Average debt across the dairy industry at the end of the 2013-14 season is $18.90/kg milksolids (MS), compared with $20.80/kg MS in 2009, immediately after the Global Financial Crisis (GFC).
The number of rural customers classified as troubled and impaired assets has also reduced to pre-GFC levels, ASB rural regional manager Richard Spittle says.
“The numbers of the farmers impacted are a lot less than they were four years ago. Our customers have been focused on repaying debt and increasing production.”
ANZ rural economist Con Williams said average term debt had increased but the effective rural interest rate had dropped.
“The average actual term debt has increased from $1.899 million to $2.905m in 2013-14. But the affordability/serviceability has deteriorated by the same amount. In part this is due to better productivity and a large average farm size. This has seen the term debt per milksolid produced only rise from $16.5 in 2007-08 to $18.8 in 2013-14.
“The effective rural interest rate has also dropped substantially, so the interest cost per milk solids has actually declined from $1.32/kg MS in 2007-08 to $1.14/kg MS in 2013-14. This peaked in 2008-09 at $1.59/kg MS due to a combination of increased debt and a larger number of farms being on fixed interest rates at the time meaning it took time for lower interest rates to flow through.”
Spittle said some farmers were still over-exposed and some still had above-average debt loading. All dairy farmers, no matter what level of debt, would still need a robust business plan this year.
He recommended focusing on cashflow this year, especially moving into the 2015-16 season when cashflow from deferred payments received in the early season would be well back on the current season.
“There are still a number of customers with high debt loading and with this lower payout, regardless of their cost structure, it will be a challenge to maintain a trading surplus through the coming season.”
The dairy industry had come to expect record peaks and rapid falls in milk price and the bank’s understanding of the volatility associated with agricultural commodities was more developed.
“We understand as a bank that the rural sector is subject to volatility going forward and as a business we need to be managing through the cycles rather than reacting to them. We like to think we’ve learnt a little bit.”
Long-term supply demand versus production growth remained positive for the industry.
ASB rural economist Nathan Penny had forecast a long-run milk price of $7/kg MS plus dividend for fully shared-up Fonterra suppliers.
“We have a confident long-term view of the sector. It’s about keeping cool heads and looking through the cycles to the long-term.”
As always, climatic conditions would play a big factor in the degree of profit or loss for farmers this season.
A nationwide drought in 2012-13 was followed by dry conditions in many part of Waikato last summer and another harsh summer would put extra pressure on farmers.
‘There are some farmers that have very strong balance sheets and are running consistently profitable business that are always looking to grow.’
At $8.40/kg MS farmers justified purchasing extra feed supplement to milk through the dry period and maximise production, but farmers would have to be aware of their break-even point this summer.
Waikato had experienced excellent spring growth, production was up and hopefully the weather would continue to play its part, Spittle said.
“If we do get a drought at some point there will be a cost-benefit point in buying bought-in feed versus drying off or culling early. That’s got to be a rational business decision.”
The challenge to farmers was to minimise their costs, but not at the expense of production. The bank didn’t expect farmers to make radical changes to their farm system because changing the feed-cost structure could be detrimental to future seasons.
The obvious opportunities to cut costs this season were to minimise repairs and maintenance and delay capital expenditure.
Farmers who needed extra financial support throughout the year were encouraged to talk with their rural manager about suspending principal payments for 6-12 months, reviewing their loan to pay interest-only for up to five years, or getting a short-term extension on their overdraft to help with liquidity.
Trading Among Farmers was another option for farmers with surplus shares and more farmers had been trading shares in recent months, he said.
Fonterra’s Dividend Reinvestment Plan also allowed farmers to receive shares in lieu of all or part of their dividend payment.
“There are so many options and it’s becoming more and more a discussion point with us and farmers on what strategy fits their business.”
First-time sharemilkers or people who bought their first farm this season would be feeling the pressure, with no deferred payment from last season coming through to this year’s cashflow, Spittle said. Their lending fundamentals would have been based on a longer term $6.50/kg MS payout and an assumed long-term interest rate of 7.5%. The loans would have been based on making principle and interest repayments with robust long-term cashflows. These cash flows should have been produced with no allowances for the deferred payment, but now had to be adjusted.
“We understand that if the payout sits at or below a low $5/kg MS, not all customers will make a trading surplus. For some it is about minimising a loss.”
In the short-term, the bank had to accept the volatility and put a plan in place with customers.
‘We understand as a bank that the rural sector is subject to volatility going forward and as a business we need to be managing through the cycles rather than reacting to them.’
Sharemilkers who had bought their first farm or had a second job would be expecting a tax bill, along with established farmers after a record milk price last season.
People should talk to their accountant and their rural bank manager if they had to stage their tax payments.
“They have to acknowledge that tax does catch up on them eventually. Tax is part of running a good business – if you’re paying tax it must mean you’re making money.”
Meanwhile farmers who had been paying down debt were, in some cases, looking at opportunities to expand this year.
“There are some farmers that have very strong balance sheets and are running consistently profitable business that are always looking to grow. Some have chosen to buy land this season.”
The fall in milk price this season had not yet been matched by a fall in land value, with record prices being paid in recent sales in Waikato.
“We are not picking up on any deterioration of land value. I thought there would have been a softening in the activity.”
The number of bidders was positive and the hold in land value was a sign of confidence in the long-term vision for the industry, he said.
ASB Rural Economists had forecast a final milk price of $4.85/kg MS for 2014-15, but with the view that further downside risk was possible.
The reduced value of the New Zealand dollar could help stabilise the milk price especially for the 2015-16 season, Spittle said.
