Comparing CHS and CoBank . . . continued

This blog is examining two alternatives for managing cash and allocated equity.  These alternatives are called "CHS" and "CoBank" because they mirror the approaches of two large, very successful federated cooperatives - CHS Inc (Minnesota) and CoBank, ACA (Colorado).  See the powerpoint presentation at http://www.blackdogcooplaw.com/case-study-managing-allocated-equity-1 as this blog unfolds in the coming days.

I last ended with a discussion of CoBank's approach of paying a larger cash patronage refund (that approached 70% of allocated patronage earnings in 2009) and building more permanent equity.  I concluded that CoBank's approach yielded a superior value proposition over CHS's approach because CoBank returns more net cash more quickly than CHS.  Hence CoBank rewards patronage more substantially than CHS.  

I also concluded that CoBank is building a stronger capital strucutre than CHS because CoBank is paying income tax to create permanent equity from its patronage earnings.  Combined with its base capital plan, CoBank has reduced its equity redemption obligation by 90% since the end of 2004.  This blog will continue that discussion with a more in depth analysis of CHS.  

CHS's value proposition and capital structure are less vigorous and vital than CoBank's.  CHS does not reward patronage like CoBank (see slides 4 and 6).  A 35% cash patronage refund basically offsets the recipient co-op's cash patronage refund obligation (remember, CHS and CoBank are federated co-ops whose members are themselves co-ops with their own obligations to pay a cash patronage refund and redeem allocated equity).

CHS does redeem far more allocated equity than CoBank (see slide 9), and CHS rewards ownership rather than patronage (see slide 5).  However, CHS's capital structure is far more "leveraged" than CoBank's.  CHS's allocated equity obligation has doubled (increased by over one billion dollars) between the end of 2003 and the end of 2009 (see slide 7).  Consider what that growth means for CHS's ability to continue an aggressive redemption policy if its earnings slide.  

While some will criticize that CoBank pays income taxes on a portion of its patronage refunds, CoBank is in a far better position to manage its allocated equity obligation if earnings slide than CHS.  If CoBank's earnings slide, its ability to redeem allocated equity will suffer very little, if at all.  Remember, its equity redemptions were only $7.0 million in 2009.    

On the other hand, if CHS's earnings slide, it is almost a foregone conclusion that CHS will slow down its redemptions (redemptions were already falling in 2009 as its earnings fell by almost half from 2008; see slide 9) as it continues to spend capital on term debt repayment, property plant and equipment and building working capital.

Further, CHS has doubled its allocated equity obligation during a time of what may turn out to be unrivaled prosperity when refining margins were fabulous.  That obligation will look even bigger and become an even bigger distraction to management if earnings slide and it is unable to continue the outsized equity redemptions of the past three years.