Navigating the Next Normal
If there’s one thing the global COVID-19 pandemic has taught us, it’s that there is no perfect forecast of the future. The pandemic and subsequent lockdowns around the globe took the concept of “not knowing what to expect” to a whole new level. Across the agriculture industry, it was a period of sleepless nights and borderline panic.
From packaging to shipping, logistics issues created an adjustment period for producers and processors as they tried to figure out who was buying what, how to package products and the best ways to deliver food to consumers. As a result, prices plummeted. Then, as consumers feared shortages of more than just toilet paper — including bacon, milk and grains — prices took off.
As the 2020 harvest hit, China ramped up its grain purchases, prompting potential concern about global shortages, which added fuel to rising commodity prices.
For those who were able to figure out their production and delivery, the year was pretty profitable overall. Spurred by government assistance programs for producers (as well as those for regular taxpayers), net farm income for 2020 was the highest in recent memory at $121 billion.
SO, WHAT’S NEXT?
The fact is, we’re emerging from a crazy time, and there is no road map for what lies ahead. Navigating the next normal is front and center in Compeer Financial clients’ minds.
According to Matt Ginder, Compeer’s chief core markets officer, many of our clients are in a good position on paper, but they realize maintaining that position is not guaranteed. “Even with stronger net farm income and greater working capital, there’s still a lot of uncertainty,” Ginder said.
“Commodity prices are higher than they’ve been in quite some time, but they’re still very volatile,” he continued. “How will things play out in the second half of 2021 and into 2022 with less government money, fluctuating prices, unknown crop yields, inflation and potential tax law changes?”
Because we’re fresh out of crystal balls, the short answer is, we don’t know.
CAUTIOUS OPTIMISM
From what clients are saying, Ginder contends cautious optimism is in play. Farmers are envisioning a bright future but have learned from past cycles that it’s probably not wise to go all in.
Between rising prices and government payments, looking at 2020, 96 percent of our grain benchmark clients made a profit with a median cash flow breakeven of $3.62 on corn. Government payments were the difference between profits and losses for nearly a quarter of those clients.
Bill Moore, Compeer’s chief risk officer, has additional guidance. “When things are challenging, many farmers really dig deep to improve their cost of production, manage debt load, consolidate loans and convert higher interest debt to lower rates,” he explained. “By doing that during down times, you set yourself up for greater success when the markets turn.”
Within Compeer’s grain benchmark, the contrast between the top quartile and bottom quartile in cash flow breakeven on corn is nearly 75 cents a bushel. “With a lower cost of production,” Moore noted, “you’ll be prepared to withstand fluctuating prices yet also well positioned for greater profits if markets stay strong.”
We encourage clients to expand that way of thinking and continue it even in periods of stronger profits. This reinforces the advice to always understand your numbers.
CASH ON HAND
The solid year many farmers had in 2020 is carrying over into 2021, putting them in a fairly strong financial position from the perspective of working capital, owner equity and debt per acre.
But with these benefits come more questions. How do you know if you’re at a point where it’s wise to invest in increasing cash reserves? The obvious answer for most producers is to invest in improving long-term efficiencies, which prepares them to take advantage of favorable conditions and weather the storms that will undoubtedly come in the future.
“It’s always good to have a working capital cushion. Get comfortable with that first,” Ginder suggested. “According to our credit team, a good rule of thumb is accumulating $250 per acre of working capital or 30 percent of total revenue.”
Next, take some time to make sure your financial house is in order. Dig into your numbers and become really familiar with your key ratios and metrics, as well as how they compare to management and benchmark targets. A few key metrics to evaluate:
• Working capital
• Owner equity
• Cost of production
• Breakeven
“This step is particularly important when things are good financially and you have the luxury of evaluating your long-term goals and looking at all the alternatives from a position of relative financial strength,” Ginder said.
At times, he noted, you may wish to heed the old saying, “You’ll never go broke selling at a profit.”
In addition to understanding your numbers, it’s also important to maintain your crop insurance plan and develop and follow a written marketing plan.
NEXT STEPS
Once you have a good handle on your numbers, it’s time to work on your vision for long-term success. What’s important to you, what are your operational goals? How will you achieve what you want to do?
One way to explore the financial ramifications for different options is through a what-if scenario analysis. That’s the benefit of partnering with an agriculture lender that understands your business and the cycles of agriculture. Some options to consider that will help position your operation for future success include:
- Investing in transition/succession planning
Depending on your age and plans, you may be concerned about upcoming capital gains changes. Start planning for that now, think about generations two and three and ways they can gain some equity in the operation.
How do you move the assets from the older generation to the younger generation? It can take several years to get to the point where the younger generations can finance their equity. Taking the initiative to work with advisers when you’re not cash-strapped or in a hurry can make a big difference. - Investing in efficiency improvements
These investments may help you maintain a competitive cost of production. Making appropriate equipment upgrades may add additional efficiencies to your operation. Just ensure you are maintaining an appropriate cost per acre. - Expanding and diversifying
Expanding can be tricky, and it’s not for all operations. In the right circumstances, however, it could be worth considering. Thinking creatively and specifically will be key. - Deferring income and prepaying expenses to manage your tax bill
- Paying down debt
Take advantage of the long-term interest rate environment. Rates are as low as they’ve ever been. Ten years from now, you don’t want to be wishing you had taken advantage of 2021 interest rates. Rates go in cycles. Anyone who locked them in in 2021 will be patting themselves on the back for the term of their loan.
Paying down debt can also be a great way to position your operation for the next cycle. Is there an opportunity to term out some debt and lock in low rates for 20 to 30 years? Or perhaps consolidate some different debts and term that out. Most can be done with just a handful of months of payback. At Compeer Financial, we offer a conversion feature on our loans so it’s hassle-free with no new appraisals, documents or hoops to jump through. - Saving for a rainy day
Sometimes the best action is no action. As Moore says, numbers don’t lie. “The math has to work for you and your business in the long term. It’s never a bad idea to put some cash aside for a rainy day.”
UNIQUELY PREPARED
Farmers have always been good at identifying risks, but right now, discerning and mitigating risk are more important than ever. In uncertain times, it’s important to feel confident about the business decisions you make.
“The next six months have the potential to be a wild ride,” Ginder said. “Volatile weather, swings in markets, strong real estate sales in parts of our territory, ongoing impacts and uncertainty about COVID-19 or even potential shutdowns could be on the horizon. Nobody knows.”
That’s why you need a solid, long-term financial partner that understands your operation and is invested in agriculture for the long haul. At Compeer, it’s our job to help you navigate to your desired outcome — whether it be expansion, preserving working capital, passing your farm to the next generation, investing in operational improvements, managing income tax liability or whatever success looks like to you.
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