Time’s up for farmers to do a stress test
It’s time we all did a farm financial stress test. We are 10 years on from the start of the world financial crisis and we need to be ready for another one. Farming commodities have always cycled and it is about demand, supply and the climate. But we need to be mindful that the worldwide financial debt and leverage of that debt is now higher than 10 years ago.
Quite simply, New Zealand farming is not strong enough to cope with a weak commodity cycle for long. Historically low interest rates over most of the last 10 years have camouflaged many farmers’ annual financial results.
The time to do a stress test is when we are in a reasonable financial position - somewhere between 9am and 3pm on our economic clock - which for many is about now. We should take the initiative on this issue and not wait for the banks to request this action. So, what would a reasonable stress test approach to this year’s budget be? For dairying, work on a milk solids payout including dividend of about $6 a kilogram of milk solids. Likewise for sheep and beef farming work on a lamb sale value of about $85 a head and for beef sale values perhaps 15 per cent lower than the previous year.
Factor in total bank term debt being interest bearing at 6.75 per cent - that is about 22-28 per cent higher than at present for many.
Then ask yourself if you can completely repay your interest bearing term debt within 30 years from annual farm trading surpluses, including personal drawings. After applying the stress test data this would represent an average term debt reduction of about 3.3 per cent per year.
I spent some time many years ago in a large New Zealand bank and worked on credit control for a period, then three years of financial trouble shooting around New Zealand and lastly as a specialist farm accountant. This is what I learnt that might help your stress test approach:
Farming losses tend to make farming people stronger and usually two key enterprises on a farm is enough. Rates and insurance are really fixed costs and are getting up near $700 - $800 a week for many farmers.
Farm working expenses keep creeping up and you should ignore government cost/price indicative data. The key is the cost at your farm gate. At an average annual cost increase of about 3.25 per cent over your working lifetime, farm working costs are going to double every 22 years. For the average farming couple their farm working expenses will be 200 per cent higher when they retire than when they started if they work on their farm for 44 years, which many do.
Decisions to reduce costs usually lead at the same time to a lower overall income - a level of risk is traded for a level of acceptable return.
Booms always bust and busts eventually boom - both can be quick to change but can also be slow to change. But change they will - usually over my lifetime every five, six or seven years. Plan B is all about anticipating a disaster, whether it is price wise, weather wise, production wise or labour wise. A low cost of production over time is usually the best approach if only because you can control it. Quality eventually prevails and that includes good seed, good advice, good soil, good marriage. Farm soil tests tend to be underrated in their importance. The law of the minimum applies and by that I mean that plants tend to keep growing until they run out of the most limiting nutrient.
For the top farming group, managing risk is the key and this holds all the pieces together. They are invariably benchmarking against their peers. They are good on the ground but also good six feet above the ground. It is surprising how some top operators take a counter cyclical approach it is all about opportunities.
I feel with Australian bank ownership that NZ farming is going to hear more talk about stress testing every time there is a major farming downturn in farming. My advice is to not fight this and get on top of it.
❚ Pita Alexander is an accountancy and agribusiness director at Alexanders.
Booms always bust and busts eventually boom Pita Alexander