Pastoral farm returns on constant low

By Brian Fallow

WELLINGTON - Returns on pastoral farming, which were reasonable earlier in the 1990s, have been abysmal for the past three or four years.

Research by the National Bank's rural economist, Kevin Wilson, found that since 1995-96 both dairy farms and sheep and beef properties have come nowhere near meeting their cost of capital.

Mr Wilson has compared farmers' total return (operating surplus plus capital gains) with the weighted average cost of capital (WACC), which is in the 8 to 11 per cent range depending on the ratio of debt to equity.

"The average total return from pastoral farming appears reasonable for someone farming in the early to mid-1990s," Mr Wilson said. But the total return since then has been abysmal [see table].

Worse, the total returns depend heavily on capital gains - that is, changes in the value of land and buildings.

Operating returns have been consistently low, averaging just under 2 per cent for the 1990s for sheep and beef properties and just over 2 per cent for dairy farms.

Mr Wilson said that such low returns struggled to cover the after-tax cost of debt servicing and gave little opportunity to accumulate cash as a buffer against low product prices or for reinvestment.

In the past, expectations of better revenues tended to be quickly reflected in higher land prices. The converse ought to apply, but in practice land prices were slower to fall when export markets were weak because of the belief that commodity prices were cyclical and another upturn would come.

Mr Wilson said there was some evidence of a weakening in land prices, although the main effect of the state of export markets had been a drop in the number of properties changing hands.

Faced with a declining total return on capital, an existing business could survive by reducing debt, accepting low wages for management and accepting a low return on equity. But each successive owner required more equity to make the business viable.

"Increasing the scale or productivity of the business is often promoted as a solution. It may slow down the rate of the inward spiral but does not address the fundamental issues. Additional land may add scale but competitive pressure for land helps hold up the price, which can reduce the opportunity to get the total return closer to the WACC."

If pastoral farming were to prosper, Mr Wilson said, the total return had to get much closer to the cost of capital and the operating surplus needed to be greater than the cost of servicing debt.

That meant not paying inflated prices for land and constantly pushing productivity up and costs down.