That is the warning from ANZ Bank rural economist Con Williams after factoring in much-reduced deferred winter payments to farmers and sharemilkers and the prospect of a lower opening advance for 2015-16.
Cashflow for the current season was somewhat better than the headline Fonterra advance rate of $4.70/kg milksolids suggested because of the high retro payments from last season’s record prices, Williams said in the December ANZ Agri-Focus.
However, they had now ceased.
“The long-term outlook for dairying remains solid but there are downside risks for incomes over the next two years.
“There is a wide range of business models and leverage (debt loadings) within the dairy sector.”
Williams said the scale of adjustment showed most farms required only careful management at this time.
But if cashflow for next season was to reduce by 85c/kg the 10-15% trimming of core operating costs, including finance, tax and drawings, would be the right response.
The challenge for every farmer would be to maintain productive capacity while reducing the operating costs not showing a marginal return.
That required complex farm management decisions, not just gut instincts, so he advised farmers to follow more formal decision-making processes.
Williams recalled the International Dairy Federation Network did a study a few years back that showed NZ had the most volatile farmgate dairy prices, as well as a high dollar, high interest rates, a changeable climate and environmental requirements.
“While there are many moving parts to the outlook there are more clouds than rays of sunshine on the horizon at present.
“This requires dairy farmers to be proactive to respond to the challenge at hand as well as being well-prepared for all scenarios.”
Williams published a cashflow table for an average dairy farm that showed monthly reductions in milk income, compared with the same month a year ago, of $30,000 at present, rising to $55,000 and then $70,000 in the 2015 winter months.
For example, milk income for the average Fonterra supplier in June 2014 was near $100,000 but would be only $30,000 next June if present payout forecasts held.
His payout assumptions were $4.70/kg MS for 2014-15, plus 35c/share dividend, and $6.50/kg MS in 2015-16 with another 35c dividend.
He also included a downside scenario cashflow alternative based on $4.50 this season and an advance rate of $5.50 for next season.
Such a scenario generated the 85c/kg cash flow reduction and the need for core expenditure cuts, outlined above.
Even that downside scenario would need a 25% lift from international dairy spot price levels now, Williams warned.
He then published an income and expenditure table for the average dairy farm over the past five seasons, sourced from DairyNZ.
His observations from that table included a relatively stable working expenditure averaging $4.03/kg but high capital expenditure totalling $850,000 over five years, 85% of which was financed from retained earnings.
It was estimated $250,000 a farm was spent on capital items in 2013-14, one of the highest annual spends ever.
“Combined with the recent buoyancy in the land market this highlights the confidence that exists in the long-term dairying story.”
Some of that expenditure was compliance-driven but it still showed that projects such as effluent containment generated a solid return on investment greater than the cost of capital.
“Such spending should place the industry in a strong position to weather the oncoming tight period.
“It has, and will continue to, create considerable productive capacity in many cases.”
Williams said farmers now needed to change mind-set from investing for growth in productivity capacity and to meet compliance requirements to managing expenditure and cashflow.
He recommended they seek the help of professionals for budgeting.
