Often, when discussing debt funding strategy with a customer (and total farm strategy for that matter), I often bring out this graph as starting point. It’s a pictorial representation of:
1. the total milk payout returns since 2007, including a rolling 10 year average line (*the grey rising line) and
2. the actual cash payout to farmers in that particular year (different than headline payout as it’s a mix of deferred payments from the previous years and the current years “advance” payments).
It always gets a bit of conversation flowing with a number of simple observations:
1. Firstly, everyone starts to notice the unmistakeable 3 year rolling trend which now seems embedded in the cycle – i.e. one great year followed by either a very poor year and then a ho-hum year. Given NZ is one of the dominant producers of exported dairy commodities, we have an inordinate effect on world prices – so this cycle is simple economics playing out- Price goes up, leading to more supply, leading to lower price, leading to less supply, leading to higher price… and so on, you get the picture.
2. Even this year with dairy payout improving, you can see why there’s still a bit of pain- this year’s cashflow, including dividend, is still only $5.75 (versus “headline” incl. dividend of $6.55)
3. But the flipside of this, is you can see why most managed ok during the commodity downturn. From a cashflow perspective, only 2016 felt really ugly at $4.20 cash paid (including dividend), but 2015 cashflow was $6.05 and 2017 is $5.75. The so called “worst dairy downturn” doesn’t feel so bad when you look at it like that does it?
4. Even more positively, next year’s cashflow (including dividend and assuming the current FY 18 forecast materialises- a very dangerous thing to suggest!) the farmer cashflow is back up to $6.90.
5. At $6.90, this compares very favourably to the long run averages (which are actually higher than you might think- see point 6 below)
6. With 2017 payout included, the average fully shared payout over the last 10 years is $6.37. If you include next year’s forecast (2018), its similar at $6.29 (drops down a fraction as 2008 drops out of the dataset which was $7.60)
You can’t consider a fluctuating revenue stream without considering fluctuating operating costs
Note:
1. COGS = “Cost of goods sold” = Farm working expenditure.
2. Milk price margin= Milk cashflow paid for in that financial year less farm working expenditure
3. Source data: Dairy NZ, NZAB
The average milk price margin (milk price over farm operating cost) since 1999 is $1.71. Next year, is set to be well above this. Also, when you look back over the last 10 years, only last year steps out as being truly out of whack versus the average.
So did we really have a truly terrible dairy downturn?
So, to sum up – these analytical points don’t make a business strategy in themselves, but the do help with your thinking of how you execute both your operating strategy (production and variable costs) and your investment strategy (debt structure and asset allocation).
Knowing that farmers:
1. Have a 10-20 Year + strategic mindset
2. Are used to the cyclical nature of commodity prices, including years where losses are incurred
3. Are largely invested in one asset class
Then it makes sense to follow a longer-term view of milk parameters and importantly, a longer-term view of your own margin over costs, when making investment decisions.
All farms are different. They have different people, different objectives, different balance sheets, and different viability. All of these factors, (including the preceding milk payout analysis) need to be taken into account to ensure the business has a consistent strategy and, just as importantly, is resilient to the low points of the cycle.
