Get back in the black
After several years of low commodity prices, is your financial statement showing red ink? The downturn may last a while. How can you get back in the black, or at least hang in there until things turn around? In our annual outlook report, we call on four experts to forecast the 2017 farm economy and dispense advice on how to get through tough times.
1. What do you see for grain prices in 2017?
Gerke: This year looks better than last for farmers in our area. We experienced another wet spring, but most farmers got crops in the field. Later moisture came at the right time. Yield looks good, but grain prices are expected to remain where they were last year unless some major event occurs.
Boehlje: Futures markets suggest continued weak prices. We won’t see $5 corn, and beans will not be in the teens. Historically, agriculture goes through cycles like other industries. Good times last three to fives years—sometimes up to seven. But for farmers, bad times can last twice as long. It’s not going to get better anytime soon unless bad weather someplace in the world improves our forecast.
Westhoff: Large global supplies of grain and oilseeds make it likely that corn, soybean, wheat and rice prices will continue to be under pressure in 2017. Corn and wheat prices for the 2016-17 marketing year could be the lowest in a decade. The market will be sensitive to prospects for 2017 crops in the southern hemisphere early in the year. As we saw in 2016, a short South American crop can boost the market, but if Brazilian production rebounds, it will be harder for prices to recover. If 2017 brings average global weather conditions, crops may be a bit smaller than in 2016, and prices could increase a little. But it would take a major supply problem to get us back to prices like 2010-13.
Liddell: An 87 percent year-over-year increase in soybean carry stocks, a 39 percent YOY increase in corn carry stocks and a 12 percent YOY increase in wheat carry stocks will start 2017 off in a bearish mood. Substantial supplies usually mean that any market rally will be muted by increased cash sales. Consequently, the first half of the year looks challenging from a price perspective. With no changes in supply and demand dynamics, Chicago Board of Trade prices should remain from $3.20 to $3.50 per bushel for corn, $9.25 to $10 for soybeans and $4.20 to $4.50 for wheat. Over the past three years, the best pricing opportunities have come at planting time, and 2017 is expected to be similar. Much will depend on the South American harvest.
2. What about livestock?
Boehlje: We’re not feeling as positive about a turnaround in the animal protein industry as we were six months ago. Exports aren’t growing at the pace we hoped. Demand from China hasn’t been as strong as expected for pork, and it’s not clear a turnaround will come quickly. Beef especially is recovering slowly from the demand downturn that came with the Great Recession. Feeder cattle prices are down substantially, but they’ll likely at least stabilize at today’s lower levels. On the brighter side, feed costs are down.
Westhoff: Increasing production of beef, pork and chicken in 2016 contributed to sharply reduced cattle prices, and hog and chicken prices dipped far below their 2014 peaks. Even if lower prices cause producers to slow expansion, the number of cattle in the system means beef production will probably increase again in 2017. Unless export demand is stronger than appears likely, 2017 could bring another price decline for fed and feeder cattle. Hog prices could be near break-even.
Gerke: Hog prices look weak, and cattle will trend even to down—but it depends on demand. Exports this year so far seem to be doing well despite the strong dollar. The world needs food, but how much can other nations afford?
3. How will domestic and export demand affect farmers?
Westhoff: We have seen record or near-record world production of the main grains and oilseeds for three years in a row, in part because of favorable weather in most major growing regions. Low prices will slow or reverse expansion in many countries, but as always, weather will drive yields. On the demand side, if the global economy continues to grow at a modest pace, we expect continued increases in meat and dairy consumption in 2017, especially in China and other middle-income countries. However, export growth does not appear strong enough to cause a quick and sharp commodity price recovery.
Liddell: South America acreage could still expand. This year, due to the drought of Brazil’s second crop, Brazil and possibly Argentina are likely to focus expansion on corn. Financial challenges for U.S. producers are expected to have the opposite effect, driving us away from corn and toward soybeans, which roughly carry half the cost of production. Regardless, current global production capacity is capable of maintaining the already strong global stocks positions of all major grain and oilseeds. U.S. exports are strong in the outset of the 2016-17 marketing year, partially as a result of Brazil’s drought.
4. Will profitability return?
Boehlje: Profitability will decline almost 50 percent from our peak two years ago. This is one of the most dramatic declines we’ve seen—even more than in the 1980s. Recovery will come from cost reductions. How much cushion do you have to withstand this downturn? Smart farmers stashed cash, but if you bought equipment and land, you burned up working capital and don’t have much resiliency. Grain producers won’t see profits increase from reduced production because harvested acreage has already grown up to 10 percent since 2010. Prices must drop dramatically before we back off on acres.
Westhoff: Income faces continued pressure. Low commodity prices mean crop and livestock receipts will likely remain well below recent peaks, in spite of increased production. Government payments under the new farm bill will offset only a small portion of the decline in crop receipts. On the cost side, fuel and fertilizer prices will likely remain low by recent standards. Farmers will continue to reduce costs. Still, most will struggle with tight or negative profit margins.
Liddell: Row-crop farmers face the third to fourth year of negative margins. The key question: How low can you push the cost of production without damaging the crop or the land’s long-term capacity?
5. How much are land values declining?
Gerke: Missouri land values have declined by about 10 percent. There are two reasons it’s not dropping more—low interest rates and heavy demand. Investors are trying to find a place to put their money, and real estate seems to be a good bet.
Westhoff: Reduced profitability usually translates into lower rental rates and land values. USDA confirmed a decline in rental rates in 2016 in many states, and the national average value of farm real estate declined a little after increasing by 50 percent between 2007 and 2015. Further reductions are likely in 2017 unless commodity prices recover significantly. Land values could come under additional downward pressure if the Federal Reserve carries through with plans to increase interest rates.
Liddell: Rental values are feeling pressure to decrease. As a consequence, total land value is coming under more downward pressure as well. A number of auctions report no sales, and we see a lack of interest in mid- to low-quality land in Missouri, Illinois and Iowa. In the coming year, there is an increasing chance that land will be liquidated to generate cash for farming operations. This has already started, and increased land sales can force total values down further.
6. How can renters and landlords strike deals that work for both?
Westhoff: Be realistic. Although some adjustments have already occurred, some tenants appear to be paying more for rents than current profitability justifies on the hope that commodity prices will rebound. This strategy is risky.
Boehlje: Overall we’ll see a 20 to 25 percent total decline in land values, and we’re halfway there. Rent prices come down more sluggishly. Landlords are moving away from sharing risk and toward cash rent. We will see a lot of churn. Landlords expect a certain income for their retirement. At the same time, most tenants need a downward adjustment. This is one of the toughest decisions a renter faces: at what price can I continue to rent? Some will have to walk away. Grain farmers who rent will be the most financially vulnerable. Farmers who didn’t want to pay high land prices but aggressively bid up rents will hurt the most. Some mid-career farmers bid up rents to expand—many purchased modern equipment to farm the additional acres and don’t have the cash reserves or land base to refinance. A high proportion of young and beginning farmers rent land, and they will also be affected.
My advice is to negotiate. Flex rents might present a solution, where you set a base price and share any profitability improvements later. But landlords may not accept the idea.
Gerke: Tenants should discuss revenues with landlords. Share your expenses and explain where your rent needs to be to make your cash flow work. Cash rents are high—it never got as crazy in Missouri as it did in Iowa, Indiana and Illinois, but some tenants are still bidding up rent. Many landlords are putting out their land for bid, and some are getting more for it. Some tenants try to hold onto their rental property hoping they’ll be first in line when the landowner sells. That can work if the landlord sells while he’s alive, but if the landlord dies, heirs may not be open to the concept.
Liddell: As margins will likely continue to be tight over the next two years, it is important to establish a viable value for land. You can accomplish this through transparent negotiation or a lease agreement that passes some risk to the landowner. The tenant should initiate regular communication with the landlord. The landlord needs to understand the value that land can generate. Overpriced land generally ends up with depleted nutrient levels and increased weed and pest problems. If the tenant is unable to pay higher rent, the landlord may need to farm the land himself. This will become more common as credit tightens.
7. How can farmers manage debt?
Boehlje: Individual farmers may face challenges, but nothing like the 1980s when farmers were underwater on land borrowings. Farmers today are not as highly leveraged, land prices haven’t gone up as much, and interest rates are lower. Credit will tighten, but we won’t see widespread problems. Lenders aren’t likely to foreclose, and refinancing will be available. Still, lenders are nervous, and loan reviews will be intense. Lenders will ask more questions: What are you doing to manage risk? Have you talked to your landlord? What’s your cost of production? What’s your working capital burn rate? How will you cover losses?
Westhoff: Some farmers are experiencing repayment problems. Many operations made money between 2010 and 2014, and debt-to-asset ratios fell to favorable levels. In these cases, farmers used reserves to handle a year or two of sharply reduced returns without excessive financial stress. However, with continued low returns, pressure is building. Farmers and lenders need to be realistic—don’t rely on a quick, large rebound in commodity prices. Make small changes now to avoid drastic changes later.
Gerke: In many cases these days, your primary lender won’t loan enough for you to operate, and expects you to obtain supplier financing. MFA Incorporated provides short-term credit for inputs such as fertilizer and seed. We see an increase in demand for this type of credit. We have met the demand, in part because we send some of it along to programs such as John Deere Financing or RaboBank. If you don’t have enough cash flow to service short-term loans, ask your lender to extend loan maturities, thus lowering your payment.
Liddell: After three years of lower commodity prices and persistently high input costs, liquidity is drying up. Credit is harder to secure, and lenders are less likely to take as much risk as in the previous ten years. Repayment has been an issue over the past year and is expected to be more of a problem in 2017. To manage debt, you must understand your equity position. What assets are available to secure credit, and how much liquidity can you create by selling assets? Your business plan should take into account how you can apply valuable assets strategically. When you secure a crop loan with hard assets like land, you run the risk of losing the land’s value. Cash is king, especially in a downturn.
8. What’s your top trend for 2017?
Boehlje: Financial pressures will be top of mind. Longer term, the mergers and acquisitions in the pipeline will prove significant: Bayer and Monsanto, Dow and DuPont, Deere and Precision Planting, ChemChina and Syngenta, and the Potash and Agrium consolidation in Canada. We probably won’t see the impact until late 2017, but with less competition, what will happen with pricing and availability of products, along with new product research and development? Another trend: digital agriculture, such as the cabless automated tractor, will profoundly change how we farm.
Gerke: Lenders want to see more working capital. Long-term lenders will favor farmers who can pay real estate loans with income generated by that land. Some require 50 percent equity before they’ll finance.
Liddell: The key trend will be the farmer’s financial health. The other trend to watch: U.S. planted acres; fewer acres would be positive for farmers. Low grain prices relative to soybean prices, combined with a lower total cost to produce soybeans, are expected to drive increased soybean acres and reduced corn and wheat.
9. What’s your best advice for the coming year?
Westhoff: Don’t panic, but be realistic.
Gerke: The more cash you have, the longer you can survive the downturn.
Boehlje: One, control your costs. Two, build the financial resilience to handle the downside. Three, all downturns bring opportunities for some people. Well-positioned operators will see more opportunities to rent or buy land and to capture good deals on buying or leasing used machinery.
How to get back in the black
- Start by cutting your most significant costs—machinery and rent. These make up 35 percent or more of all costs for most grain farmers. –Boehlje
- Lower your input costs. We expect fertilizer prices to decline, which may help. Seed prices haven’t dropped, but you might opt for lower-cost seed. Keep buying good genetics because production is what counts, but you might buy fewer traits. However, if a bug shows up, you’d better have a backup strategy. –Boehlje
- Cut back on family expenses. Studies show that discretionary spending doubled over the last five to seven years. Don’t replace the car, and put off expensive vacations. Ask your kids to take out student loans rather than you putting up the cash—interest rates on student loans are attractive, and you may be able to pay them off in a few years. –Boehlje
- Focus on reducing costs per unit of production, rather than cost per acre or per animal. If cutting fertilizer application by 10 percent has little impact on production, that might make sense, but if it reduces current or future yields quite a bit, it might not be smart. –Westhoff
- Refinance long-term interest rates—they’re extremely low now. –Gerke
- Look for alternative financing sources. Input merchants and dealers are preparing to handle more debt. Total debt will rise on the operation and machinery side, but will not go up much on the land side except to support refinancing of losses and restore working capital. –Boehlje
- Plan based on cash flow rather than on reducing income taxes. Don’t purchase machinery just to defer taxes. –Gerke
- Find new sources of income. Take a job off the farm or custom harvest for neighbors. –Boehlje
- Develop a business plan that clearly states your objectives and addresses key elements such as cost of production, available equity and cost of living. Sit down with advisors and vendors such as your banker, marketer, accountant and agronomist to strategically plan for the future. They can help execute your plan if they are included in the process. –Liddell
- Market throughout the year to glean better prices. Stop marketing to generate cash at critical times. Utilize market “carry,” along with storage, to enhance your crop’s value. –Liddell
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