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As milk prices increase … who or what needs to be paid first?

Larry Davis Published on 19 January 2010

During September, October and November of 2009, we have seen milk prices begin to recover.

As we look into the futures market for the first six months of 2010, we see a continued upward trend. Market observers tell us that demand has picked up both domestically and internationally.

The number of cows in production has decreased over the past year, as has overall production. Along with these changes, we have also experienced a decrease in feed costs. All of these facts lead us to the conclusion that the worst economic storm for a dairyman in a generation is beginning to ease, and a recovery is underway.

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I have been asked over the past few months several questions related to this recovery. In general terms they are as follows:

1. How soon should a dairy operation begin to pay back debts?
2. How should debts be prioritized for payback?
3. When is the right time for refinancing and consolidating debt?
4. How soon should I consider expansion?

The first three questions will be addressed here, with the fourth being a topic for a future article.

Paying back debt
Many dairies have needed to either access short-term lines of credit, use input supplier credit or both in order to provide their operations with the necessary liquidity to survive the milk price downturn. Term debt for cows, equipment and real estate may also exist in the operation and could have received some special repayment terms, including deferred payments or interest-only status from the lender.

As milk prices increase and cash flow improves to above break-even levels, all of these debts should be paid back. When this time comes, dairy operations should begin conversations with suppliers, banks and other creditors in order to formulate a plan with input from all parties as to how and when all of these obligations should be repaid.

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Prioritizing debt payback
After talking with creditors, a plan should be put in place to pay back debt. This plan should include prioritizing the payback of specific debt. Typically, input suppliers would be paid first, followed by short-term lines of credit and then term debt.

Suppliers that have continued to provide the operation with feed and other inputs should be paid current first, as they have provided the best source of liquidity. Many of these suppliers have been very patient in waiting to receive payment for their products and need to be brought current as soon as possible. In many cases these suppliers are providing current inputs to the operation that are vital to its future.

Short-term lines of credit and/or revolving lines of credit should be paid back next. These could include line facilities from banks or credit cards. The sources with the highest interest rates should be paid first.

Term debt repayment needs to be discussed with those creditors. Generally speaking, this type of debt is the best secured and has the lowest interest rate associated with it. If payments have been deferred or interest-only has been employed, this would be a good time to refinance or reschedule this type of debt.

Refinancing and debt consolidation

Supplier debt and/or short-term revolving debt can be consolidated with term debt and refinanced at this time as well. A lender is going to strongly evaluate collateral position, future cash flow and the long-term goals of the dairy operation before making this type of long-term commitment. Depending upon many variables in each individual operation, a lender may decide that supplier debt and short-term debt should be paid back as soon as possible rather than burden the operation with more long-term debt. This would be especially true if the operation has aspirations of expansion in the near future.

However, if a dairy operation has good equity, collateral and solid cash flow using reasonable assumptions for milk prices, it may make good sense to refinance excessive supplier and shorter-term debt to a longer term and stretch out payments in order to provide better cash flow in the near term.

Summary
The past year has produced some of the lowest milk prices in the last 30 years, causing significant pain for nearly all dairy operations. In recent months we have seen the number of producing cows decline along with overall production, and milk prices have begun to recover. With improving returns, dairy producers need to begin paying down supplier and short-term debt as well as reviewing their long-term debt and considering debt structure alternatives. Each operation needs to do what’s best for its individual situation, but generally speaking, every operation needs to pay down supplier debt as soon as possible. This will provide the best opportunity to position dairy operations to withstand future price cycles. PD

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Larry Davis
  • Larry Davis

  • Vice President
  • KeyBank Food and Agribusiness Team
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