Managing expenditures in tight times: Lessons from the Northeast

Progressive Dairyman Editor Dave Natzke Published on 14 June 2017

Northeast U.S. dairy producers have shown remarkable resilience in the face of falling revenues, according to the annual Northeast Dairy Farm Summary. However, sharply declining asset-to-liability ratios and growth in debt per cow are worrisome, according to presenters featured during a recent Farm Credit East webinar summarizing the 2016 results.

A collaboration between Farm Credit East and Yankee Farm Credit analyzed financial results from more than 450 dairy farms from New England, New York and New Jersey at this year’s Northeast Dairy Farm Summary. The summary did not include financial results from organic producers.

Prices, margins measured

Northeast milk prices fell for a second straight year from an average of $25.58 per hundredweight (cwt) in 2014 to $18.24 in 2015 and to $16.85 in 2016, according to Chris Laughton, Farm Credit East director of Knowledge Exchange.

The record year for net margins in 2014 has been followed by two years closer to breakeven, Laughton said. Despite a $1.39 per cwt milk price decline from 2015, farms managed to post slightly higher earnings in 2016. Average net earnings increased from a loss of $30 per cow in 2015 (not counting nonfarm income), to a net gain of $15 per cow in 2016, a remarkable achievement, given the lower milk price.

While earnings were modestly better in 2016, when things like debt service and other cash needs are factored in, cash flow was actually tighter, and many farms experienced cash deficits. This was reflected in the cash position of the average farm.

Including non-milk farm income, the average farm was able to post a modest gain of 6 cents per cwt on an accrual-earnings basis. However, cash flow was generally insufficient to meet cash requirements for the second year in a row. When family living expenses and scheduled debt service payments are taken into account, the average farm was short 10 cents per cwt in 2016.

Expenses, expenditures cut

How did Northeast dairy farmers make ends meet despite lower milk prices and the cash crunch they faced?

“The answer is basically by lowering costs: A combination of lower commodity prices, belt tightening and economizing, as well as increasing productivity,” Laughton said.

Led by reductions in feed costs, fuel, crop inputs and spending on repairs and maintenance, net cost of production (COP) decreased by $1.57 per cwt to $16.79 per cwt. Additionally, capital purchases declined, representing a “don’t have it, don’t spend it mentality” on the part of many farmers, forgoing facility and equipment purchases and major expansions, Laughton said.

“We started seeing this at mid-year – dairies lost less money last year than they did in 2015,” said John Lehr, Farm Credit East business consultant who works with 60 producers with about 50,000 cows. “With the milk price decline, that’s counterintuitive, but they were able to cut discretionary costs and cut costs in general more than the milk price drop was. The dairies that did the best were the ones who reacted the quickest, as opposed to those that took a wait-and-see approach.”

Selected cost categories

Looking at individual cost categories:

• Feed costs declined by 22 percent from 2014 to 2016. Some of the decline was due to lower commodity prices, and some farmers likely didn’t push their cows as much on the feed side.

• Labor costs also went down. The decline was not due to lower wage rates (average spending per worker increased slightly) but rather due to increased cow productivity per employee.

• Fuel expenses dropped by half, almost all entirely due to lower oil prices, rather than reduced consumption.

• Cuts in supplies (general) were likely due to budget cutting.

• Repairs costs were down, probably deferred.

• Crop inputs (fertilizer was a big part) were down.

• Other expenses were down 9 percent, a testament to the general economizing on the part of farmers.

Producers can’t grow their way out of a “cost problem”

A longer-term review shows fixed costs have remained remarkably stable over the past 20 years. In contrast, nearly all the increase in COP has come in increases in variable costs or production inputs, at least up until the last two of years, when significant savings have been squeezed out of those.

“Not only have variable costs been rising, but the rate at which they have been rising has accelerated,” said Laughton. “This indicates that it can be difficult to grow out of a cost problem. Expansion will dilute fixed costs, but fixed costs are often not the problem. If you have a problem in variable costs, expansion will not automatically solve the issue. There are economies of scale in variable costs, but it’s important to get better before you get bigger if you have a cost problem.”

Lehr called on producers to play particular attention to breakdown on variable and fixed costs on a milk cwt basis – “the gross margin model.”

“We really have to understand where the cost structure of the individual dairy is, the strengths and weaknesses, to avoid the blanket statement of saying you have to add 20 cows or 2,000 cows,” Lehr said. “Understanding that cost structure allows producers to do some other things. It’s about milking the right cows, milking the most profitable cow. Be as agile as we can.”

Asset-to-liability ratios have fallen sharply in past two years

The asset-to-liability ratio looks at assets that will be converted to cash in the current year, divided by liabilities or bills that have to be paid in the current year. With the exception of 2014, that ratio has been consistent in past years, with current assets at 2.8 times current liabilities. That dropped significantly to 1.8 in 2016.

“It’s still not too bad; the average farm has nearly two times current assets compared to current liabilities, but it is a significant erosion of liquidity compared to the recent past,” Laughton said.

Troublesome is a big chunk of current assets related to feed inventory. While feed will be used to generate revenue, it cannot be directly used to pay bills.

Taking out that inventory, a “quick ratio” compares cash vs. currently liabilities. According to Laughton, the average dairy farm “was trucking along” at a cash-to-current liability ratio of 1.1–1.2, but that fell to 0.5 in 2016.

“The average dairy in the Northeast is relying on that feed inventory being converted to milk, and that milk check coming in to pay bills,” he said. “There’s a lot less money in the checkbook in 2016, and a lot more farms were waiting on milk checks to pay bills that were due.”

Investing in efficiencies

In addition to lower costs, the small increase in average net earnings was also due in part to increased per-cow productivity.

“It’s important to consider when looking at cost per cwt, there’s the cost of actual spending per employee and per cow, but also the productivity of that employee or cow,” Laughton said. “The top profit farms were not necessarily the ones who spent the least on feed or paid their employees the lowest. It was more about productivity and the margin generated, rather than the absolute amount of spending.”

“If we look at the past 10 years, more progressive farms have invested heavily in labor efficiency, cow comfort, genetics and nutrition, and it’s paid off,” Laughton said.

From 2006-16, the average cows per worker increased by 9 percent, and milk pounds per cow increased by 16 percent. ”As the result of a multiplier effect, more efficient workers milking more productive cows meant a 26 percent increase in pounds of milk per worker,” Laughton said. “That’s a big reason why farmers were able to save money on a per cwt basis.

“There’s been a tremendous focus on cow comfort,” Lehr said. “The smart money being spent right now is on cow comfort – cow cooling, fans, rubber, stalls – those type of investments are being looked at closely. That’s driving overall efficiency.”

John Fessbenden, Farm Credit East senior loan officer, sees many operations focusing on ”the core” – making sure the assets they have meet the objectives of that core vision. Some are shedding excess assets, using it to pay down debt. They’re also positioning for lower prices by attempting to gain efficiencies. Areas of focus include technology, labor savings, cropping and genomics, zeroing in on handling the right number of cows the most efficient way.

Fessbenden said one area of management needing to be reviewed is the number of heifers retained for herd replacements.

“We’ve been raising every heifer that hits the ground,” Fessbenden said. “The tradition has been maintaining the number of replacements at 90-100 percent of the current milking herd. We’re doing a better job with heifers, so we should evaluate how many heifers to keep. By being more selective, we might be able to keep the ratio at about 75 percent of the cow herd.”

“The other strategies were looking at strengths, weaknesses, opportunities and threats (SWOT) determine where that next dollar should be, or should not be invested,” Lehr said. “Sometimes that ‘not invested’ piece is more important.”

Debt level a growing concern

Many farmers took on additional debt or restructured existing debt obligations to bridge the cash gap in 2016. Most increased their leverage in bank loans and trade credit (increasing time to pay), resulting in total liabilities per cow increasing from $3,335 in 2014 to $4,190 in 2016, an increase of more than 25 percent in two years. Per-cow debt increased by 14 percent in 2016 alone.

“This is a bit worrisome,” Laughton said. Adjusted for inflation, current debt levels (per cow) are similar to the 1980s. “The rate of increase we’ve seen over the past two years is probably unsustainable.”

This will be an important issue in 2017 and beyond. The “average” farm has little reserve debt capacity available. If there are additional tough years, the ability for the average farm to borrow necessary funds may be limited.

Herds with 100-299 cows are in the toughest position

The DFS study breaks herds into four sizes: <100 cows; 100-299 cows; 300-699 cows; and 700 cow or more. Size was not an automatic guarantee of profitability. There were positive correlations between size of farm, efficiency and profitability. However, not all large farms saw strong earnings; some lost money, and some smaller farms were remarkably profitable.

Farms in the 100- to 299-cow herd size are in the toughest financial position, mostly related to labor, Laughton said. In many cases, herds of that size face large-herd expenses, but have small-herd resources, and can no longer rely solely on family labor, increasing total (hired) labor costs.

Near-term outlook

The 2017 price outlook looks a lot like 2015, with projections ranging from $1.12 to $1.49/cwt. higher than 2016’s average. It remains to be seen whether we will see a stronger rebound in 2018 or if milk prices will continue to remain near the levels seen since 2014.

“Since farms were able to economize and increase earnings in 2016 despite the drop in milk prices, if they are able to continue in that vein, they should see some increased earnings and recovery in 2017 as milk prices move up somewhat, but they won’t be much better off than they were in 2015,” Laughton said. “Realizing positive earnings (in 2017) will be dependent on maintaining those efficiencies that farms realized last year, and keeping COP from rising too much, as it often does when milk prices rise.

“There’s a real question whether the variation (milk prices and net earnings per cow) we’ve seen over the past 15 years will continue, or whether we’ll bounce along the bottom for several years,” he said. “The circumstances that brought high prices in 2014 were unique global events. It’s unclear we’ll see those high prices again, or be destined to a more modest era of marginal profitability.”

Globally, milk producers have been backing off slightly, but in the U.S., and especially the Northeast, cow numbers and milk production continue to increase.

“This means we probably won’t see any milk price increase anytime soon, and on top of that, we’re going to keep seeing the milk marketing challenges, where finding a home for milk at any price will be a challenge,” Laughton said. “That’s happening in the Upper Midwest as well, as production bumps up against processing capacity. The recent trade dispute with Canada certainly hasn’t helped, in that it brings more milk that needs a home in border states like Wisconsin and New York.” end mark

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