Balance Sheet Changes May Bail Out Cash Flow

In today’s agriculture economy, “creative financing” means looking beyond cash flow to put your operation on better footing.

We have developed case studies examining three actual farm operations, all solvent (a positive net worth) but with liquidity problems (insufficient working capital and, in some cases, negative net cash income). Instead of focusing on variable costs, the producers restructured loans, unloaded underperforming assets and applied other “creative” solutions to liquidity problems.

Steve Johnson, farm and agriculture business management specialist with Iowa State University Extension, is presenting the case studies at our free GrowingOn® 2016 meetings scheduled for February 29 in Emporia and March 1 in Seneca and Ottawa. Larry Landholder is one of the featured producers.

Larry owns 1,500 acres and rents 500. His operation is solvent, with net worth of $4.5 million, including $2.5 million in land equity. Net farm income for 2015 was positive at $64,000. However, Larry lacks working capital, which is negative $77,000 ($34/acre), and has two machinery loans with annual payments of $138,000 and one real estate loan payment of $95,000 a year. Suppose Larry trims his input costs by $35/acre. That boosts his income by $70,000 — certainly an improvement. But Larry still can’t meet his machinery payment and he risks reduced yields. And what about next year?

Instead, looking at his strong balance sheet, he could use equity in his land for a new $130,000, 10-year loan to pay off a machinery loan. A new 20-year loan for $800,000 on real estate equity would allow him to pay off the other machinery loan, pay down his operating loan and strengthen his cash position. As the simplified table below shows, working capital would jump from minus $77,000 to $414,000. And while real estate payments would rise from $95,000 a year to $180,000 a year, machinery payments would drop from $138,000 annually to zero. Netted out, that’s $53,000 a year less in debt payments.

Financial categories Status Quo Solution
Working capital -$77,000 $414,000
Machinery/equip. payments (princ + int) $138,000 $0
Real estate payments (princ + int) $95,000 $180,000
On a per acre basis
Working capital per acre -$38 $200
Machinery payment per acre $69 $0
Real estate payment per acre $63 $120

We invite you to attend one of our GrowingOn meetings in eastern Kansas to learn more about how Larry Landowner and other producers are managing fixed cost to better position their operations for success in today’s challenging agricultural economy.

The Perfect Storm

The inverse thrills of the past year will be remembered by many livestock market participants. Cattle, hog and poultry producers all had their share of adversity and resulting market turbulence.

Avian influenza ran riot through turkey and egg houses and pork producers saw a slingshot effect that carried production to record levels and prices to four-year lows as output more than recovered from the 2013-14 bout with porcine epidemic diarrhea virus. Fed-cattle prices set new records on short supply only to plunge by $21/cwt. in the course of six weeks, a magnitude of loss for that length of time exceeded only in 2004 – during the mad cow crisis. Even dairy producers saw market volatility.

“The livestock industry experienced back-to-back extremes,” said Jud Jesske, Frontier Farm Credit vice president of agribusiness lending with an emphasis on beef producers. As can be seen in the chart below, weekly total meat production swung from as much as four percent below a year earlier during 2014 to better than 6 percent above in 2015.

Weekly Beef, Pork, Broiler Production

The strong dollar doesn’t help. Based on USDA’s agricultural trade-weighted index, USDA’s index began its upward sprint in August 2014. By the end of the year, it was 10 percent above a year earlier. While foreign exchange rates are far from the only factor affecting exports, it is widely agreed that a strong dollar makes U.S. products more expensive in global markets.

The Strong Dollar provides headwinds for exports

Data: USDA/ERS

Total U.S. meat exports plummeted beginning in May 2015 (see chart below), and the 2015 total is estimated to be down 1.3 billion pounds from 2014, bolstering domestic supplies by a like amount, according to CattleFax  That is the largest one-year drop, with the exception of 2004 in the wake of bovine spongiform encephalopathy.

US Total Meat Exports

From May 2015 to October 2015, beef exports slumped by more than 30 percent to their lowest level in 20 months. Pork exports recovered from the plunge seen during the trough in supply due to PEDv. But in November 2015, they fell 18 percent below the same month in 2014. Broiler meat exports also have slipped by almost a quarter from year-ago levels.

Cheap corn = more meat

Adding to the supply, production rose dramatically as both cattle and hog weights climbed. Combined with slower exports, the net meat and poultry supply in the United States increased nearly 4.5 billion pounds from 2014 to 2015, the largest yearly increase in almost 40 years. Looking at the past decade, meat supplies rose from the third smallest in 2014 to the largest in 2015.

“Many of our customers felt the effects of the disease outbreaks and the resulting market gyrations,” says Marshall Hansen, vice president of Frontier Farm Credit Agribusiness Finance (ABF). “However, volatility is a fact of life in agriculture. And while it was exceptionally high in 2015, most of the operations we work with were in a good position to deal with it.”

Several ABF customer operations hit by the deadly bird flu HPAI H5N1 lost months of business and were forced to lay off employees, but are now rebuilding flocks. Case Gabel, a young Nebraska cattle feeder, notes that “cattle equity swings on a weekly basis have been unprecedented. But forward crush margins are as healthy as we’ve seen in several years and futures and options allow us to minimize financial risk.”

As the year drew to a close, the market looked as if it might improve following the quarterly hogs and pigs report and monthly cattle on feed report, both of which indicated slightly tighter supplies than were expected. Heading into 2016, we will share additional insights into each of the livestock markets, beginning with the impacts of HPAI.

ARC Payments Again for 2015; Less Likely in 2016

With 2014 prices and county yields both now known, it is possible to run some math/numbers and get an idea which way Agriculture Revenue Coverage-County (ARC-CO) payments may go for 2015, which will be received in 2016, and for 2016, received in 2017. Such government support may be difficult to predict due to its moving parts, but it can become a noticeable help to your cash flow, balance sheet other financial measures.

Nationally, more than 90 percent of corn and soybean farms and base acres enrolled in the program. Some 800,000 farms received 2014 ARC-CO payments totaling $3.9 billion, with $3.3 billion of that being paid on corn base.

Based on prices, it would appear similar payments will materialize for 2015. ARC-CO guarantees are based on a five-year Olympic average, dropping the high and low years. USDA’s actual national average prices for 2014 were $3.70 and $10.10. The $3.70 corn price and $10.10 soybean price will replace 2009’s $3.70 and $9.59 as the low prices that will be dropped from the five-year average – so they won’t affect the guarantee. Alejandro Plastina, Iowa State University Extension economist, calculated payments will be triggered at national average prices for the 2015 crop below $3.92 for corn and $10.32 for soybeans.

The wheat price guarantee will improve slightly because 2009’s $5.50 will drop off and the lowest in the new five years will be 2010’s $5.70. The $5.99 seen in 2014 will increase the Olympic average.

The yield factor could increase revenue guarantee

Keep in mind, however, that payments are based not just on prices but on county yields, again using Olympic averages. USDA has released 2014 county yields, allowing estimates for the 2015 crop year. As shown in the table, Iowa State’s calculations indicate the revenue guarantee will increase in more than half of all counties nationally for corn and beans and in 80% of counties for wheat.

Corn Soybeans Wheat
Average increase/acre $13.95 $8.94 $11.47
% Counties with increase 55 52 80
% Counties no change 22 33 0 (3 counties)
% Counties with decline 23 16 20

 

Shown are average changes, but about 20percent of counties will see a corn revenue increase of more than $41/acre, though soybeans and wheat changes are smaller. Notice in the map that parts of Iowa and Nebraska and Kansas will have steady or lower corn revenue guarantees. For soybeans, more counties will see no change.

Lower 2016 guarantees are very likely

Brent Gloy at Purdue University figures it will take a 2015 corn price of at least $5.18 or more and soybeans $11.30 or more in order to avoid a dropping price guarantee in 2016. “Market-year average prices at those levels seem quite unlikely at this point,” he says. USDA’s projected price ranges for corn and soybeans in its December supply/demand report top out at $3.95 and $9.65. For wheat, it will take a 2015 marketing year price of above $5.99 (which will be the previous low price that is dropped) to avoid a dip in the guarantee. If USDA’s December estimate – with a high end of $5.20 – is correct, wheat’s price guarantee also will be lower in 2016.

ARC isn’t a huge safety net – it added less than 10 percent to the gross revenue for the 2014 crop – but for some it may still help income with some 2015 crop payments in the fall of 2016, Steven Johnson told attendees at this year’s Farm Credit Services of America-sponsored Growing On meetings. “Crop insurance is still the important piece of risk management; it guarantees up to 85 percent of revenue,” he said. “That, combined with structured marketing and fixed-cost reductions, are where to focus heading into 2016 and beyond, especially since ARC is unlikely to play much role after 2015.”

Corn2015ARC change soybeans 2015 ARC

Map source: http://ageconomists.com/2015/12/07/how-did-your-county-do-changes-in-the-arc-co-revenue-guarantees/#more-153494

Third Quarter Commodity Review

A snapshot of market forces and current expectations, excerpted from our third quarter financial results for 2015:

GrainThe margin outlook for most crop producers continues to look challenging for the next several years with most forecasters projecting corn and soybean prices to be at or near break-even levels for the average producer. Yields for producers in the Western Corn Belt appear to be above average for most of the crop acres in our territory.

Young TurkeyThe Avian flu that hit the egg and turkey industries in the second quarter resulted in the death or depopulation of approximately 35 million Midwest egg laying hens, decreasing average monthly hen inventories from 300 million in April to 269 million in June, the lowest inventory level in over 10 years. There have been no further outbreaks in 2015 and adversely impacted egg and turkey producers have begun repopulating inventories. However, the potential resurgence of HPAI in the fall from migratory birds returning south represents a risk to the poultry industry in the United States, prompting producers to make bio-security improvements and review potential vaccination strategies. Based on low egg layer inventories, delayed repopulation at HPAI infected sites and seasonal holiday demand, egg and turkey prices are expected to remain high through 2015.

CattleDuring the third quarter of 2015, fed cattle prices declined by $30 per cwt., which represents an approximate 20 percent decline. Feeder cattle prices also declined by $40 to $60 per cwt., a similar percentage decline. This market movement was caused by a larger supply of beef as demand has declined and supply increased. Contributing factors included large numbers of market ready cattle at very heavy weights, competing proteins at lower prices, and a decline in exports related to a strong U.S. dollar. This cattle price decline will result in lower profits for calf producers compared to a year ago, but most calf producers will remain profitable. Cattle feeders will likely experience losses on current inventories that were not covered by contracts or other risk management strategies. In the case of both calf producers and cattle feeders, most producers experienced exceptional profits during 2014 and have retained significant risk bearing capacity going into this market correction.

FarmlandLand prices and demand for farmland have moderated in our territory. Reduced commodity prices compared to previous years has led to some uncertainty and 2015 harvest results could play a key role in future land market values. Lower commodity prices and decreased margins are putting pressure on cash rents and overall land prices.

Click to view full Q3 financial report.

Note: As stated in our third quarter financial report for 2015, current expectations are subject to uncertainty and changes in circumstances. Actual results may differ materially from expectations due to a number of risks and uncertainties.