Buckle up your safety belts. Crop producers will need to drive defensively in 2015.
It’s still early in the new-crop season. True, 2015 corn prices have climbed more than 70 cents since bottoming in late September. There’s even a chance corn futures could spike as high as $5.20 by midsummer, if weather scares and demand tweak markets just right, DTN’s Senior Analyst Darin Newsom told the DTN/Progressive Farmer Ag Summit earlier this month.
Despite that potential, growers with debt still face a worrisome scenario in the year ahead. Cash rents haven’t budged much, fertilizers still hover above year-ago levels and seed discounts haven’t materialized. When spring crop insurance guarantees set for most states March 1, they aren’t likely to cover cost of production, land-grant universities forecast.
So the uncomfortable discussions with farm lenders this winter may focus on minimizing losses, not necessarily showing a profit in 2015.
When AgStar Financial’s Jim Moriarty advises audiences of Midwest corn and soybean producers, he urges them to prepare for two to three years of tough markets ahead. He points out that USDA’s gloomy five-year season average cash price outlook for corn through 2018-19 runs a mere $3.51 per bushel.
(Updated USDA forecasts released this week peg 2015-crop season-average cash corn prices at $3.40 per bushel, wheat at $5.00 and soybeans at $8.50 — all pretty much below cost of production for many growers.)
At normal yields on a typical Minnesota farm in AgStar’s upper Midwest territory, that scenario could burn through $165,000 in losses for every 500 acres of corn, Moriarty said.
“Burn rates” at that velocity will leave lenders requiring more comfort. Instead of the normal $200-per-acre working capital levels that sufficed for corn growers in the past, Moriarty thinks $400 to $600 per acre might be necessary to withstand back-to-back losses.
That could be a special hardship for operations that have experienced rapid growth in recent years, or younger operations that have not acquired much equity yet. On the other hand, established operations will benefit from holding enough cash to capitalize on opportunities when they occur.
“It may take several years to get costs back in line with prices or for supply and demand to rebalance,” Moriarty said. “There’s no need to overreact, but proactive financial management is important. It’s always best to plan from a position of strength.”
GET ‘ER DONE
One starting point is to winnow cost of production. Based on 2013 farm financial records, the high-cost 20% of farm operators in southern Minnesota needed $5.77 to breakeven on corn, according to Bob Craven director of the Center for Farm Financial Management at the University of Minnesota. In contrast, the low-cost 20% needed only $3.88 per bushel, including land costs.
By Craven’s calculations, the low-cost producers “could almost make money” if corn prices come close to $4 in 2015, not counting any potential government payment from the new Average Crop Revenue (ACR) program. On the other hand, high-cost producers in his sample face red ink under almost all scenarios, he said.
Accurate cost assessment is crucial, he added. Operators who use the cash method of accounting for tax purposes — instead of accrual accounting — may have a distorted view of their profits. Over a five-year period, the difference between Schedule F incomes and accrual net incomes can vary about 66%, he said. Buying more farm equipment at year-end to avoid paying taxes on a cash basis is the wrong answer if you’ve had an accrual loss.
Fortunately, many operators are entering this down cycle healthier than at any time in their careers, giving them opportunity to refinance or restructure debt with favorable terms, said Farm Credit Services of America CEO Doug Stark. Farmland values remain near all-time historic highs. For three consecutive years, between 2010 and 2012, Iowa operations earned $2-per-bushel profit margins averaging over $350 per acre, he noted.
“Those are extraordinary margins, and this was average,” Stark said. “It wasn’t uncommon to see farmers with $500-per-acre net margins back then.”
That’s equity that might be deployed now. For example, it’s still possible to refinance equipment where you have significant equity in five to seven year, fixed-rate loans at 3.9%. Surprisingly, mortgage rates have also tumbled in the last few months, giving those with real estate ownership a chance to lock in 20-year mortgages around 5% and freeing up cash to cover rainy day funds. Working capital is the first shock absorber for volatile markets, so making sure you have enough provides security in uncertain times.
“Do it now after two or three years of profits,” Stark said. “If you come in to a lender’s office after two or three years of losses, you’ll be having a different conversation… There’s a cost to holding liquidity short term, but look where you might be three to five years from now.”