A mixed bag of financial results can be seen on the agricultural sector horizon for 2015 and beyond. The outlook for individual producers hinges on three primary factors: enterprise choice, weather conditions, and debt position entering 2015.
The U.S. agricultural sector as a whole is at the tail end of an extended number of years of high (record in many cases) profitability, primarily fueled by returns to crop producers. The magnitude and length of the “good” times depended on geography, crops produced, and how weather patterns impacted the ability to produce. Increases in agricultural land values followed similar patterns, with the largest increases in the Midwest and Northern Plains. Clearly, beginning in the second half of 2014, crop producers have entered a period of lower prices. Predictably, agricultural land values have stabilized, or declined modestly in some regions of the country; however, cash rents haven’t come down much, keeping margins tight. What will be the magnitude and length of the setback? If history is any guide, the industry could be looking at a three- to five-year period of lower grain prices.
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Recent price offers for 2015 crops are close to the break-even needed to cover costs for the best (lowest cost) producers, so management will be the key to making it through this period. Production challenges due to weather or other factors will present additional concerns, and marginal managers could see significant financial stress.
On the other hand, livestock producers, especially dairy and beef cattle producers, are experiencing high prices and solid profits overall (Returns to individual producers may depend upon which specific phase of the industry they engage in.). In addition to high prices resulting from a drought induced “tight supply,” livestock sector profits are also being enhanced by the very thing that is eroding crop producer returns: low crop (feed) prices. How long will the strong financial outlook for the livestock sector last?
The general answer is probably several years, with the exact outcome depending largely on weather. Beef cow herd rebuilding can and will take place in the foreseeable future; however, the process will take a long time, leading most analysts to believe that profitability in the livestock sector will remain strong for several years to come. Dairy sector profitability may swing more quickly due more rapid supply increases.
Long-term drought (which persists in significant areas of the Plains) obviously intensifies the financial woes for crop producers, not only impacting actual crop yields but ultimately pulling down benchmark yields for crop insurance and government safety net programs. Dairy and beef cattle producers to a large degree rely on forage-based production programs. Those in drought stricken areas find little comfort in today’s high milk and cattle prices and will feel the impacts of broader financial forces the most.
Debt situation is good for ag
Unlike during previous agricultural sector financial downturns, the overall debt to asset position of the agricultural sector is in extremely good shape as of the end of 2014, and interest rates remain at historically low levels. With that said, we offer some words of caution. First, while average debt levels are relatively low, in some individual situations that is not the case. Those with higher debt levels will find it more difficult to navigate through periods of tighter margins. Second, there are debt related concerns even for the livestock sector. Escalating calf and feeder cattle prices result in unprecedented credit volume requirements for those producers and regions that make a living purchasing calves or feeder cattle and adding value through a stocker or feeding program. Similarly, for those in a position to rebuild cattle herds the value of breeding livestock results in the need for significantly more capital than has been historically required. Risk management strategies need to be in place in the event of price declines or production shortfalls. We mentioned that one bright spot regarding the current agricultural finance situation is the generally low interest rate environment and high land prices. A question that should be on the minds of industry participants is when are those likely to change, and by what magnitude?
The safety net that has historically been an important shock absorber when net incomes declined has changed dramatically. Individual producers have complex choices to think through regarding the most appropriate mix of commodity program and crop insurance alternatives. From many commodities, some potential “holes” in the overall safety net need to be kept in mind and perhaps planned for.
Overall, the agricultural sector financial outlook is cautionary. Some sectors and regions will continue to thrive; however, many crop and livestock producers likely will experience challenges. Concerns have not yet resulted in significant declines in agricultural real estate values in most areas; however, a significant rise in interest rates or a steeper decline in farm incomes could start to affect land values more significantly. Managers need to know where their business stands on a constant basis. If you haven’t yet, switch to analyzing business performance based on accrual measures rather than cash basis measures and consider switching to managerial/cost accounting. Analyze performance and monitor projected versus actual cash flows frequently so you know where you stand financially all the time. Constantly focus on cost control and liquidity management, concentrating on managing large-cost items at every opportunity. Consider fixing interest rates and possibly restructuring debt in such a way that interest rate risks and liquidity levels are managed.