“So do your budgets and be careful how optimistic you’re being,” DairyNZ project manager, people and business, Geoff Taylor, told a recent Morrinsville workshop on investing in off-paddock facilities.
Farmers should ask themselves about their financial goals and whether intensification would achieve them, as well as what the financial impact would be. They should also consider whether farm staff had the skills to manage an intensified farming system and how the operation’s risk profile would change.
First, farmers needed to think about the real driver for considering intensification. It could be stock performance, boredom or keeping up with the Joneses, all of which were valid, Taylor said. However system intensity was not a good predictor of animal outcomes, with DairyBase data showing there was no relationship between feed costs and improving in-calf rates. Some farmers with feed costs less than $200 a cow were achieving similar results to those who spent more than $1000/cow.
Intensification was a good predictor of milk production, a moderate predictor of operating profit but a poor predictor of operating return on assets and equity growth.
Some options came with a significant cost and had the potential to erode equity quickly.
“Some people do quite a limited analysis before following their neighbours because they’ve made money,” he said.
Cow shelters costing from $1000 to $4000/cow needed to be seen as a depreciating asset not an appreciating asset like land.
Environmentally, intensification could have positive and negative implications.
“You don’t know which until you do the numbers,” Taylor said.
Studies had shown that if a farm operating under Horizons Regional Council’s One Plan built a cow shelter because it was losing money because it needed to cut back on nitrate leaching, it lost less. At base production of 350kg milksolids (MS)/cow or $950kg MS/ha the housing option showed a net present value (NPV) loss of $6400/ha. At moderate intensification, giving production of 400kg MS/cow or 1300kg MS/ha, that loss was reduced to $3700 NPV/ha. To get the best results the system needed to be further intensified, meaning profitability ended up close to where it had started from, with production of 500kg MS/cow or 1630kg MS/ha showing a positive NPV of $1300/ha.
Waikato case studies showed results from a 47% reduction in nitrogen loss to water/ha/year to a 67% increase. More research was being carried out.
Two dairy farms were modelled for low, medium and high intensification, one in Canterbury and one in Waikato (see Table 1). In Waikato, while MS production/cow and gross revenue/ha increased at higher intensification levels, operating profit didn’t lift as much because of feed substitution. In Canterbury there was less opportunity to get it wrong, Taylor said.
The return on assets (ROA) for the six different options varied from 4.7% to 6.2% which he said would have farmers either questioning whether intensification was worth it or not hesitating before going ahead. But he cautioned this was just a snapshot.
“Intensification is an investment decision and should be evaluated with respect to the quantifiable benefits generated over time and associated risks.”
The value of assets over time was a very important part of the equation and he urged farmers to be challenging when they heard different data and to ask hard questions.
“People often buy on emotion and justify on logic,” he said.
“Ask the questions that dig in behind.”
He showed a comparison of a low to medium intensification move giving an operating profit of $225/ha compared with a low to high move which resulted in a $498/ha operating profit. Operating return on assets was calculated at 2% in both cases with payback periods calculated as 7.3 years for the first and 11.5 for the second.
The internal rate of return was 11.7% for the low to medium change and 4.6% for the low to high move. The outcome was a NPV of $828/ha for the first, creating value, and -$891 for the second, which destroyed equity in the business.
In case studies from real farms a barn cost $1440/cow with total costs of the change of farming system reaching $1756/cow. Supplement use increased by 223% but MS production 22%. The ratio between the total cost of intensification and the cost of the barn when machinery, shares, stock and effluent disposal were added was 1.22. Operating profit was $907/ha with the payback period nine years. ROA was 11%, giving an NPV of -$924/ha and an internal rate of return (IRR) of 7%.
In contrast another barn which cost $2320/cow and system change which cost $3970/cow in total, meaning a ratio of 1.71, saw a 145% increase in supplements which caused MS production to lift 36%. Here operating profit was $589/ha, it took 17 years for payback to occur and the ROA was 6%.There was an NPV of -$7378 and an IRR of 1%.
Taylor said over-capitalisation was also a risk. A $6.384 million low input farm investing $188,000 to move to a medium input system or $567,000 to become high input showed a market value of land and improvements of $6.480m or $6.578m for these alternatives, an analysis showed. The market value of the investment was calculated at $96,000 in the first case and $194,000 in the second meaning a 49% or 66% discount on the cost of infrastructure.
“Using the wrong tools can be misleading and lead to uninformed decisions,” Taylor said.
“You must value the investment over time and NPV is your best bet as it gives the best indication of how equity will change over time.”
Farmers should run their own figures instead of using benchmarks. And they needed to remember it was not all about the money as they could have different values and drivers.
“The final decision may not maximise profit,” he said.
Other considerations could include lifestyle, cow benefits, interest in what they were doing and managing a perceived risk such as flooding.
“You must have your eyes wide open and think about regional and countrywide implications too. People often overestimate their skills as they don’t understand how the risk profile of their business has changed.”
The right skills to match the planned intensification were important. With good management any system could get a good return. High-input systems meant more decisions had to be made so managers needed to be experienced and understand the key levers of the business. They had to benchmark, budget and monitor against a plan, network and operate in a decision-making team. If staff didn’t have these skills, farmers needed to know how they would secure them.
Risks such as projected benefits not being achieved, milk price volatility, being locked into the system, unbudgeted additional spending and higher interest rates increased as systems became more intensified. Some could have a high impact on the business, along with risks which had a low likelihood, such as breaching animal welfare or environmental standards. Farmers needed to understand all risks and manage high-impact ones rather than just letting them happen.
“You need to do a sensitivity analysis to find out what your survivability’s like,” he said.
“If intensive farms go wrong they can go very wrong. And remember that a 10% shift downwards in international prices wipes out 45% of New Zealand farmers’ profit but 80% of United States farmers.”
