production." But, in an IPO document, it is "very hard" for a company to talk up anything beyond what is doable.

"The upside potential is significant for King Salmon if it can relocate farms but it is a difficult process. Market expectations are that it isn't going to be easy," he said. Milford looked at the offer but didn't participate. Those that did include the New Zealand Superannuation Fund, which picked up 6.4 percent.

First NZ Capital, one of the lead managers for the IPO, rated King Salmon shares "outperform" in a January 30 note to clients, saying relocating up to six farms would be expected "to achieve better sustainability, social and economic outcomes" and if all six went ahead or if the three new sites are approved it could add between $2.3 million and $8.9 million to pretax earnings.

It gave a price target of $1.49 and said a recent global short supply of Atlantic salmon had driven up prices in the past 12 months and "should also be supportive for King Salmon's prices."

For Mr Guy, the relocation must look like a no-brainer use of his ministerial powers to amend the Marlborough Sounds Resource Management Plan via regulation. The move is consistent with the government's Business Growth Agenda to increase the productivity of natural resources. It would allow the industry to grow and create jobs.

At the same time the benthic effects of salmon farming, which leads to the deposit of fish faeces and waste feed on to the seabed causing nutrient enrichment, would be reduced in deeper, faster-moving water. King Salmon actually hatched the idea in February 2015 and ministers directed the Ministry for Primary Industries and Ministry for the Environment to investigate the use or ministerial regulation-making powers to enhance the salmon farming industry in March of that year.

Public consultation ends on March 27, after which an advisory panel chaired by former Environment Court judge Peter Skelton will review expert research, analyse written comments and hold public hearings in April. The panel and government agencies will then provide advice to the minister.

(BusinessDesk)