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Payout lift opens up dairy opportunities.

Tags: Rural Rural Insight

Fonterra’s recent profit announcement and payout confirmation of $6.12/kg milk solids (MS) plus a dividend of 40c/kg MS was greeted with a collective sigh of relief by farmers and rural communities around New Zealand last week.

The volatility of dairy payouts is now such that farmers only feel confident when the final payout is confirmed, and in their bank for the season, given that volatility over the past decade has been double that of the 20 years before.

The recent annual AgFirst Waikato-Bay of Plenty dairy farm cost survey highlighted just how vital a payout with a “6” in it was for farmers not only in the study region, but nationally.

Survey compiler Phil Journeaux found the model farm used in the annual survey had incurred an additional $126,000 of term debt as overdrafts were capitalised into loans to cope with the low payout of 2015-16.

Bayleys national country manager Duncan Ross said this amount has proven a significant figure for bankers seeking to get funds repaid by farmers as the payout takes a swing up. It is almost an additional $1 a kg milk solids of debt for the average dairy farm, but amounts are significantly greater for larger operations.

He describes many dairy farmers facing a “back to the future” season as the improved returns promised get channeled back into debt repayment, to get them back to a debt position they were in over two seasons ago.

“As an industry agriculture still faces some issues around debt, and dairying in particular. “The rate of agricultural debt growth sped up through the past couple of years, growing 7.5% to July 2015, then 5.4% to July 2016, slowing somewhat this July to 2.5%. A large portion of that has been dairying having to take on board debt to cope with the downturn – banks are going to want to see some of that repaid now.”

Of the almost $59 billion now owed by the agricultural sector, estimates are almost $50 billion is owed by dairying.

This significant upward movement in debt loadings has led to a shift in bank’s expectations on loan amortisations in recent years.

“It had proven relatively easy a few years ago to acquire a loan and only be expected to make the interest repayments on it. However a shift in attitudes and the last downturn means banks are looking to recover significant levels of debt from the sector, in some cases debt is as much as$40 - $50/kg milk solids.”

He anticipated for some farmers carrying large levels of debt, the lift in payout would prove something of a double edged sword.

"For some farmers carrying large levels of debt, the lift in payout would prove something of a double edged sword."

“Assuming they can maintain their lower cost levels, great, but the increased profit levels will be sought for repayment on principal, and that comes from after tax income.”

Banks have also been struggling for deposits on a tight local market, further prompting them to try and recoup more principal from large local rural borrowers, in order to lend on to new borrowers.

Duncan noted that despite a tough three years the dairy sector had on the whole weathered the downturn relatively well, with only the most extreme debt laden operations being forced to exit.

“Typically most people have looked at their cost structures and gone back to farm how they farmed 10-12 years ago, with lower inputs, particularly lower bought in feed levels, and in some cases lower stocking rates.”

This was borne out by the results of the AgFirst survey this year. Survey data highlighted how dairy farmers had managed to reduce farm working expenses back to 2013 levels. For 2016-17 they were $3.81/kg milk solids, and for 2017-18 were estimated at a similar level, $3.77/kg milk solids.

The feed cost component of farm working expenses has dropped from almost 36% three years ago to 28%. Total farm working expenses were going to be a more manageable 57% of total farm income for this season, compared to 65% for last season, and a massive 95% over 2015-16.

Duncan says the lift in payout brings the opportunity not only to repay some debt, but for farmers to make some major strategic, even succession, decisions about their farm and family’s future.

“The lift provides an opportunity to assess where you are at, and if perhaps it is time to move your asset. It could be you have a portfolio of farms, this is a chance to soundly evaluate their profitability on a more sustainable payout footing, and decide if perhaps it’s time to quit some of that debt and shore up the balance sheet, or release some of that equity within the portfolio for other investment.”

He said interest in dairy farms remains strong, founded on a belief in the industry’s long term fundamentals. There were also buyers in the market in strong cash positions who were appealing customers to banks wanting borrowers with good equity input.

"Interest in dairy farms remains strong, founded on a belief in the industry’s long term fundamentals."

“There is a real silver lining in a decision to sell down and end up in a healthier equity positon as a result. This can enable you to focus on investing in the remaining farm asset, improving the operations you decide to retain.”

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