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Address short-term financial challenges

Progressive Dairyman Editor Dave Natzke Published on 19 December 2017

While the long-term outlook for agriculture is bullish, dairy producers face short-term financial challenges, Rod Wautlet, Agri-Business Consultants LLC, told producers attending the 2017 Vita Plus Dairy Summit, Dec. 6-7, in Madison, Wisconsin.

Among the major challenges in the year ahead are lower milk prices, continued downward pressure on milk premiums and hauling subsidies negatively impacting basis, debt carryover and/or servicing costs, and inflation related to labor costs.

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Wautlet said milk price forecasts have changed dramatically in the past three months, with the end-of-November price outlook down over $1.50 per hundredweight (cwt) compared to price projections in September. The 2017 Class III price will average about $16.34 per cwt., but the 2018 average could dip below $15 per cwt.

Combined with shrinking basis (see Analysis finds wide range in ‘basis’), many producers face the prospect of milk income falling below break-even levels.

While Wautlet sees an average cost of production of about $16 per cwt (Class III) among the herds he works with, there’s a plus or minus $1.50 per cwt range ($14.50 to $17.50 per cwt). “If your cost of production is $16 per cwt on a Class III basis, and we’re projecting a 2018 Class III price of $15 per cwt, there’s going to be an $1 per cwt gap we’re going to have to figure out how to deal with,” Wautlet warned.

In addition to lower milk prices and shrinking basis, dairy producer nonmilk income from bull calf and cull cow sales is down $1 to $1.50 per cwt from highs of 2015, he noted.

“Short-term, we have to minimize our losses,” Wautlet said. “It’s going to be damage control, and we need to live to see another day.”

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Affecting liquidity, Wautlet said some of his clients do not have 2017 cropping lines of credit paid off as the year comes to an end. In addition to paying interest on that carryover debt, fewer producers have prepaid for 2018 operating costs. (A show of hands revealed few producers in the audience had prepaid for 2018 seed needs.) Those producers also lose any cash discounts offered by suppliers.

Identify ‘lazy’ assets

Wautlet urges producers to evaluate current assets for utilization and efficiency, with an emphasis on “how hard those assets are working for you.”

“How fast you are using and turning over assets?” Wautlet asked producers. Categories of lazy assets he commonly sees are surplus dairy replacements and feed, as well as holdings of high-priced land.

“We have gotten so good at management that we have surplus females,” he said. “The good news is that we have youngstock; the bad news is we have youngstock. We need to be able to project what are needs are, but with the average cost to raise a heifer at $1,700 to $1,800 per head, dairymen selling youngstock are losing money.”

In addition, the cost to carry feed inventories are huge.

Production targets

From a production standpoint, producers should strive to sell more than 1 million pounds of milk or more than 65,000 pounds of combined fat and protein per full-time employee per year, Wautlet said. A good production goal is to sell 6 pounds of combined fat and protein per cow per day. In addition, maintain a death loss of less than 6 percent; have a pregnancy rate of at least 25 percent; and keep the somatic cell count less than 150,000 cells per milliliter.

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In addition, producers must know their cost of production and identify ways to adjust it.

“You can only change your COP four ways,” Wautlet said:

1) Get the same amount of milk on less expenses

2) Keep your expenses the same and get more milk

3) Increase nonmilk revenues

4) Change your basis

Producers should know what’s included in the numbers, including owner draw, principal payments, depreciation and capital replacement. Nonmilk revenues, including livestock and crop sales, should be accounted for.

Monitor key indicators

Wautlet lists key financial indicators for a dairy business, establishing goals and identifying levels which make the business “resilient,” in position for “recovery” or leaving it “vulnerable” to challenges. They include:

Asset turnover is the value of production from assets and is a measure for how efficient the business is in using capital.

Goal: greater than 40 percent

Resilient: greater than 50 percent

Recovery: 40 to 50 percent

Vulnerable: less than 40 percent

Debt per cwt of milk sold. Wautlet said one of the key items to focus on is debt per cwt, “because all cows are not created equal.” He warned that technology investment must be offset by cuts to operational costs. For example, investing in robots needs to be offset in labor cost and better overall production performance. Under a robot model, you can have higher debt per cwt if the tradeoff is less labor cost per cwt and all other expense are neutral.

Goal: less than $25

Resilient: less than $20

Recovery: $25 to $30

Vulnerable: greater than $30

Working capital or current ratios measure liquidity and cash reserves. Subject to seasonal sensitivity, it measures current assets to current debt.

Goal: greater than 1.5

Resilient: greater than 2.0

Recovery: 1.0 to 2.0

Vulnerable: less than 1.0

Work with lenders

Wautlet encouraged producers to benchmark against other producers. ”Don’t be average,” he said. “Dairies are getting more progressive, larger and innovative.”

Finally, be proactive versus reactive. With tighter margins, he urged producers to keep lenders apprised. “Don’t forget about your lender,” he said. “Unless you're debt free, your lender is a big part of your operation.” Consider them your ally, not your enemy and use them as a resource and sounding board.

Gary Sipiorski, dairy development director with Vita Plus, offers one more suggestion: Producers should see their accountant before the end of the year. Even though they do not think they will need to prepay 2018 expenses, they should still evaluate their 2017 financials to make sure they do not have a tax liability because they prepaid 2017 expenses in 2016, therefore lowering 2017 expenses.

Rod Wautlet is a business and financial consultant with Agri-Business Consultants, an affiliate of Vita Plus based in Madison, Wisconsin. He works with dairy farmers to assess their operations, set financial and business goals, and provide guidance in making decisions affecting short- and long-term success.  end mark

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