Agriculture Faces The ‘Perfect Storm’

Corn field and storm

Today, most everyone that is directly or indirectly tied to the commodity grain side of U.S. agriculture is smiling all the way to the bank. Most Midwest farmers are seeing their profits dramatically increase to record levels, as a surge in prices has outpaced higher costs, and the equity on their balance sheets is exploding on the upside, due to the dramatic appreciation in farmland values. 

Investors, who have recently discovered the attractiveness of financial investments in farmland and related ag assets, feel validated in moving into an unconventional investment area, agriculture, given the turmoil in financial markets and the unprecedented economic uncertainties facing the global economy. 

Whether you are a farmer or a financial investor, the “trend has been your friend”. Farmers are even trying to get their children to come back to their farm operations, unlike the 1980’s, when farm kids headed to jobs in the big cities due to the poor farm profit picture.

Farmers’ optimism and profit bonanza has been a dramatic revenue and profit booster for downstream suppliers, including basic suppliers and the distribution chain for inputs (fertilizer, crop protection chemicals, and seeds), farm machinery, and farm technology/service providers. 

The major questions facing agriculture, especially the commodity grain side of Midwest agriculture, are twofold:

1. Is Midwest agriculture at a peak, or very near a peak, in terms of crop prices (focusing on corn), profits, and farmland values? 

Our answer, discussed in the first and second article of this series in the September and October 2011 issues of Crop Life magazine clearly suggests that agriculture is facing Ag Bubble 2.0, reflecting “irrational exuberance”, not a “new normal”, which will result in a traumatic downward cycle. 

2. What are the risk/reward parameters of current Ag Bubble 2.0, in terms of crop prices, profitability, and farmland values?

It is our view that Midwest agriculture is at or near a peak and that the downside risks in the short- to – intermediate term (next 2-3 years) are sizable. Furthermore, agriculture faces a “perfect storm”, which could extend the downside risk in farmland, beyond the next few years. 

Reversal In Fortunes

At or near a peak, Midwest agriculture faces a dramatic reversal of fortunes over the next 2-3 years. Given the broad diversity in agriculture from a crop, level of productivity in terms of yields, as well as regional perspective, our discussion and analysis will focus on Midwest agriculture and high productivity corn acreage (180-200 bu/acre), such as in Iowa and Illinois.

As discussed in the second article in this series (State Of Agriculture: Irrational Exuberance Or The New Normal?), Ag Bubble 2.0 has been largely driven by short-term supply dislocations. For example, adverse planting and growing conditions have resulted in back-to-back corn production shortfalls in the U.S. in 2010 and 2011, and near-record low U.S. corn stocks. Record corn prices has rationed demand and creates the incentive for record or near-record U.S. planted acreage, as well as a strong global supply response, in the 2012 planting season. A rebound of the global supply side is the catalyst for a major trend reversal in crop prices and the risk of a dramatic plunge in per acre profits for the 2012 corn crop, from record levels expected this year.

Tables

Tables for “Agriculture Faces The ‘Perfect Storm'” can be found in the November 2011 issue of CropLife magazine.

• Crop Prices – Downside Risk to Corn Prices of $4.25-$5.25 Per Bushel from Current $6-7 Levels. Corn prices could strengthen once again over the next 6-8 months and challenge the previous peak of close to $8.00 per bushel in order to provide the incentive to expand corn acreage in the “battle for acres” in 2012, as well as continue to ration current short 2011 production. Should U.S. farmers plant 93+ million acres of corn, ending stock would dramatically rebound. Our estimate of the downside risk to corn prices is $4.25-5.25 per bushel range over the next two years. While weather is a wild card for 2012 corn production, since La Nina conditions have once again resurfaced, should production be negatively impacted, the inevitable decline in corn prices would only be delayed a year until 2013. 

• Crop Profitability – Downside Risk of 30-50% from Forecasted Record Level of $660 Per Acre This Year. Farm profits are expected to reach a record level in 2011, which might set a high water mark for a number of years. Corn profits/acre (excluding farmland costs) are forecasted to surge to a mega-profit level of $660 for the 2011 crop, which is a dramatic increase from the estimated previous peak of $420 for the 2007 crop. Despite higher input and machinery costs, the dramatic expansion in margins reflects the simple fact that corn prices have dramatically escalated above cost increases. Unfortunately, an expected reversal in corn prices, at the same time that costs are expected to continue to escalate in 2012, are forecast to result in a dramatic squeeze in profits (excluding farmland costs) to the $300-400/acre level over the next two years. However, given the expected continued volatility in prices, we would expect the most productive and astute marketers to demonstrate farm profits above these levels. 

• Farmland Values – Downside Risk of 20-40% from Current Levels Over the Intermediate Term. Given the dramatic escalation in farmland values since 2005, especially over the last two years, farmland values are vulnerable. Downward pressure on prices and profits expected for 2012 will act as a catalyst for building downward pressure on farmland prices in 2012. The combination of dramatically lower crop prices and profits, and an expected rise in interest rates from current abnormally low levels, create the catalyst for a dramatic reversal in farmland prices over the next 2-3 years, which will be discussed in the following section. Our analysis suggests that farmland values (high productivity corn acreage), conservatively, has 20-40% downside risk from current levels. 

Facing The “Perfect Storm”

Farmland values reflect the health of U.S. agriculture. Farmers in the Midwest, flush with cash from last year’s crop, as well as anticipating record mega-profits this year, continue to bid up farmland prices. Farmers have well recognized that farmland investments over the last 25+ years have proven to be a sure bet, in terms of appreciation. While farmland transactions at $8,000+ per acre have been common, average farmland values in Iowa have increased 8.6%/year from $787/acre in 1986 to an estimated $6,250/acre in 2011, with only 2 years that did not see year-to-year price gains. On a similar basis, even more noteworthy, is an estimated annual average increase of 13.6% over 2005-2011, with estimated 19.6%/year gains just over the last two years (2009-2011). 

Despite the long-term escalation in Midwest farmland values, there is a growing probability that values are reaching a strategic point of inflection and will be subject to growing downward near-term pressure and significant intermediate- and long-term downside risk. Continued farmland purchases by optimistic farmers, with excess cash, could continue to levitate farmland values, in the face of an expected dramatic decline in crop prices and profits over the near-term. However, at some point, even the most optimistic farmers will be forced to capitulate. Looking back in history, many farmers who paid record prices of $4,000+/acre in the late 1970’s look smart today, but were burdened by underwater investments for 25+ years, until 2005-2006. 

Agriculture faces a “Perfect Storm” in terms of a secular reversal in the key drivers of farmland values.

The fundamental drivers of the value of any capital asset, such as farmland, are future earnings expectations and the discount rate, or cost of capital, which are used to discount future earnings. The dramatic surge in farmland values over the past 6 years has been driven by the dramatic rise in crop prices and profits, at the same time that interest rates have fallen to record lows, as evidence by the current 2.0% interest rate level for 10 year U.S. treasury bonds (risk free rate). Based on our view that crop prices and profits are at, or near a peak, in 2011-2012, a key reversal of the three key value drivers, especially a long-term secular uptrend in interest rates from current abnormal low level (due to Federal Reserve policy actions to stimulate the economy), will put significant downward pressure on farmland values over the intermediate-to long-term.

Farmland Value And Interest Rates

Interest rates play a major role in farmland values, since they are a key determinant of the cost of capital, used in the valuation process. The downward trend in long-term interest rates since the mid-1980’s has been a key value driver that has supported the steady rise in farmland values, especially during the last 4-5 years. 

While one can argue that current abnormally low interest rates will remain low over the next 12-18 months, it is only a matter of time until interest rates start to rise to more normal levels (4-5% interest rate for 10 year U.S. treasury bonds). The “bond vigilantes”, or the bond market, will start to increase interest rates, apart from U.S. Federal Reserve policy actions, once economic activity start to strengthen, in concert with an expected rise in inflation from current levels, which even under conservative assumptions, can be expected to start to develop in the next two years. 

We will discuss in detail, the alternative methods of valuing farmland and the basis for our forecasts for significant downside risks in Midwest farmland values in the next article in this series, expected to be published in the December 2011 issue of Crop Life magazine.

What Could Change?

Forecasts, especially short-term ones, in agriculture always carry risks, since many key variables are outside agriculture’s control, such as adverse weather which can impact production. There are a number of “wild cards” that could impact our forecasts, apart from serious economic concerns over the risk of a double-dip recession in the U.S. and Europe in 2012, as well as a dramatic economic slowdown in developing countries.

The key “wild card” that could delay the timing of when Ag Bubble 2.0 deflates, is a repeat of a La Nina weather pattern in 2012 that depresses production levels, It is important to note that back-to-back La Nina conditions does not guarantee lower yields and production in the second year. However, should La Nina conditions in 2012 create a replay of 2011, which would reinforce current high prices/profits/farmland values for another year, we would expect the vengeance of the supply side of Economics 101 will be delayed one year. 

Importantly, forecasting is hazardous, especially when you take a position that is diametrically opposed to the consensus. However, there are unique times, such as today, that an emphasis on anticipating strategic “points of inflection” and fundamental changes in the direction of key market drivers, provides opportunities to limit risk and take advantage of the downside, when market conditions ultimately bottom. 

Leave a Reply

State of the Industry Stories

State of the IndustryAgriculture’s Troubled Waters
March 3, 2014
Water quantity and quality issues threaten to hamper agriculture on a wider scale in the not-too-distant future. Technology breakthroughs and improved practices are providing potential solutions. Read More
State of the IndustrySponsor Profiles: Simplot, SST And WinField Support CropLife State Of The Industry Report
January 8, 2014
The sponsor partners of the CropLife State of the Industry report have demonstrated ongoing leadership including their support of this report. Read More
State of the Industry2014 State Of The Industry: Agricultural Concerns Creep In
January 2, 2014
With many strong sales years under its belt, the agricultural community is hoping for another positive growth experience in 2014, but mindful of a few challenges that might keep this from happening. Read More
State of the IndustrySeed Systems Top Watch List
January 2, 2014
Retailers are closely following herbicide tolerance and drought resistance traits. Read More

Top 100 Articles

CropLife 100CHS: Driving Momentum To Help Farmer-Owners Grow
December 11, 2014
CHS Inc., the nation’s leading farmer-owned cooperative and a global energy, grains and foods company, must capture new opportunities to Read More
CropLife 100BRANDT, Verdesian Ink Distribution Agreement
December 9, 2014
The agreement grants BRANDT the exclusive right to sell and market Verdesian’s patented Steric chemistry in the Turf and Ornamental and eastern U.S. ag markets under the BRANDT Reaction product line name. Read More
CropLife 100CropLife 100: The Colors Of Custom Application
December 5, 2014
Although many color spray rigs are in the yards of the nation’s top ag retailers, the majority of them still come in only a few shades. Read More
CropLife 100Pinnacle Invests In Meridian Agriculture Distribution
December 4, 2014
Meridian will provide retailers with supplier-branded products and numerous opportunities to differentiate themselves from their competitors. Read More
CropLife 100CropLife 100: Entering A New Seed Era
December 4, 2014
The seed category has been re-vitalized during the past few years, and more good news (and varieties) are headed the industry’s way in 2015. Read More
CropLife 100CropLife 100: The Depressed State Of Fertilizer
December 3, 2014
Following downright giddy growth earlier this decade, fertilizer sales have fallen back down to earth the past two years. Read More

Latest News

FertilizerGlobal Fertilizer Market: Cloudy With A Chance Of Sprin…
December 22, 2014
While spring demand in the Northern Hemisphere will prevent prices from slipping significantly, Rabobank believes that lower farmer margins will incent farmers to be more prudent in fertilizer application. Read More
Management2014: Looking Back, Looking Forward
December 22, 2014
Paul Schrimpf and Eric Sfiligoj discuss key emerging issues from the year past that retailers will be watching closely in Read More
FungicidesAlfalfa Expert: Root Rot More Widespread Than Previousl…
December 22, 2014
Once thought of as a wet-soil disease, aphanomyces root rot is more widespread than many realize. Read More
Seed/BiotechKaren Arthur Joins AgriThority As Seed Treatment Produc…
December 19, 2014
Prior to joining AgriThority, Arthur directed research and development programs, overseeing laboratory and field research, to build the Valent U.S.A. seed treatment portfolio. Read More
EquipmentJohn Deere To Sell Crop Insurance Business
December 19, 2014
Deere & Co. has reached a definitive agreement to sell its crop insurance business, subject to regulatory approval, to Farmers Mutual Hail Insurance Co. of Iowa. Read More
Crop InputsNufarm Fills Regulatory VP Position
December 18, 2014
Nufarm announced today that Rob Schwehr has been promoted to the position of Vice President of Innovation & Regulatory Affairs for Nufarm Americas. Read More
Seed/BiotechReport: China Approves Viptera Corn, U.S. Officials Awa…
December 17, 2014
Chinese authorities have informed some agriculture industry officials the government has approved U.S. imports of a type of genetically modified corn developed by Syngenta. Read More
FertilizerMonty’s Plant Food Brings In New Sales Rep
December 16, 2014
Monty's Plant Food Company has hired Warren Kearns as its newest Sales Representative for the South Carolina area. Read More
EquipmentHagie Wins 2014 CropLife IRON Product Of The Year Award
December 15, 2014
The self-propelled sprayer maker has a hit on its hands with the new STS Series model. Read More
Syngenta
Seed/BiotechSyngenta Sees China Approving Contentious GMO Corn Soon
December 15, 2014
Syngenta will make an announcement when it receives official documentation from China that Agrisure Viptera corn, known as MIR 162, has been cleared for import. Read More
Crop InputsVerdesian Life Sciences Names Vice President Of Communi…
December 15, 2014
Amy Bugg will oversee the execution of all promotional strategies for the corporate brand and the complete product portfolio. Read More
StewardshipFarmers, Retailers Attend 4R Certification 4U Workshop
December 15, 2014
More than 160 farmers and ag retailer attended the “4R Certification 4U” workshop December 12 to learn more about the 4Rs of nutrient stewardship, water quality research in the area and cost-sharing opportunities. Read More
Matt Hopkins10 Best New Agriculture Apps For 2015
December 15, 2014
These new agriculture apps are certain to help ag professionals do their jobs more efficiently in 2015 and beyond. Read More
ManagementARA Learnings, Retail Buying Intentions: Welcome To Cro…
December 12, 2014
This informal video program puts news and events effecting retailers into context, and features Editors Paul Schrimpf and Eric Sfiligoj. Read More
Seed/BiotechMonsanto Herbicide-Tolerant Technology Closer To Commer…
December 12, 2014
The final EIS moves Monsanto one step closer to the introduction of Bollgard II XtendFlex cotton and Roundup Ready 2 Xtend soybeans, paving the way to provide access to dicamba-tolerant soybeans and cotton. Read More
Seed/BiotechUSDA Issues Final Environmental Impact Statement On Her…
December 12, 2014
The USDA Animal and Plant Health Inspection Service (APHIS) is issuing a final environmental impact statement on varieties of cotton and soybeans that have been genetically engineered for resistance to several herbicides, including the one known as dicamba. Read More
CropLife 100CHS: Driving Momentum To Help Farmer-Owners Grow
December 11, 2014
CHS Inc., the nation’s leading farmer-owned cooperative and a global energy, grains and foods company, must capture new opportunities to Read More
LegislationARA Applauds CFATS Passage Prior To Holiday Adjournment
December 11, 2014
The streamlined bill provides a four-year authorization of the CFATS program and guidance to DHS on key issues of chemical facility security Read More