I recently had the opportunity to attend a meeting of credit managers for Midwest ag supply and input companies, in part to get a sense for the major financial issues facing the distribution channel in the year ahead. Five lenders were invited and made individual presentations.
I gleaned three key observations from the presentations. None of them are new, but we haven’t needed to discuss them for some time. They include the following:
- In general, agriculture balance sheets remain in good shape, but liquidity is being stressed.
- Both fixed and variable costs still need to come down.
- Assessing the management and stress of your customer is key.
Let’s take a look at these on an individual basis, and consider what you should be looking out for as you go through the planning months this year.
1. Balance Sheets
Balance sheets remain sound with good levels of equity and liquidity, but as expected, debt, and financial risk have been consolidating at disproportionate levels in larger operations. Operations with both high levels of rented acres and rental rates have been hit harder in this downturn than most. Liquidity (working capital/value of farm production) is declining across nearly all segments, but is declining at a quicker pace in larger, higher-risk operations.
Many lenders require a liquidity ratio of 20% to 30%, which provides a cushion for adversity to both the lender and the producer. It is not uncommon today to see that ratio under 10% or negative. As liquidity shrinks, buying patterns will change based on income tax situations, discounts, cash available, and delayed crop mix decisions based on anticipated price.
As liquidity shrinks and traditional lenders seek to manage exposure, other nontraditional lenders are entering the picture. Landlords may be asked to change the timing of rents from spring to fall. Input suppliers may be asked to carry inputs for longer periods. In some cases, there will be limited risk to these new lenders. However, many times the challenge for these types of lenders is communication and expertise.
Many nontraditional lenders do not clearly understand the financial information, and may fail to check with existing lenders, complete lien searches on collateral, or file the proper lien documents. These lenders may view their actions as a benefit to the producer when in fact it may delay tough decisions in cases where time might not be the ally of the producer.
2. Fixed and Variable Costs
Fixed costs associated with labor and equipment rose to excessive levels in some cases during the last five to seven years. Correcting excess equipment and labor issues can create tough decisions for producers when equipment values are soft and part of the labor may be family.
There are many ideas on what these two segments should be, but producers generally should confine these to less than 20% of the expected gross revenues on a typical corn-soybean rotation. The need to reduce both labor and equipment may cause some producers to rethink their use of custom application or application methods.
Land costs are moving down, but may still be higher than what is sustainable long term. Many producers have significant equity in owned land. However, the equity may not be truly available for “rebalancing” the balance sheet. Historically, farm land nearly always trades at levels above cash flow, but recently the market value and cash flow gap widened significantly. Today lenders often cap loan levels to more closely reflect cash flow ability of the land causing some equity to be accessible through liquidation only.
Like land costs, variable costs are falling, but not at a pace quick enough to keep up with falling grain values. Input suppliers should expect continued pressure on price and volumes negotiated by producers, in addition to delayed decisions on what to purchase. Some early estimates of inputs still reflect the need to fall roughly 10% in relation to projected gross revenues.
3. Management and Stress
Cycles tend to highlight who the risk managers are that understand their financial situation. Recognizing and managing the risk between total costs and total revenues will remain at a premium for those operations carrying significant financial leverage. This cycle is nothing new to agriculture and like any other cycle, some producers will thrive in the opportunity. Others will struggle to make decisions quickly enough or significant enough to survive. Stress will become evident as some producers withdraw from normal communications and change social habits.
A number of these changes will be planned and needed, and others will simply be stress related. Those producers who decide this is just another cycle will make critical adjustments on their own, while remaining engaged and open with information on what they are doing and why.
As you choose new opportunities, make sure you are considering the benefits and risks for both parties.