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Financial state of the dairy industry in 2016

Progressive Dairyman Editor Dave Natzke Published on 11 March 2016

A second straight year of declining milk prices will test – and potentially change – short-term management plans for many dairy producers, according to dairy accountants and lenders contacted by Progressive Dairyman.

The USDA’s February dairy outlook estimated the 2015 U.S. average all-milk price at $17.08 per hundredweight (cwt), down about 29 percent from 2014’s record high of $23.97 per cwt. The 2016 price, projected in a range of $15.30 to $16 per cwt ($15.65 per cwt midpoint) in early February, would mean another 8 percent decline.

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Although most input costs are also down from 2014, tighter margins will require tighter management.

West

Western dairy producers are “cautiously pessimistic,” according to Bob Matlick, Frazer LLP. “Everybody in the West expects negative margins in the next six to nine months. It’s [a question] of how deep those negatives are going to be.

“Probably 70 to 80 percent of operations put adequate equity back into the business as a result of 2014 and can sustain six to nine months of what we see on the horizon, but they’re going to dig into equity to sustain that,” Matlick says. “The other 20 percent to 30 percent that didn’t; we’re going to see some fallout as a result. We’re seeing some guys exiting the business right now. With the volatility, they’ve had enough.”

Frazer LLP is an accounting firm with dairy clients from Texas to the Pacific Northwest.

“With its cheese market, Idaho might be better positioned to withstand a downturn of that duration,” he says. “Arizona is about the same as California. New Mexico is still trying to find out how bad the storm (Goliath) was, as well as Texas.”

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Matlick says more producers are doing “future projection modeling” – looking nine to 12 months into the future. At the recent World Ag Expo, several producers asked for “stress tests” to model what might happen.

“They learned from the volatility of the past,” he says. “It used to be called ‘burn rate,’ but now it’s called ‘sustainability’. How much equity do you want to eat up for how long?”

“When we project, the biggest drivers are number of milk cows, milk per cow and feed costs,” Matlick says. “On larger operations, we’re seeing pretty wide swings – 10 percent to 15 percent by season – in what we call ‘cow flow,’ the available heifers, available fresh cows, because of summer breeding.

We try to fill holes by buying and selling heifers and working hard on breeding issues. Cow cooling is important for milk production, but I think equally or more important for breeding.”

California heifer prices remain strong, but a lot of those animals are headed to other parts of the country, he says.

“Texas is looking for milk because a lot of cows are being culled as a result of storm damage,” Matlick says. “I have clients tell me the total impact will be 130,000 to 150,000 cows. Another client told me it was a ‘million-dollar storm’ for every producer.”

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Based on recent USDA weekly cow culling reports, spikes in dairy cow culling in Texas and New Mexico are reflecting the storm’s impact. “There’s a tremendous amount of mastitis,” Matlick says. “It may have reached its peak, but we’re going to see more.”

As far as dairy growth goes, “Texas is building, but I’m not seeing anything new in California and Arizona,” he says. “California is the focal point. It has some real issues.”

Those issues include state pricing policy, labor, the overall economic climate of doing business and uncertainty about water and water law.

Idaho

In Idaho, dairy producers’ short-term goals have changed with lower milk prices, according to Mark Brady, CPA, CVA, with Cooper Norman. The firm’s clients milk about 50 percent of the cows in the state, and many of those producers are positioning themselves to weather the current downturn.

“Producers are hopeful that the current price of $13.50 per cwt will rise back up to at least $16 per cwt soon to be able to break even again,” Brady says. “Now, they’ll be hopeful just to limit the loss rather than breaking even.”

While feed costs are down, Idaho producers had to use more bedding this year due to the weather. Labor has also been up in price over the last couple years.

“While a few producers talk about expansion, for the most part everyone is staying with what they currently have,” he says.

Northeast

In the Northeast, “the mood is definitely a notch lower than it was last year, with many dairy producers cautious or uncertain about the immediate future,” Mark Mapstone, Farm Credit East consultant, says. “The economic reset we’re experiencing has some producers downright grumpy.

“This year, it’s not about making money; it’s about limiting how far you go backward,” Mapstone says. “Milk price continues to come down faster than feed, so margins are tight. Lower fuel and fertilizer expenses will help some, but milk prices forecast to drop again in 2016 erode most of the savings potential.”

Coming off record-high milk prices in 2014, dairy producers had some cushion in 2015. That’s not the case in 2016.

“Even if milk prices remained the same as 2015, it will feel tighter as a result of less liquidity in general,” Mapstone says. “A year ago, producers had significantly more liquidity than they do going into 2016. We’re seeing less prepaids, less cash in the bank and less borrowing ability on year-end 2015 balance sheets compared to year-end 2014.

This year will be a strain on the ones that aren’t as efficient producers or have less liquidity going in. Debt level will make a big impact on cash flow with highly leveraged producers.

“Producers are looking to do what’s right for their farm’s bottom line, even if it means shipping more milk,” Mapstone says. “Producers are looking to maximize output from their facilities – getting to capacity, looking for ways to maximize milk per cow and control costs where they can. Feed, labor and crop expenses are typical areas they look to take out cost when they can.”

Improving the milk price incrementally by boosting milk components is another way to prevent deeper losses.

“A two-year-or-longer low price cycle like this should be a good lesson to some producers about the importance of building a strong balance sheet and developing good relations with their lender. My best producers worked hard at being proactive about doing their cash-flow budgets early and prioritizing capital spending plans for 2016 and beyond,” he says.

“It’s not just the down cycle that has producers worried,” Mapstone says. “Industry pressure from forced animal welfare and environmental regulations are another concern.” Specific to New York, the continued push to increase the minimum wage is also an issue.

Midwest

Record milk prices in 2014 had dairy producer balance sheets in great shape going into 2015 from both a working capital or liquidity and an equity standpoint, according to Sam Miller, managing director of agriculture banking with BMO Harris.

However, 2016 bottom lines will be lower for almost all producers when compared to last year, with the latter half of 2016 being the wild card for prices.

“Margins compressed as 2015 progressed and became more painful as the year ended and the new year started,” he says. “Lower feed costs and crop inputs will certainly help cushion the margin compression – but not enough to make up for lower milk prices.”

Upper Midwest producers have the added benefit of above-average quality and quantity of feed harvested last fall.

“The working capital positions led by improved feed inventories and borrowing capacity on lines of credit have many dairy producers in position to navigate tighter margins,” he says.

Conditions may force some producers to delay dairy expansion plans.

“Large-herd producers are continuing to evaluate expansion plans for future periods but may slow down these plans given current economics,” Miller says. “Many more factors go into an expansion than the current market environment, including buyers for the milk produced, project siting and permitting, and the availability of both construction and operations labor.”

Other strategies include fine-tuning management.

“Large-dairy-herd producers are fine-tuning all aspects of their operation to focus on cost of production and efficiency,” Miller says. “This includes ramping up training for employees so practices are consistent, reducing capital expenditures to only the highest-payback items, evaluating purchases to make sure value is being achieved at desired return levels and, in some cases, price risk management practices are being evaluated.”

Nationwide

Gary Genske of Genske, Mulder & Co. LLP suggests dairies are carrying the highest debt load they have ever carried, even including 2009. For example, through the ’70s, ’80s and ’90s, Genske says a California dairy’s cost-per-hundredweight to service debt was $0.75. Today, California dairies have on average debt service costs that are just a bit higher at $0.80 per hundredweight, according to current financials.

Genske says given that interest rates were between 7 and 8 percent in those previous decades and are now at 3 or 4 percent, dairies today are carrying twice the debt they historically have.

Genske’s accounting firm has clients in more than 31 states.  PD

Progressive Dairyman Editor Walt Cooley contributed to this report.

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