January 5, 2017

DrKohl_color The Ag Globe Trotter

Dr. Dave M. Kohl

Welcome to the weekly edition of The Ag Globe Trotter by Dr. Dave Kohl.

Over the course of the year, I observed the changing landscape of agriculture. Through my travel, networking, presentations and participation in numerous events, I witnessed the dynamics and shifts in different sectors of the industry. As the new year begins, let’s examine some observations from 2016.

Many commodities are in the third year of an economic reset. Analogous to a baseball game, innings one through three of the reset impacted cash flows and profits. Now, many producers are in the fourth through seventh innings, burning through working capital or core equity. Of course, for some, liquid assets are not available and the only remaining equity is in land.

Analysis from University of Minnesota’s FINBIN data shows that the top half of producers are still squeezing out a profit. Strong yields and production, selective cost controls, disciplined marketing and risk-management practices, and, in some cases, government payments have preserved a level of profit for many of these farms and ranches.

Some farm businesses with negative margins are not covering total costs (fixed and variable), but are covering only the variable costs. A well-tested economic guideline is when short-term variable costs are no longer manageable, it is time for drastic action. Basically, the options are to either discontinue production or take extreme measures to stop the financial bleed of the business.

Next, I continue to observe that those managers and businesses committed to the execution of a marketing and risk-management plan are making money. According to University of Minnesota’s Center for Farm Financial Management, larger operations able to market corn for an additional $0.15 per bushel, and soybeans for an additional $0.77 per bushel, were able to add approximately $85,000 in net income for the operation. This is a great demonstration of planned, incremental profit that really paid off. In short, those managers who plan and strategize, but then execute and monitor are more likely to retain profitable and sustainable businesses.

Yes, in my travels I talk with some business managers who are losing significant amounts of money. The reasons for loss are various, but in most cases, growth or high-priced rented land play a large part. With tight cash flows and reduced balance sheet equity, these operations will face careful scrutiny in the coming loan-renewal season. The key for these operations is preparation. A lender that receives accurate and complete financial information as well as a plan of action will be a better resource for the producer.

At least for now, farmland values appear to be holding. In some sectors of the Midwest region, land values are down 10 to 20 percent. Land values in the Coastal regions and the Southern region are generally maintaining their strength. Crop insurance, interest by hedge funds and high-equity positions of farmers and ranchers have combined to provide resistance for further drops.

Another issue in agriculture and rural America is the increase in land taxation. This impacts both landlords and renters in states that used additional income from the great commodity super-cycle to build schools and infrastructure. Now, with suppressed commodity prices, this taxation has become a major burden to already-squeezed margins.

In my conversations and financial analysis, the cost of healthcare continues to emerge. For many in agriculture and rural areas, premiums have skyrocketed. Some producers shared printouts of changes in their healthcare plans. Shared plans ranged annually in cost from $20,000 to $36,000 for a family of four. Other producers with high-deductible plans have seen some relief with premiums, but not much. One producer had a plan for a family of four and farmed approximately 3,000 acres of row crops. He shared that it cost him $0.14 cents per bushel of corn, or $0.27 per bushel of soybeans and $0.24 per bushel of wheat just to pay his healthcare premiums. When commodity prices were at their zenith, these types of costs were palatable. Today, however, these medical insurance costs can amount up to 5 to 7 percent of the price per bushel for a given commodity. In addition, those with high-deductible plans must maintain excess financial liquidity for emergencies.

As the new year begins, many accountants have advised producers to prepay expenses to defer taxes, citing lower future tax rates as a possibility. While this was a heated campaign issue for the new Administration, be cautious. If one does not take physical delivery of these goods, the prepaid expense can become an unsecured line of credit. This could be extremely problematic if the agribusiness firm should unexpectedly file bankruptcy. In today’s environment of economic stress, take care to assess the financial condition of agribusinesses from which you purchase prepaid products.

As I encounter young people and managers in the expansion mode, it is clear that now is a good time to acquire assets. One young farmer told me that for $28,000 he purchased a good-condition forage harvester that is normally priced in the range of $125,000. Also capitalizing on the timing of the economic cycle, others are purchasing livestock and assets at discounted prices. In an industry driving toward economic efficiency, perhaps, now rather than five years ago is the right time to start up, grow or expand your business. There’s an old adage, “timing is everything in business,” which seems to hold true.

As we move into 2017, proposals of the new Administration and Congress must be monitored closely. Policies on international trade and agreements, interest rates, immigration, taxation, regulation, and, particularly, the environment and banking will provide either a headwind or tailwind to certain agricultural sectors as well as those interrelated businesses. Opportunities and challenges in areas such as organic, local, natural, GMO, food safety and animal welfare signal a transitory time for the agriculture industry.

Regardless of national policies or other outside forces, an increased focus on financial and risk management will be required for a successful business. This type of efficiency and proactive management is the product of continual learning, use of advisory teams and the ability to plan, strategize, execute and monitor your business. As the landscape of agriculture continues to change and evolve, the various outcomes of business will be interesting to watch.