Now it seems the land price topic risks being more bad news when we are awash with that – the industry is now facing the reality of a $3.90/kg milksolids (MS) milk price and commodity prices don’t look positive for next year. Three years of low milk prices would be very hard for most of the industry to manage, with the potential for very severe consequences.
Needless to say it is guaranteed that land prices will fall and perhaps significantly. Our rolling average milk price has now fallen from $6.80/kg MS in 2013-14 to close to $5.70/kg MS this year and could fall further by next season. But I would pick that the 40% land price fall estimate by the Reserve Bank’s worst-case scenario, and some commentators, won’t happen. There are too many relief points in the system, including buyer interest from offshore, whether we like that or not. There will be domestic market interest as well from buyers supported by record-low interest rates and confident the medium-term milk price will sit somewhere between $5.50/kg MS and $5.80/kg MS.
Rather than talk land values when so many variables are unknown, I thought despite farm financial management being one of the most boring things to write about, the topic and the opportunities have never been more relevant or important.
There are many fantastic stories of farmers managing costs well, with tips, ideas and approaches in this magazine and others. But I thought it worth writing about the process of managing finances because what we do with our budget is more important than just having one.
I run the risk of offending readers here, but evidence suggests the industry is not, on average, very good with financial management. A survey at last year’s National Fieldays at Mystery Creek showed 44% of farmers said they didn’t have a budget, and elsewhere it has been reported only 15-20% of farmers regularly review their budget through the season. These statistics might sell New Zealand dairy short, but overall not many farmers are able to forecast their cash, profit and loss, and balance sheet position.
The process that we find useful with our business, and with my own farm is as follows:
- What is the context, what are we aiming to achieve?
- Setting assumptions; optimistic, realistic, pessimistic.
- What farm system and farm management plan will best achieve our targeted outcomes?
- Plan the detail.
- Check implementation of the plan and regularly re-forecast.
- Use tools that make re-forecasting easy and that keep your professional team informed and involved.
The most important context is our own financial situation. Is the business focus still on the medium term? In which case we are looking to minimise the damage from the dairy down-turn – we want to maintain soil fertility and pasture species as best we can, we want to ensure we are still rearing enough good quality replacement livestock, we are replacing the plant and equipment which would, if kept, start to cost money for repairs and maintenance, and at the same time we want to minimise debt build-up.
Most of us should know or at least sense if the financial situation is more serious, in which case the priority is the next 12 months. This is a case of doing what we must do, and not much else. This short-term approach has graduations, from targeted maintenance fertiliser on the lower-fertility paddocks to no maintenance fertiliser at all. Hopefully you have the support of people who can assist with targeting limited funds.
Then we need to, independent of Fonterra, consider our budget assumptions, particularly around milk price. For many years Fonterra set conservative milk prices, and for 7-10 years the milk price was that or higher. For the past two seasons high opening milk prices have become low ones – it is sensible I think to be doing initial budgets somewhere around $4.50/kg MS. The 2016-17 season is definitely one where the risks are asymmetric – it’s far better to overachieve a conservative budget than underachieve an optimistic one.
We then need to make some farm system and management decisions. With lower prices most of us will be tending to reduce stocking rate, reduce bought-in feed and be tending towards a more self-contained system. Although the Dairy NZ labels of System 1 (self-contained, no feed inputs) to System 5 (grazing off, high bought-in feed) are useful, it doesn’t mean that System 1 = low-cost and System 5 = high-cost. There are examples of low cost systems whether low or high input. The objective of the planning exercise is to keep production as high as sensibly possible supported by the lowest possible cost structure.
For example, a 200,000kg MS farm has an operating cost structure of $800,000 including drawings. If we can achieve a budget producing 5% less milk (eg 190,000kg MS) but with 10% lower costs ($720,000) then we can reduce our operating cost structure from $4/kg MS to $3.78/kg MS. Provided debt servicing levels are not too high, and we are still earning a dividend on Fonterra shares, we still have a good chance of breaking even at a $4.50/kg MS milk price.
To get maximum value, we need to construct our budgets in some detail. Although a budget that estimates total fertiliser spend is a start, it’s better to go to the next level of detail, the tonnes of each type of fertiliser we expect to use and the price that we expect to pay for that fertiliser. If the price of urea falls, we can adjust the price in our forecast but keep the tonnes the same. That way we make sure the gains in reduced pricing flow through to lower expenditure.
A budget only works if it’s used. We sit down each month and look at actual expenditure. We want to ensure we’ve received the goods and services we’re paying for, we’re paying what we expected and check whether the expenditure happened in the month we thought. This latter point is important because we might need to adjust the forecast position based on what actually happened. We also take the chance to review the coming months and the seasonal impacts on likely income and expenditure.
Use the right tools. There are some smart tools available in the market. These products are moving to the cloud which enables production and milk price changes to be automatically updated. These tools take account of the effect of selling down livestock on the cash and balance sheet position. They also allow us to work collaboratively with our consultant, accountant and banking partners. Ask them about the options available. There is no substitute for good communication at times like these.
Lower-order sharemilkers and contract milkers might not have so much flexibility to reduce costs and make do.
On one farm I am involved with in Southland, costs have been reduced from more than $5/kg MS to $3.80/kg MS. Cost reduction has been from two factors – feed and grazing costs are down by half and
we have fewer cows producing more per cow.
But our contract milker is now getting more than $1.30/kg because of the additional work they are doing – in this case money well-spent. It has been said many times but it’s worth saying again, without our farmers we don’t have a farm so let’s look after them as best we can.
It’s not all doom and gloom. Fonterra shareholders should receive a strong dividend and beef prices are up – both factors that mean farmers can operate and break-even at a lower milk price.
Dairy will be strong again, land prices will reflect their earnings, and farm businesses will be successful. But I can’t help thinking those in the driving seat will be strong financial managers.
Andrew Watters is the first to contribute to our new Industry Insight column, where industry leaders bring up an issue they have been pondering. Andrew is executive director of MyFarm, a farm and horticultural block syndication investment company, a Nuffield scholar, and, with his wife Alison, past winner of the Sharemilker of the Year title and owner of a 600-cow Wairarapa dairy farm.
