What is a grain farmer to do? Encouraged by both record-high crop prices and production over the past few years, you bought more land and upgraded your combine. With record-low interest rates, these were shrewd business decisions that pencilled out. They made sense, right?
Except now crop prices are flat, and those responsible for input costs and land pricing seem not to have noticed. Or not yet anyway.
Your cash flow is suffering as a result. And you’re left wondering, what is a farmer to do?
It’s a scenario all too familiar to those who lived the glory days of farming in the ’70s, only to try and survive bankruptcy in the ’80s. And there are murmurs in the industry — some alarm that we may see the devastation of that time on farms today.
To get a handle on those fears, let’s start with some big-picture facts.
The national scene
Record-setting crop prices and production have translated into record-high income on the farm. According to the 2015 Canadian Agricultural Outlook from AAFC, net cash income (farm receipts minus expenses) on Canadian farms reached $14 billion and $13 billion for 2014 and 2015 respectively. That’s 21 per cent higher than the average from 2009 to 2013.
And it’s no secret that those records translated into land prices. In 2012 both Ontario and Saskatchewan saw land value increases of a whopping 30 per cent.
Across the country those increases fell to 22 and 14 per cent in 2014 and 2015, respectively, according to the FCC numbers.
Now, forecasts suggest land prices will tread water.
“Land prices are softening because, in some provinces, land values are over their potential earning given lower commodity prices,” says Craig Klemmer, senior agricultural economist with FCC.
FCC’s 2015 report, Farmland Values Explained, examines the price to earnings (PE) ratio of land, price being the farmland value/acre and earnings being crop receipts/acre. In the ’70s these PE ratios exceeded the long-term average and were unsustainable when faced with high interest rates and a rapid decline in farm receipts.
FCC found the 2014 PE on most farms was higher overall but still consistent with cash receipts, except in Ontario and Quebec where population growth and urban pressures on land values saw their PE ratios increase by 60 and 50 per cent respectively.
However, what’s most interesting to note is that the same report suggests we shouldn’t be using cash receipts to value land at all. Land values and purchases should be based on net cash income.
“The ability to pay for land is perhaps more connected to net cash income than cash receipts,” the report reads. “The former measure reveals true profitability associated with land. Yet crop receipts are a more important driver of farmland values from a statistical standpoint. It is important to emphasize the importance of the last point: the purchase of land should be based on profitability and debt repayment capacity. Yet, revenues appear to drive the value of farmland at the aggregate level.”
With farmland now making up 64 per cent of the asset value of farms in Canada, it would seem important that farmers should be aware of the distinction, because at that level farmland becomes a much higher concentration of risk on the balance sheet. Can you, indeed, pay for it?
Given the usual cycles in agriculture, Klemmer sees the current slowing in appreciation of asset values of land as “appropriate for the market before we get ourselves into a bad situation… land value increases of about five per cent are a normal value increase. They could go to zero or a small (negative) decline due to the impacts of ability to pay via crop prices.”
“Some correction was needed,” he says.
But is it the ’80s all over?
Only two per cent of farmland turns over ownership in a given year, Klemmer says, so, after a couple of years of unsustainable prices relative to income, only two to four per cent of land has actually turned over, and entire farms are not likely leveraged at that high price. Instead high-cost land is supported by the rest of the farm.
That, says Klemmer, is a substantial difference from the buying patterns of the ’70s.
As well, commodity prices are down, but not as sharply as U.S. corn prices and nowhere near how they tanked back in the ’80s. This gradual decline gives producers time to adjust. The low Canadian dollar is also softening some of the commodity price impact, providing a 30 per cent buffer, although Klemmer admits this is only relative to U.S. products as other currencies around the world, such as Australia, are suffering as well.
There are also other indicators supportive of Canadian agriculture that weren’t there 40 years ago. For one thing, debt-to-asset ratios have been declining the past few years, putting farmers in a better position than 10 years ago, Klemmer says. Farmers made strategic investments in their operations with land and equipment. As well, even with high land values, the amount of debt relative to asset appreciation is lower.
It should be pointed out that a good deal of this improving ratio might simply be a reflection of inflation on land bought at a lower price, and not an indication of good management, but none the less it makes for a better ratio.
And we are certainly not in the interest rate nightmare of the ’80s. Interest rates are expected to remain low at least until mid-2017. Klemmer believes that when they do go up, both short- and long-term rates will rise incrementally. And while input costs continue to escalate, especially those sourced out of the U.S., lower fuel and fertilizer costs will offset some of that.
FCC and Ottawa both insist agriculture is in a good position moving forward, and that while the agriculture economy might soften, future population growth and a growing global middle class demanding higher-quality food will ensure markets for our products into the future.
The view from the grains and oilseeds sector
Land values, according to FCC’s Farmland Values Explained, are affected by interest rates, crop receipts and momentum effect. We’ve already looked at the first two, but what about that momentum effect? If farmers are susceptible to it, could industry and analysts be as well? We’re all looking at the same numbers, but assessing these numbers relative to an entire industry might result in quite different conclusions than when applied to your farm. Or mine.
Record-high net farm incomes, record-high farm net worth at $2.1 million per farm, total debt-to-asset ratios declining over the past few years, and farm family income reaching another record — the AAFC outlook is pretty darn rosy. So why are we glancing over our shoulders at the ’80s?
Perhaps it’s debt. Not once does the outlook mention total farm debt. But according to FCC numbers it rose 68 per cent since 2005 to a record $84 billion.
So, let’s say you’re the farmer who just bought more land and upgraded your combine. Now you have to pay for it. Farm receipts in the grains and oilseeds sector declined by five per cent in 2014 and another four per cent in 2015, while expenses remained relatively the same. And net operating income per Canadian grain farm decreased an average of 10 per cent since 2013.
On huge farms that represents some pretty huge numbers. Like you, many of those farms took out loans to buy more land and equipment, and now have those payments to make. That declining net operating income basically represents cash available to pay off creditors.
Your farm is also paying a smaller percentage of your household needs. While total family income per grain farm has increased from $145,000 in 2013 to $151,000 in 2015, the income coming to the family as a portion of the net operating income is actually decreasing slightly, meaning the increase comes from off-farm wages, investment income and farm salaries.
This isn’t to point to anything necessarily dire. It’s an observation that overall numbers only tell part of the story, and farmers need to crunch the numbers in their own sector and on their own farm so they understand why cash flow might be tightening up, making it harder to pay the bills or get ahead.
So what is a farmer to do?
For 15 years Lance Stockbrugger worked as a chartered accountant and adviser in the agricultural sector and he continues to work as a sought-after speaker on ag financial issues, with his most popular talks on buying versus renting land and equipment leasing or buying. He also farms 4,000 acres near Englefeld, Sask.
Stockbrugger agrees we’re unlikely to see the bankruptcy rush of the ’80s. “People are going broke but not in the same numbers as before,” he says. “More farmers are watching their financials more closely, and if the farmers don’t know them, the bankers do. The industry is more on top of it than it was in the ’80s.”
But while producers aren’t necessarily going bankrupt, “there are a lot of auction sales where it sounds like they’re getting out or restructuring. And what we’ve heard is, they have no choice. They are selling equipment to refinance. In the ’80s they just kept pushing, thinking it would get better and then went bankrupt. Today they are reacting sooner.”
Perhaps farmers could have survived the heady crop and land prices of the ’70s if 20 per cent interest rates hadn’t killed them in the ’80s. But an extremely low interest rate can create financial trouble too, and Stockbrugger calls out “easy money” as a culprit on some farms.
“One thing people have to stop using as a reason for buying is that ‘money is cheap’ right now,” Stockbrugger says. “Yes, it is, but we still have to acquire debt in moderation. If something is truly needed and will improve your operation, then yes, but if we’re only buying something because money is cheap, that doesn’t make sense… It’s easy money, but it has to be paid back. In the short term it might be easy, but is the farm gaining ground? Are we getting ahead or simply chasing the money?”
Too many farmers are making decisions today based on 2012 numbers, Stockbrugger says. In 2012 margins were huge. But those margins are not happening and are not forecast to happen. In fact, 2019 things are predicted to be even tighter than today.
“Any reasonable person in business would look at that and say, ‘we can’t make decisions based on 2012 numbers.’”
Land prices will remain high as long as interest rates are low, Stockbrugger predicts, but he wonders if farmers are prepared if 10 years from now rates go to even seven per cent. It’s hard to know, given that money left over to service debt is decreasing.
For some it might be too late. “People who have doubled their acreage in a year based on assumptions that may not be true? They will be in trouble,” he says. “If it’s been a slow and gradual increase, they will likely be OK. A well-planned, diversified and structured farm will ride it out.”
It mostly comes down to managing ratios: debt serviceability measures your working capital and ability to repay debts; debt to equity measures how you are financing your operation; and current ratio compares the current assets to current liabilities to determine the cash available to service the next 12 months’ debt that needs to be repaid.
“In some instances the equity ratio is backwards,” Stockbrugger says. “The bank owns more of their farm than they do. Finance companies get to the point where they’ve got more riding on your farm than you do. It’s created by competition within the financing industry. But it spirals. A few bad years, depressed prices and you have to figure out how to get out of the spiral.”
And, what if you’re caught in the spiral? What if you can’t pay for that land and upgraded combine?
It’s all about the cash flow. Your ability to pay the bills is the first thing a banker will want to know. Some of the hard things Stockbrugger says to consider include:
- An Auction. Sell some long-term assets. It’s a tough one, but a piece of land or redundant assets like that spare semi or extra tractor might have to go on the block. Enough said.
- New combine every two years? Maybe run the old one a little longer.
- Give back some rented land: some of that marginal land you never make any money on, or that quarter you just never seem to have time for.
- Cut costs. Farmers are price takers, so the only control is over costs. There’s not much room with inputs because you risk losing productivity and cash flow. So maybe pick on equipment. Move short-term debt to medium term. Hold off on purchases and leasing.
- Don’t use short-term money for a long-term asset. Use your operating loan to finance your inputs, and finance long-term assets over the long term.
- Act early: if you know you’ll need to expand your operating loan, ask in January, so there’s no crisis in June.
- Change your management style. It got you into trouble and needs to change. And get help from the outside to learn to manage differently.
- And if you’ve managed to hang on to farm another day: PLAN, so near death doesn’t happen again.
Along with every other farm adviser and accountant, if there’s one word Lance Stockbrugger has to say about managing your farm both for profitability and to avoid disaster, it’s just four letters long: plan.
Reports from AAFC and FCC are likely true. The agriculture industry will take this bump as it always does, by digging in and waiting it out. But it is the individual farmer who will bear the brunt of his or her decisions relative to expensive land and equipment purchased at low interest rates but who now face softening commodity prices.
Craig Klemmer, Lance Stockbrugger and the people at Ag Canada will likely agree that, stats or no stats, farm level financial management skills and planning have never been more important.
Add to that a certain level-headedness that is hard to regain after a period of record-breaking profits.
Perhaps looking back at history isn’t such a bad thing. Not to make us afraid, but to remind us.