May 20, 2013

Many producers have been soaring through the past decade’s ag boom—by many accounts the longest ag boom in history—but is it starting to wind down? And will everyone be prepared?

By Mike Karst, Senior Partner, Entira

You know the type—the confident risk-takers riding the wave of record high commodity prices, gobbling up all the farmland they can get their hands on as land values surge, and trying out non-traditional farming practices to grow their business quickly. Historically high corn prices are making revenues grow steadily, giving them more cash to work with. All of this has provoked confidence and temptation for farmers to make bold investments to get bigger, faster. Farmers want to be in BIG business.

These fast-moving farmers are maverick-like in their behaviors—they are exciting to watch, and their energy is contagious to us agribusinesses who support and partner with them. It’s been a good run no doubt, but as prices are likely to simmer down--and other indicators are hinting that the end of the boom may be looming--these farmers should take a hard look at their position and evaluate how well they’re leveraged for impending volatility. And agribusinesses serving these farmers, whether directly or indirectly, need to find ways to help navigate them through the rocky conditions ahead.

As the farm economy begins to level off, it’s the irrational exuberance we have to watch out for. One risk indicator that may, on paper, appear positive is low leverage.  While leverage continues to be at historically low levels, it is important to consider the cash flow implications of price volatility. Farming is a seasonal business, and setting up your business to require sustained yield improvement at record-prices is risky. In the fourth quarter of 2012, agricultural loans grew at a faster rate than the prior three years, thanks to forces like higher input prices, surges in capital spending in anticipation of tax changes, higher feed prices and higher feeder livestock prices because of short supply. (Federal Reserve Bank of Kansas City, Agricultural Finance Databook, January 2013.)

The current average farm debt-to-asset ratio is very low at 11.7 percent. To put that in perspective, the average farm debt-to-asset ratio was 20 percent in the 1970s during the last ag boom, right before it all went bust in the 1980s. (Federal Reserve Bank of Kansas City, Main Street Economist, Issue 6, 2012.) Those of us who have been in the industry long enough saw a lot of good farmers go out of business in the 1980s. Land values had been soaring, and farmers were buying it up like crazy believing they were setting their families up for long-term prosperity. But then the farm economy tanked and so very many dedicated farm families lost it all. 

Is this the year the bubble will burst? It’s hard to tell. Plenty of economists are predicting drastic fluctuations … not the least of which is $4 corn. I like the historical perspective of ag super cycles from Dr. David Kohl, professor emeritus of agricultural economics at Virginia Tech University. Dr. Kohl says, “All cycles end, and usually they are abrupt with consequences.”

Here are just a few of the economic storms farmers must be prepared to weather:

  • Swings in grain prices. Higher prices have helped sustain historical profits in the crop sector. They won’t stay high forever, and prices are predicted to fall significantly this year.
  • Actions in Washington (or inaction, rather). Spending cuts and lack of a farm bill could mean the government will scale back even more on programs that support farmers and their safety net. Many of the “maverick” farmers I know have taken advantage of these government programs and could be at great risk.
  • Reduced demand for exports. USDA reduced the 2013 grain export forecast by 50 million bushels. If the weather improves we easily could end up with a surplus, increasing storage costs and impacting prices.
  • Drop in land values. As grain prices recede, this may impede future land transactions and/or land rent adjustments to market value—thus squeezing margins for tenants.
  • The weather. Will it rain enough this season? Will there be another drought? There’s no perfect solution when it comes to the weather. Ideal moisture will certainly fuel the production response to high prices, and could result in a surplus, driving prices lower. If prices drop, there will be no more riding the coattails of high commodity prices to counter poor yields. On the other hand, another drought causing another year of poor yields would mean another hard year for dairy and livestock producers.

Yes, a drop in grain prices would be music to the ears of dairy and livestock producers—severely battered by feed prices jumping 18 percent in 2012, on top of the 20 percent jump in 2011 (per the Federal Reserve Bank of Kansas City). Lower prices would help their profit margins and could begin to shrink the income disparity between livestock and crop sectors. And although these would be welcome changes in dairy and livestock, these producers need to be prepared to make the most of them.

Time to Stop and Think

This is a time for all ag sectors to prepare for both best- and worst-case scenarios. Even another year or two of good performance will fuel temptation to make big investments—but the wise approach would be to take this period of uncertainty to be disciplined and focus inside the business to tighten operations and squeeze as much as possible from investments already made. Otherwise, if something catastrophic were to occur, it’s going to hurt more.

Farmers need to ask themselves this: If it all comes crashing down, can I sustain my assets? Even if they are highly leveraged today, if and when interest rates go up and inflation hits, will they weather it safely or bottom out?

Certainly, there are many growers who are taking appropriate risks in their progressive practices. As agribusinesses, our role is to advise our producer-customers against risky behaviors, which might quickly take them from “maverick” to “martyr.” We should encourage them to take a critical look at the farm’s business operation to see where they might be able to run things more efficiently. We can also advise our non-producer customers to take heed when doing business with maverick farmers who are at risk for losing it all (and taking some of us with them) when the cycle ends.

So as changes lurk on the ag economic horizon, it is a critical time for ag businesses to evaluate the ways we need to evolve accordingly. Is there an opportunity to expand or diversify in terms of services and expertise you are not offering today (i.e. crop insurance, estate planning, farm management, financial analysis)?

One of Entira’s primary missions is to help clients understand what drives farmers’ behaviors and decisions. Entira associates have intuition that can only come from being grounded with prior experience in production agriculture and continued time spent in the field. We are good at seeing trends others don’t see until it hits them in the head. That’s because we grew up in farming families or still farm today, and our work with clients at Entira allow us the opportunity to see some of the big changes that are coming in agriculture.

We recently completed a study on farmers in the Delta, and it overwhelmingly revealed farmers find financial analysis—and using that insight to make decisions—to be a weakness. Now is the time for ag companies to play an advisory role and help them use the investments they’ve made during the boom to boost productivity and efficiency. Encourage them to create a solid strategic plan to guide them and help with decision making in the next phase of this cycle. And by all means weigh the potential outcomes before making new investments.

There is a lot at stake, as farmers have legacies to watch over, serious business challenges to overcome; and the next generation will have different challenges to overcome. By slowing down to strategize ways to ensure strength and stability for the long-term, farmers can significantly lessen their risk of martyrdom. It would be unfortunate to witness these highly successful farmers go from genius to out of business.

Entira is passionate about serving our clients market intelligence and strategic planning needs. Please contact us if we can help you explore ways your business could better meet farmers’ changing needs, or email me directly at mkarst@entira.net.