Paul Dykes: Income improves but shopping sprees unlikely

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Effluent management systems, animal shelters and feed pads are among the factors that are absorbing money at a phenomenal rate

Photo / Christine McKay
Photo / Christine McKay

A record Fonterra dairy payout, much improved orchard returns and rising prices for red meat have put a smile on faces across the agribusiness sector, but uncertainty still hangs over rural New Zealand.

Whereas similar returns in the past might have triggered a shopping spree, the bumper effort in in the 2013-2014 year is being greeted with satisfaction by farmers, although many have their eye on prudence.

ANZ rural economist Con Williams says there is an estimated $53 billion of bank debt in the agribusiness sector. Overall, 20 per cent of farmers account for 50 per cent of this debt with the growth slowing since the global financial crisis. Dairy represents about $32 billion of total farm debt.

"Farmers have made a lot of progress in terms of looking at their investment [in the farm] from a cash-positive point of view rather than capital gain," Williams says. "They are recording good revenue and profitability, as long as costs are restrained."

There are increasing environmental and industry standards to meet and some spending will go to satisfying these demands, Williams says.

Those who can afford to spend are not splashing out on consumer items. "Some are looking to invest in more land, or in on-farm infrastructure, such as new effluent ponds."

Dr Jacqueline Rowarth, professor of agribusiness at Waikato Management School,

University of Waikato, says research by postgraduate Thomas Macdonald is revealing the level of investment farmers are making in an attempt to meet compliance regulations that have not yet been finalised.

New effluent management systems, for instance, as well as animal shelters and feed pads, are absorbing money at a phenomenal rate.

"The big uncertainty for them is whether the $100,000 to $500,000 being spent means that they will be considered compliant for the next five years. This uncertainty is causing stress, just as debt-loading causes stress," Rowarth says.

The average dairy farm gross income based on the Fonterra milk price for the season just ended was about $1.17 million (not fully paid out until October), about $357,000 ahead of the previous year's average. However, many farmers are already banking on a weaker 2014-15 year. The Fonterra global dairy trade (GDT) result in mid-July was a disaster for those dairy farmers pinning their future on a solid Fonterra milk price payout next year.

ANZ had already suggested the payout would be nearer $6.25 than Fonterra's opening forecast farmgate milk price of $7 a kilo of milksolids (kgMS) for the 2014-15 season. This was before the 11 per cent slump in GDT whole milk powder prices in mid July.

Two weeks later, Fonterra slashed its forecast for the 2014/15 season to $6 and announced an estimated dividend range of 20 to 25 cents a share, amounting to a potential payout of $6.20 to $6.25, well Ben Russell from Rabobank below expectations, stripping at least $3.4 billion from dairy farmers' wallets.

The payout would be $336,000 less for an average Fonterra shareholder, down 26.5 per cent for a 100 per cent share-backed farmer.

"Mechanically, putting this revised milk payout into our average farm model produces farm profit of $920 a hectare," says Williams. "This is well below the seven-year average of $1485 a hectare and well down on the record $3500 a hectare in 2013-14." He says the ANZ is also likely to move to $6.

Reserve Bank figures show that debt levels in the farm sector have increased far more rapidly than farm incomes over the past decade, with debt growing by 290 per cent between 2000 and 2010 before stabilising.

The bank estimates that about 70 per cent of dairy debt is on floating rate mortgages, so rising interest rates could exacerbate any stresses should incomes fall.

Con Williams from ANZ.
Con Williams from ANZ.

The escalating cost of rural land helped farmers justify to their bankers increased borrowing but there are now signs that prices are coming off from their peak set earlier this year.

Quoting the ANZ Property Focus report for June 2014, Williams says the key question is whether prices are once again becoming disconnected with returns. "And perhaps the recent slowdown and anecdotal evidence of buyer resistance to higher prices in the traditionally more expensive regions such as the Waikato, Taranaki and Canterbury, suggests this could be the case." The report says it is difficult to see rural land values pushing too much higher in the medium term, with many of the traditional valuation metrics for the different farm types looking stretched, interest rates on the way up, and the milk price on the way down.

Throw in increasing environmental regulation and general inflationary pressure onto farm costs, and 2014/15 will be a year of consolidation at best.

"That's not to overlook positives though.

There is still plenty of confidence in the long-term food story; rises in interest rates are likely to be modest; productivity growth is accelerating once again and foreign/corporate buyers are still active."

Rabobank chief executive Ben Russell sees the 2013-14 season as a golden trifecta -- a rare year in which commodity prices, good growing conditions and low interest rates coincide.

"Our recent rural confidence survey shows that farmers are aware they should plan for a tougher year ahead, especially dairy. Some sectors will have reasonably challenging financial times.

"We're using $5.75 as our [Fonterra] payout for short-term budgeting purposes. The bank would rather be a little conservative on that number when determining the working capital and cashflow needed - we'd rather not underestimate that.

"We assess our longer-term lending on our year-on-year milk price number of $6.30 and we haven't changed that."

He says it's not getting easier to be a farmer, and even good farmers can make a loss. "They are a lot more focused on discipline and operating with a cash surplus.

Compliance costs continue to grow; the environment is looming as a key issue, the impact on water quality, employment compliance - it's an evolving regulatory landscape.

"But there are plenty of positives. We are not pessimistic about agribusiness. It is well positioned and has growing markets close by."

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