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2023 Annual Letter: Lessons Learned and the Significant Opportunity Ahead from Gold Leaf CEO Jack McCarthy

To Our Partners & Friends:

The past year was challenging but transformative for Gold Leaf. It was an incredibly difficult year for almond growers - something that we are working hard to navigate ourselves, but that we expect will tee up substantial opportunities for investment in high quality but discounted farms. More on that below. We also appreciate your support in transforming our business - moving into our new structure, which we believe will benefit investors via lower risk and higher returns, and allow us to more easily build a great business on your behalf. 

To start, I want to touch on performance. Despite the difficulties in almonds, we estimate modest appreciation of our farms, due in large part to maturation of our mostly young orchards. Each dollar invested with us, if spread proportionately across our equity investments, is now worth $1.29. This compares to our benchmark, where the same dollar would have declined to $0.99 over the same period. (We are thankful to have performed better than much of our industry during this period. But we are not satisfied - we will continue to do our damndest to improve every day and maximize performance on your behalf.)

Where We Are: Gold Leaf & The Almond Industry

Our business today is split between developments (not yet producing a crop), immature farms (not yet producing at “steady state” yield or organic status), and mature farms. Arizona (Route 66) and the OZs are nearly entirely in the development or immature stage. Even the core company, Gold Leaf Farming LP, was only 43% mature in 2023. We are still mainly a development and immature farm firm - across our equity base, we are split 40% development, 36% immature and 24% mature.

This is fortunate. Our development and immature farms have no crop or at least less reliance on annual crops to drive returns vs. mature orchards. It has been a good time to be heavily weighted towards young farms that appreciate as they age. At Route 66, you can see our valuations continue to climb - the trees get older each year, and as we have proven water, planted the orchard, and this year had our first block harvested with California-level yield (a major milestone for Route 66 investors!), the property gets more valuable. The OZs are similar, and even GLF LP’s aging drives appreciation, offsetting low almond prices.

Most growers are not like us - they have mature farms reliant on today’s price. Almond price has now been at or near historic lows for 4 crop years. Ups and downs are the “norm” in all commodities, but it doesn’t make them any less painful. Here is inflation-adjusted almond price over the last ~30 years:

Since 2020, almond growers have taken an absolute beating. We estimate 75-90% of almond growers are losing money at these levels. In fact, I don’t know a single almond grower who made money in 2022 or 2023. Remember, though, two things happen in commodities when times are this tough:

  1. Low prices solve low prices - with economics so bad, growers are ripping out or abandoning acreage and have no cash to replant. Acreage declined in 2022 and 2023. Almonds have been a very profitable industry over the long run - so acreage declines are rare. This is the first time we’ve had back-to-back acreage declines since 1995. This reduction in supply, while demand grows each year, will eventually cause the next price upswing - which will persist for years given new plantings take 5+ years to ramp. 

  1. Low prices cause forced selling (and high returns for buyers like us) - many growers can survive a year or two of cash losses, but after four years, they are at a breaking point. They have no cash left, and with recent tough performance and higher rates, banks are tightening up. We bought GLF26 from a large grower who should have never sold this crown jewel farm - but he was forced to sell, by his bank. There is a lot more of this coming - remember, there are 1.6M acres or $40-50B of almond farms in California.

So - the current conditions are creating a once per 20+ year buy window. We will sooner-or-later head into an upcycle and can currently buy very high quality farms for cheap. Our focus in 2024 continues to be seizing this moment.

Lessons Learned in 2023

In 2023, we navigated and began preparing to exploit the difficult almond market. At the same time, we executed a major change to our corporate structure. All this made for a challenging year - for me personally and many on our team. Of course, tough challenges are also great learning opportunities. I’ll share a few reflections below on lessons learned in 2023.

It’s About the Farmers, Not HQ

One of the early executives at Chick-fil-a, Jimmy Collins, had a saying: “if you aren’t selling chicken, you’d better be supporting somebody who is.” 

I love this attitude. At Gold Leaf, we want our 80 folks thinking - if you aren’t farming, you better damn well be supporting somebody who is. We encourage most of the decisions to be made at the farm - by our Farm Operators and Farm Managers, with only a few leveled up to the Asset Managers and fewer still to the Leadership Team and me. We want our AMs and FMs to feel like they are running their own businesses - like a Chick-fil-a franchisee. The Leadership Team and I should be focused on supporting them, making it easier to farm profitably.

This distributed vs. centralized approach is enabled by the talent density we have worked hard to build. We call this (from Good to Great) Right People, Right Seats (RPRS). We are maniacal about hiring and retaining only the very best - over the last several quarters, we have both upped our “bar” of who is indeed RPRS and then held ourselves to it - going from 88% in Q1 2023, down to 80% in Q3 (we raised our bar), to 92% today (as we turned over those below the bar). 

There are a few reasons for this talent focus. We want to build the Yankees and then go play Single A, running circles around the limited competition we have in an overlooked market. We also know great people attract other great people - one of our fantastic FMs, Oscar Diaz, has referred in two other great FMs, Armando Galvan and Amalia Mendoza. Finally, great people can handle a lot. We can give them a ridiculous amount of authority because they are ridiculously capable and act like owners every day. In Kingman, we got a bunch of “extra” yield data on the region’s first ever harvest because we carefully hand harvested not only our own blocks, but also the neighbors’. That idea was the team’s, not mine. In California, we made >$500K of extra revenue in a very tough year via water banking - our FM Armando’s idea and successful project.

This year, in the spirit of “everyone better be supporting the farmers” we asked our FMs to weigh in on our budget for all central spend. About 8% of our cost is headcount not directly tied to a specific farm - Accountants and the small central HR and Ops Support teams. All of the FM’s feedback was to go more lean and mean. “Do we really need to make that hire?” “We can all take on more acreage.” Etc. So we stayed lean. In 2024, we will have less central headcount than 2023, despite more acreage - because we let our FMs act like the owners they are. 

Set the Right Expectations

One of the lessons I have learned as a young entrepreneur (and still work to avoid) is over-promising, especially regarding things I can’t control or predict. (Commodity price, weather, etc. - especially over the short-term.) 

In the past, we showed forecasts of steady annual cash flows based on a flat commodity price, with a discount to the long-run average ($2.50 vs. ~$3.00) to be conservative. It was good to be conservative on price - that 50 cent reduction is worth an extra 2-6% IRR that we didn’t bake in. We've learned, however, that we were implying with our “flat” price a flat or steady cash flow, in an industry where that is not the reality. In ag, commodity price is rarely “at” its average (almonds have ranged from $1.50 to $4.50 but rarely sat at the ~$3.00 average for long). Our cash flow therefore may average a low/mid-teens rate over 10 years, but in any given year range from 0% to 30%+. 

We want to provide reasonable estimates of what we think the business will do over the long-run but avoid overly specific promises about the short-run. We do know and therefore feel comfortable communicating that we are in an industry that has had 12-20% returns for many decades, and that the supply constraints causing high returns will get tighter due to water, weather and urbanization. It is a long-term great place to be - but does have short-term variability.

This is just comms - is it really important, you might ask? I’d argue yes. For one, if I do a better job setting expectations, we will attract the right partnership group - those solving for long-run performance. And, in the spirit of “it's all about the farmers” - we need to allow our farmers to farm. As Brandon says, the trees don’t know if price is up or down. The best results (higher yields and therefore lower cost per pound), will come if we let our FMs give the orchards what they need, even in low price moments like today. Quality orchards drive quality results, this year but also for the next 25. Quality farming requires a shared commitment to the long-term.

Prepare, Don’t Predict (Invert, Always Invert)

If we can’t predict certain aspects of our business - like next year’s weather or price - how do we decide where to focus as we build? Our approach is to leave predicting aside, and prepare. 

This is related to the idea from the late, great Charlie Munger - “invert, always invert.” Rather than planning for a precise forecast of what we want to achieve, invert the problem - and think instead about what we don’t want to happen. Then, build the company to weather those issues.

We have tried to incorporate this approach in building Gold Leaf: 

  • We always knew we couldn’t farm without water, so we bought only in areas with senior rights (in the 2020-2022 drought, we had water at every farm)
  • We realized early the importance of not just buying the right farms, but farming them well - increasing control over the ops and lowering risk. So we built an in-house team of A+ people to farm on your behalf. (Few institutional investors have this advantage - they need real farmers like us to care for their portfolios.) 
  • We will have bad weather or low price years, so we buy up on crop insurance and have used less leverage over time
  • We know individual farms can suffer from bad luck (e.g., frost at bloom), so we suggested the move into a single company structure - diversified across crops, growing regions and water districts

Charlie’s partner Warren Buffett alludes to this prepare-not-predict approach with his “Noah rule”: “predicting rain doesn’t count, building arks does.” 

The current almond environment is certainly putting us to the test. But we are working hard to one day have built an ark. We appreciate your help to further that goal in 2023 via your support of the new structure. By strengthening the company, we will not only make it through but take advantage of today’s tough times, so we can produce and thrive in future booms.

Let Great Performance Pull Us Forward, Don’t Push Growth

Our goal is not to build a big company, it is to build a great company. One that owns quality farms, attracts a quality team, performs exceptionally in every sense, and ultimately earns attractive returns. 

To get started, we did need some amount of “push” to get going and achieve liftoff. We started with 132 acres in 2017, then 262 in 2018 - hardly a scale operation. Today, at ~12,000 acres, we want to have zero pressure and no effort around “pushing” on the company to grow acres. Instead, we want a dynamic where we focus on great people, great farms and great operations, letting buy opportunities naturally flow our way - pulling us forward into growth, because we deserve it.

I have shared in the past my dad’s experience in construction. He began as an intern, worked his way up and eventually ran a large general contractor for most of his career. Eight years ago, he left and bought his own small firm. He proceeded to do what we’re attempting - he built a super team, focused them on greatness in their niche, and then actively discouraged growth. They turned down work and clients, waiting for the projects where they could really outperform on customer satisfaction and profit. Their first year after he bought the company, they did $25M of revenue. Every year the team would set conservative plans based on team and service excellence, and then let client demand drive growth. As they got in this rhythm, the company couldn’t help but grow. From that initial $25M, they eventually scaled to over 20 times their initial size. More importantly, they have industry-leading margins and a best-in-town reputation. Growth has come, but they’ve been pulled to it by clients because they deserved it, not pushed into it themselves. I think my dad would also say that it is a lot more fun to be great than big.

For us, this means listening to our FMs about staying lean and mean - and continuously raising our talent bar. It means back-to-basics operations, which Jackie has developed and coached into our team - hitting On-Time Execution and COGS consistently, every single week and month. It also means buying the right farms, becoming even choosier than our historic 2-3% hit rate on deals. In every sense, our goal is to be great - and to let growth happen if it may.

Where We’re Headed

Near term, our focus is clear. We will continue to navigate the portfolio through low almond price and selectively buy quality mature almond farms, given the once per 20 year moment we’re in.

We are positioned well to seize this opportunity - we have an A+ team, operate a portfolio from Sacramento down to Bakersfield (covering the entire central valley, where 80% of the world’s almonds are grown), and know exactly what we are looking for. When we see “hold forever” farms at a discount given today’s market, we want to be ready to act - so we are out fundraising now. 

Once the cycle turns upward, we’ll focus on maximizing cash flows during what we expect to be a multi-year high price period. And, pruning back any farms in the portfolio that turn out to not be the “hold forever” assets we want (if we got something wrong - especially yields or water - we will sell). 

Long term, we are building a company to emulate the greats in ag. Companies like Driscoll’s, Wonderful or Cargill. These companies started as farmers - growing crops with some edge over other growers, whether it be lower costs, higher quality or otherwise. In our crops, we seek out advantage via low cost per pound (driven mainly by high yields and senior, cheap water). We think eventually, we can build an edge in organic and sustainable production. Perhaps someday, we will emulate these companies and move into other complementary businesses.

For now, we are focused on the near-term challenge and opportunity in almonds.

In Conclusion

As we continue to navigate and hopefully exploit the current almond downturn, I have been reflecting on great leaders who navigated through hard times. Andy Grove, the long-time Intel CEO, has a great quote: “Bad companies are destroyed by bad times; good companies survive; great companies are transformed.” 

We are appreciative of your help in 2023 to transform our company via the new structure, your patience as we continue to learn and grow in a challenging moment in almonds, and your partnership and support as we work to build something great.