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ESG Focus: Huon Salmon Litmus Test for ESG M&A

ESG Focus | Nov 22 2021

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FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future:

ESG-Focus: Huon Salmon a litmus test for ESG M&A

The recent acquisition of Huon Aquaculture by Brazilian meat-packer JBS offers a great case study on ESG M&A, and an opportunity for investors to weigh impending global regulation on the world’s oceans.

-A battle between two big SDGs – environment versus feed-the-world
-A good litmus test for ESG M&A
-A series of unfortunate events
-All food roads lead to Coles and Woolworths
-Global regulation to roll out this year

By Sarah Mills

JBS’s acquisition this month of listed Tasmanian salmon farmer Huon Salmon ((HUO)) for $550m ($3.85 a share) threw the ESG spotlight onto the Australian aquaculture industry. 

The fate of Huon will be a litmus test for the ESG credentials of not just of JBS and Australia’s aquaculture industry, but for those of supermarkets Coles ((COL)) and Woolworths ((WOW)). 

All ESG food roads lead to Coles and Woolworths, and outside of regulation, it is these two companies that will ultimately set the standards for the salmon industry (and other food industries) in an ESG world.

A battle between the “E” and “S” to see which will reign supreme

Food is one of the biggest ESG issues, and arguably the most controversial. We all have to eat.

One set of the United Nations’ Sustainable Development Goals (SDG) demands the world be fed. These contradict another set of UN SDGs demanding improved environmental outcomes, including pollution and biodiversity.

Other SDGs focus on health, so one assumes the quality of food is also a combatant in the ESG ring.

So the pressure is on the world’s food producers to feed a wealthier world demanding more protein while simultaneously improving environmental production standards and ensuring food is healthy.

Many assume that, push come to shove, feeding the masses will win out at the expense of environment and health (the latter being left to the pharmaceutical industry to manage the symptoms of poor nutrition). Or will it?

Investors are likely to view Huon’s fate as an early guide to which of these SDGs will dominate going forward.

Ticking all the boxes for a good ESG story.

In one corner stands the environment. Salmon farming, like all farming, has an environmental impact, ruled by stocking densities, which has biodiversity impacts. And there’s the carbon footprint.

In the other corner stands social concerns. Many workers objected to the takeover; and food is a health issue relating primarily to stocking densities and animal welfare.

Last but not least stands governance. Huon experienced a string of misfortunes, which brought the company to its knees.

It is also a great case study for ESG M&A

The Huon Salmon takeover should provide a good case study on the dynamics of ESG-driven takeovers as the world moves into a protracted period of ESG-driven M&A activity. 

The Guardian reports that Federal Greens senator Peter Whish-Wilson expects JBS will ramp up its operations at a time when Huon will be subject to fewer reporting requirements as a private company, leaving Tassal Group ((TGR)) as the only publicly-listed Australian salmon farmer.

Will the takeover confirm environmentalists’ fears of a large less-scrupulous predator snapping up a smaller operator with respectable environmental credentials, which are then reduced for profit. Or vice versa?

Twenty years ago, the former would have been a shoe-in (excluding brand considerations). But the plot is getting more interesting.

And there are other dynamics to consider. 

It doesn’t make sense for JBS to trash Huon.

Huon is a premium product and overstocking could harm not only the quality of the product but the brand. Few businesses wantonly destroy a strong premium brand on acquisition.

From a brand perspective, JBS is likely to seek to solidify Huon’s position as a premium product in the global market. It can always establish a separate operation and brand for a cheaper product.

The inclusion of salmon farming might also reduce the beef producer’s greenhouse-gas emissions as a percentage of revenue, given methane is clearly on the regulators’ agenda post COP26.

It could possibly gain further forms of ESG leverage from the acquisition if the company is on its mark.

But let’s start at the beginning, before going deeper into M&A.

A Series Of Unfortunate Events

Huon Aquaculture is the ESG jewel in the crown of Australia’s aquaculture industry.

For decades, it has been carving a position as a leader in truly sustainable salmon farming, producing a premium, healthier product.

Those of our readers who care about the quality of their food will know that Huon Salmon is by far the best farmed salmon in Australia and possibly the world.

Huon went to market seeking suitors after a series of heavy knocks, which forced it to announce in August a -$128m loss, despite posting a 39% increase in production.

The hardest knock was covid, which triggered a -10% fall in salmon prices and a doubling of freight costs. 

Huon suffered more than rival Tassal because its channel mix was skewed more to wholesale markets, and 44% of production was directed to tight-margin export markets.

It had also ramped-up production heading into covid which proved ill-timed.

Then followed three unfortunate incidents in quick succession, which raised more than a few eyebrows. In one incident, salmon escaped from nets; in another incident, the nets caught fire; and finally the company suffered a large theft of salmon shipments.

Whether these were simply misfortune, or the acts of an opportunistic criminal organisation, disgruntled employees, a would-be predator or a competitor will never be known, but such a coincidence is enough to raise the governance flag.

Analysts consider the company was well run. While the majority was family and fund-owned, which often creates a different oversight from alternative structures, Huon’s governance and workplace measures were in line with industry standards. 

The company would have most likely have had to increase its expenditure on security had it remained listed. 

Meanwhile, Huon met with no shortage of suitors. Canadian aquaculture company Cooke and mining billionaire Andrew (Twiggy) Forrest both made a tilt, but neither at the price JBS was prepared to pay – $530m.

Observers suggest bidding may have been dampened by the general uncertainty surrounding covid, and upcoming ESG imposts.

Environmental regulation is only likely to increase, raising the ESG reputational, financial and operational risks for JBS and other industry operators.

But Twiggy Forrest did put up a fight and hoped to scarper rival JBS’s bid on environmental concerns.

“Until JBS declares its unequivocal commitment to adopt the same animal welfare – including the principle of No pain No Fear – and environmental sustainability standards across their global operations, Huon shareholders have no certainty for the future of the company under JBS Group’s control,” said the mining magnate.

Naturally, JBS countered by saying it unequivocally supported the no-pain no-fear principle across its global operations.

It added that it was committed to the “highest standards of fish health and sustainable farming practices from water management to animal welfare, net zero emissions and stocking densities”, establishing the board’s understanding of the acquisition’s ESG ramifications at the outset.

Forrest’s campaign forced JBS to make a second “off market” offer for a smaller controlling interest in Huon if it received 50.1% support from shareholders, in the event Australian Super sided with Andrew Forrest.

Meanwhile, Andrew Forrest was able to leverage Huon’s misfortune for his own benefit, building his industry brand as he prepares to invest in near-shore farming at Tattarang – a land-based finfish production facility — at a cost of more than -$100m.

All farming has an impact and ocean salmon farming stacks up fairly well against other forms of farming.

Analysts observe that the environmental credentials of near-shore farming are less than for ocean farming, given carbon is needed to transport water (a service provided for free in the oceans).

Ocean salmon farming is also broadly considered a relatively environmentally friendly form of farming when compared with agriculture – given its lower greenhouse-gas footprint.

Then Brazilian meat giant JBS Food received approval in early November from the Foreign Investment Review Board to buy the company, which was swiftly followed by majority shareholder approval, JBS gaining the minimum 75% support it needed to take full control.

Huon will constitute just 2.5% of JBS’s $20bn global operations, so at this stage salmon farming is unlikely to prove much of an environmental offset, but it provides a base upon which to build.

M&A from an ESG perspective

Huon’s takeover has a few parallels with MIRA’s takeover of Bingo Industries in August: two companies in pivotal ESG industry positions are caught up in the covid bait-ball, then snapped up by opportunistic predators.

Both were at the end of a long investment period, which would position them well for the decade ahead within in an ESG environment, assuming good strategic execution.

Huon has 13 production sites and three-value-added product processing units and Bingo boasts its Recycling Ecology Park in the prime logistical position of Eastern Creek NSW.

FNArena’s broker database suggests Huon was set to experience a strong earnings recovery across FY22 and FY23 thanks to higher prices and moderately lower operating costs.

Whereas MIRA’s was something of a stealth attack, JBS’s bid drew considerable controversy, thanks to workers, environmental concerns, and Twiggy Forrest’s media attacks.

It is an example of a big company swallowing a small company with a good environmental record.

While salmon swim upstream, its hard to see how Huon’s practices are likely to influence that of giant JBS, although it may perhaps set the standard for JBS’s foray into a new industry.

Investors wary of regulation

Morgan Stanley covers aquaculture in its report titled EU Sustainable Blue Economy: “No Green Deal without the oceans, no green recovery without the blue economy” says that one in four seafood products consumed in Europe come from aquaculture.

Salmon’s key environmental impact is that of biodiversity, which is expected to come under greater regulatory scrutiny after the authorities bed down decarbonisation. 

In May, the EU Commission announced a coordinated approach for a blue economy covering shipping, offshore energy, biodiversity and sustainable food production (aquaculture and fishing).

By the end of this year, the EU is set to announce a plan to conserve fisheries resources and protect marine ecosystems.

The UN Convention on Biological Diversity published its draft framework in July and is to be discussed at the next COP meeting.

The EU plans to promote biodiversity by protecting 30% of marine space by 2030. 

Of particular interest to investors will be Target 2 in the EU’s Restoration of land and sea guidelines, which aims to ensure that at least 20% of degraded freshwater, marine and terrestrial ecosystems are under restoration.

It plans to design artificial reefs and restore seabed habitats – all potential opportunities for those operating in the aquaculture industry and beyond. 

The battle will soon be on to see who will foot the bill for these restorations: aquaculture companies, major polluters or shareholders.

The EU has implemented guidelines to support growth in EU low impact aquaculture (low tropic, multitrophic and organic aquaculture).

The EU Commission also plans new marketing standards to improve consumer information on the environmental and social impact of seafood – and this could really sort the salmon from the sardines.

So perhaps JBS’s takeover of Huon Aquaculture is well timed. Huon is generally ahead of the global salmon-farming curve.

It is in the hands of the supermarkets

But in the end, it is not JBS calling the shots but the world’s supermarkets and their shareholders; and possibly the regulators. 

Farmers will produce what supermarkets and their shareholders, and corrupted governments, are prepared to accept – that is why the Huon takeover will provide an ideal litmus test.

Supermarkets have their own ESG backs to guard, but the question is how savagely will investors hold the retailers to account.

At the moment, the supermarkets rely on the Aquaculture Stewardship Council (ASC) certification system but such a certification system yields considerable disparities in the quality of product and environments in which it is produced.

Woolworths ((WOW)) is reviewing its ASC certification after successfully implementing the system and finding it failed to protect from “adverse ecological outcomes” – no surprises there.

Certainly Coles ((COL)) and Woolworths combined have the power to transform the entire industry. All roads lead to Rome and it is likely that ESG pressures will rise on the retailers.

Given salmon represents such a small percentage of the retail giants’ inventory, alone, it is unlikely to shift the behemoths.

But the Tasmanian aquaculture activists have been very vocal.

Should they turn their campaign towards the supermarket giants, it is conceivable that investors might also take up the cause, particularly as biodiversity rises in importance over the next five years.

Industry review – under the regulatory spotlight

Salmon farming has become a national environmental issue, ironically thanks to the efforts of Huon’s founders.

The two major Australian operators are Tassal and Huon. 

While both operate under the same regulator and regulations, Huon gained the environmental high ground after Huon co-founder Frances Bender blew the whistle on Tassal on the ABC a few years ago for creating excessive environmental damage in Macquarie Harbour.

Huon’s stocking densities also out-competed Tassal, the company producing a far superior product.

In the past nine years, Environment Tasmania and other groups lobbying contributed to a halving of Tassal’s expansion on Tasmania’s East Coast, preventing its encroachment into the Mercury Passage near the iconic Maria Island Marine Reserve.

It also successfully lobbied for the introduction of Go and No-Go zones for salmon farming, and pressured Australian Ethical to exit the industry.

It forced the ASC decertification of Tassal operations in Macquarie Harbour and prompted a review of ASC standards and changes to methodologies for measuring dissolved oxygen levels.

It lobbied the World Wide Fund for Nature to drop its endorsement of Tassal’s brand and worked with fishers to end the seal relocation plan.

Is there a big future for ocean-based aquaculture?

The Huon transaction attracted a great deal of focus on the aquaculture industry. 

Some are billing land-based farming as a solution to the effects of ocean farming on local marine diversity.

But land-based farming is more difficult than ocean farming. It is incredibly expensive, has a higher carbon footprint and a generally a less optimal outcome for animal welfare. 

On the flipside, its impacts are less visible and less recordable.

Analysts say that to date, no research has been made available outlining the net impact of both forms of farming.

One would expect stocking densities to become a key ESG metrics, given this would affect chemical and antibiotic usage, which affect both biodiversity and health outcomes.

Australian aquaculture density levels are low by global standards and the harvesting is relatively quick and humane. 

These are big positives for investors seeking an exposure to aquaculture and for larger companies seeking to green their operations.

And as Tassal is the only remaining publicly listed company, this should provide some support for the share-price. 

Investors will be keeping a keen eye to the regulatory environment; and predators will be weighing up the benefits of taking Tassal private, away from the glare of the public eye.

Meanwhile, the environmental battle is set to continue. The Guardian reports that an expert who quit a government panel in charge of Tasmania’s salmon industry says no sound scientific evidence has been provided that might justify a planned doubling of production over the next decade.

The panellist also said many environmental concerns raised were persistently ignored, perhaps providing some insight into the political stance towards the industry.

Last but not least, Tasmania’s old man of the pen, Richard Flanagan, has published a book on the subject titled Toxic, leaving little room for denialists to hide.

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