Owen Hembry: Dairy farm owners face life after the boom

The prospect of falling returns, rising debts and sliding land value is depressing for dairy farm owners, particularly those who bought during the boom of only a year or so ago.

That rocketing international dairy prices would drop back was expected. What came as a surprise was the speed of descent - greased by the global economic crisis.

But how far will the fallout spread, how precarious are the positions of some farmers and are there implications for the wider industry?

Stuart Locke, associate professor at the University of Waikato Management School, forecasts dairy-land prices will drop by 15 to 30 per cent during the next three years.

"I can't see the milksolids prices recovering in the short-term, and those prices cannot sustain the land values that were running through in mid- to three-quarters of the way through 2008," Locke says.

The ANZ Commodity Price Index for dairy products more than doubled between August 2006 and November 2007 but dropped 58.4 per cent by February this year. It has since risen again by 11.5 per cent.

Data from the Real Estate Institute of New Zealand says 62 dairy farms were sold during the three months to May - fewer than half during the same period of the previous two years, although up 31.9 per cent on the period to April.

Locke is picking early next year for the volume of sales to start rising.

"My guess is that by the end of this year, first quarter of next year, people who are in difficult situations will make the call to exit," he says.

"And the people who have deferred retirement because they don't want to put the sales through at these figures will say 'maybe we will go'."

It appears it's not just dairy farm owners who need to worry.

Changes in dairy-land value flows on to other sectors, Locke says. A study of 20 years of data shows that 89.4 per cent and 87.9 per cent of the price movement in pastoral fattening and pastoral grazing land respectively can be explained by the movement in dairy land.

There is a strong correlation between the payout to farmers and dairy-land price, Locke says, which jumps up almost immediately when the payout rises.

But what happens when the payout falls?

Fonterra's forecast payout to farmers for the new season is $4.55/kg of milksolids, down from $5.20 predicted for the previous season and the record available payout of $7.90 in 2007/08.

Before the 2007/08 payout, the 10-year average was $4.60/kg.

The past 20 years have seen falls in payout but not by large amounts, Locke says. "So what tends to happen is we don't get as many sales going through and the prices tend to hold stable.

"What we've observed in the last six months is quite atypical to that. That is, we've actually seen prices drop significantly, and that's the first time I've seen that pattern emerge."

REINZ data shows the median price for dairy farms for the three months to May was $3.75 million, down from $4.05 million for the same period last year but up from $3.2 million in the three months to April.

"If my forecast of three years to four years of fairly steady [dairy] prices is true, then I think we will see that slump in land prices actually materialise, that people will say I can't hang on for the recovery," Locke says.

Some farmers were debt free, having been in the industry for years and worked through to a low level of indebtedness, he says.

"Those that bought in last year or the year before at very high payout figures and geared up to anything like 60 to 70 per cent are really in trouble."

Gearing of 60 per cent is not unrealistic for those buying in for the first time, he says.

A model for a Waikato dairy farm drawn up by Locke shows someone who bought a 130ha property with 300 cows last season at $40,000/ha, $2000 per cow and $100,000 of equipment, with 50 per cent debt gearing, would face a loss of $144,501.

If the values are dropped to better reflect the present environment at $27,000/ha, $1200 per cow and $50,000 of equipment - at 50 per cent debt gearing - the model farmer is still losing $65,301.

There will be some transfer of farm ownership because of people being too highly geared, Locke says.

"I'm not saying it's going to be all mortgagee sales. I'm saying that there will be people getting out and I think there will be other willing buyers, many of whom will be what I call the family corporates, just buying up more and trying to get greater economies of scale in what they do, which isn't necessarily a bad thing.

"I think what we'll see is that [land] which is dairy will stay dairy, and people will make it work at some level. But I think we're going to take the pressure off dairy conversions."

Westpac economist Doug Steel says land prices will probably pull back a bit, and it was likely dairy would pull back the most. However, the Reserve Bank has been talking a lot about agricultural debt and the stresses the agricultural sector may be under as incomes come back, he says.

Reserve Bank Governor Alan Bollard has been pretty explicit about keeping short-term interest rates at a low level for an extended period, which should help mitigate the downward pressure on land prices, Steel says.

Steel does not expect to see a large scale sell-up by dairy farmers.

"Certainly the banks have a bit to play in that as well," he says. "Banks are part of the solution to seeing the industry through the other side of what's certainly going to be a pretty tight cash-flow situation through this year, especially in dairy."

Reserve Bank statistics show agricultural lending during the last year was up 20 per cent, which is a pretty staggering rise, Steel says.

"Even if they have got a little bit overdone, I think on the back of the very high payout before, it should only be limited to the most extreme cases of over-buying that you might see some prices come back."

And the outlook for the dairy sector is positive, Steel says.

A report by the OECD and the UN's Food and Agriculture Organisation last week said dairy products were expected to remain among agricultural commodities with the highest growth rates of consumption.

Average dairy prices, in real terms, were likely to be slightly higher in 2009-2018 relative to 1997-2006, driven by rising energy and vegetable oil prices, it said.

However, the rush to white gold may be over for now, and some farmers might find the downside of this cycle too steep to survive.