The Low Margin Era of Agriculture

In a recent seminar, Dr. David Kohl advances that we have moved from a commodity super cycle peak to now an extended low margin era in farming.  By now, I hope that most producers have moved on from the peaks in prices we saw half a decade ago.  But multiple years of high prices are like an all-night party, the hangover effects tend to linger long after the soiree is over. 

New technology in agriculture will continue to keep supplies in excess of demand.  The producers who will survive the low margin era are those who are able to strategically embrace technology.  Nebraska had its first soybean field planted with a driverless tractor in May.  Last year, England had its first barley field successfully planted and harvested without a human setting foot on the ground.  These changes in technology will both lower the number of laborers and change the type of labor needed down on the farm. 

Another factor for the low margin era is the new worldwide resources of land that are going into production.  This year, new land which will go into ag production equals the size of the states of Vermont and Maryland.  Brazil, which is already getting two crops per year with some of their grain production is looking at how to now get three in a year.  This will continue to drive up supply.

Weather is always a huge factor.  We have seen producers in the middle of the U.S. this year who are not able to get a crop in the field due to the excessive moisture and flooding.  All these factors combined mean that huge profits we saw like the long home runs will be replaced with smaller bunt singles, base hits, and sac flies to get profits over the plate.  This will be a new era of managing expectations and a focus on the financial fundamentals of the producer. 

In the low margin era, the proactive producer will be the one who thrives.  These folks thoroughly understand and can effectively communicate their financials both on the farm and to external advisors.  They monitor their expenses and revenues be each line, knowing that a 5% increase on a revenue line and a 3% decrease in an expense line may make the difference between profitable and in the red.  Proactive producers have a well thought out marketing and risk management plan which they execute.  They are driven to outperform their neighbors in all areas.  All production assets of land, machinery, labor, and capital are fully employed.  Finally, they have a modest personal life and are not excessive spenders. 

Those producers on the struggle bus are often equity complacent.  They don’t seem to care about multiple years of losses as they have plenty of equity on the balance sheet.  They have growth issues with a lack of capital, technology, or management.  There is no transition plan to exit farming or know how to have the ranch successfully move to the next generation.  They are often unteachable, falling on one of two extremes.  The producer is either a victim with a cloud of problems that follow him like Pig-Pen, or he is the fount of all things farming and will not be taught anything new.  It is often in these families, you will see a lack of financial discipline and planning.  Spending will run wild and free. 

In the low margin era, it is more important now than in the past to accurately be able to monitor the management ability of your producer.  Everyone can close their eyes and hit a ball over the fence occasionally.  You want to see those who are heavily disciplined, working day in and day out to do the little things right.  We have a tool on the website that can help.  If you go to our agriculture tab here: at the bottom, we have an Excel sheet you can download called “Rating the Management”.  This sheet has 20 questions that rate the producer in areas of financial, production, marketing/risk management, and other.  I suggest that just as important as it is to risk rate your ag credits using financial analysis, it is also important to rate the producers.  Understanding these may help you know which ones you want to move out of your institution while there is still time and which ones are the ones to keep.

I would be amiss if we only focus on the producers in the current low margin era and leave out the lenders.  Some of you reading this blog may be in an institution which will not survive the low margin era.  The Federal Reserve is already raising the warming flag for small, heavy weighted ag credit unions and banks.  Some of you tend to want to bury your head in the sand and wait for this time to pass.  But you do not know when that will happen and when your head is buried, other parts of you are exposed!

First, make sure you are using financial statements and your analysis of the management as tools to communicate in your institution and with your producer.  Remember, you want to show the issues and give them options.  They will need to decide what actions to take. 

Next, make sure what the producer is saying is correct.  Is there actually grain in the bin?  Did the farmer contract his price?  Is there crop insurance?  The low margin era will test the honesty of some producers. 

Third, make sure you and all on your team are investing in continuing education, training, and personal development.  The time you think that you understand it all, is the time you will fail.  I suggest that everyone should have at least 40 hours, and probably more, training annually in areas of their job. 

Fourth, make sure you are calculating the financials correctly and critically thinking through what you are seeing.  Try to take off the friendship you may have with the producer or relationship with both of you coaching the same little league team.

Finally, remember as a lender you need to be conservative in good times, courageous in tough times, and consistent all the time.  By doing so, you can succeed as a lender in the low margin era.