Summer Agricultural Outlook: Storm Clouds Gather

It isn’t lost on us that the figurative economic storm clouds gathering are due at least in part to the literal storm clouds that have overstayed their welcome this summer.

Any historian of economics assumes the inevitability of business cycles, so following the record profits in 2022 we could anticipate, well ahead of 2023, the waning prospects for a continuation of the financial boom in row crop production. 

And they did wane.  Interest rates rose, crop prices fell, inputs fell rather more slowly and rents held steady as a surfeit of operators continues to vie for more acres to gain some efficiencies of scale.   Minnesota crop farm earned, on average, a bare profit, working capital declined, and economically they operated at a loss (return on assets was lower than the cost of capital). 

We expected the pinch to be keener this year, with financial breakeven, economic loss, likely the best case.

Hopefully it betrays our practical historical bent more than an ideological orientation:  the idea that ZIRP wasn’t forever and any return to even average interest rates after such a long scrape along the bottom was bound to be jarring.  Memories are short, another apparent inevitability in economic analysis.

Interest rates would inevitably have to rise, and there is a strong inverse correlation between those & crop prices.  Corn would likely fall.  Is it correlation or causation or both?  I have no strong view, except that history repeats or at least rhymes.  And here we are, with local corn less than $4 and interest over 7%, even 8% on operating lines.

It is worth reviewing the long history—this is only higher; it is not high.

Now we have to consider the possibility of below trend yields in Minnesota this year.   How much stress is possible?

As ever: it depends.  The economics of crop production in the Upper Midwest has had a good run, helped along by falling interest rates (until very recently), ethanol mandates, and amazing advancements in productivity (the yield trends in the formerly marginal counties in MN are astonishing). 

We get a decent cross-section of crop production courtesy of the FINPACK database.  Averages can hide as much as they reveal, but we have found the samples to be representative of the state of the industry, and with a combination of art and science, a means of forecasting business cycles in farming.  For easier comparisons, we confined our dataset to crop farms in the southern half of Minnesota.

Here is a quick summary of key data points, reported ’22-’23 and as they might have been forecasted as of planning season last January. 

		1000-2000 acres				2000+ acres
			Walker				Walker
	Reported	Reported	Forecast		Reported	Reported	Forecast
	'22	'23	'24 Winter		'22	'23	'24 Winter
Corn price	$6.16	$4.94	$5.00		$6.09	$5.00	$5.00
Corn yield	212	200	205		210	205	205
Net profit	$524,470	$47,431	$130,497		$1,073,464	$115,340	$123,308
Working capital days	366	257	337		329	233	264
Return on assets	15.42%	2.66%	5.40%		14.29%	2.56%	3.78%
		Historic and projected data derived from https://finbin.umn.edu

Farming is nothing if not volatile, and taken at its face, there is nothing alarming, just the routine ebb-and-flow of the business cycle from ’22 to the winter ’24 forecast.

The slippage since Winter is a bit more attention-grabbing.

	1000-2000 acres		2000+ acres
	Walker		Walker
	Forecast		Forecast
	'24 Update		'24 Update
Corn price	$4.00		$4.00
Corn yield	185		185
Net profit	($304,744)		($930,440)
Working capital days	177		116
Return on assets	-4.92%		-8.03%

There are so many moving parts.  Farming is both volatile AND amazingly complex.  This difference above purely a function of the factors shown (plus a proportionate decline in yield and price prospects for soybeans).   The drop in prices is applied to both old and new crop as the tendency in farming is to raise and store crop mostly unhedged.  Any hedges or contracts on place on crops old or new would mitigate the damage.  The loss potential loss on ’23 crop stored unpriced would be $170,000 for the mid-sized farms and $380,000 for the largest.

This is the long view, with Winter and Summer worst-case scenarios tagged at the end.

As a sidebar, we typically split the largest from the mid-sized farms for the sake of competitive analysis.  That the largest farm’s return on assets is barely higher, and their relative liquidity is in fact less, than the mid-sized group is worth a separate study.

Over time return on assets has to exceed the cost of capital [interest rates] for a farm to remain competitive, even viable.  1999-2023, both groups exceeded that threshold, at least 9% average ROA vs. 6% average interest on all debt. 

Working capital it still quite positive and even worst case, higher than at the end of the lean times 2013-2019 and much higher than in the late 90s. 

Is this a “keep calm, carry on” signal?  We can see that farming is a) cyclical, b) on the balance, profitable, and c) liquid.  This storm will pass, if indeed it ever arrives?

I rarely meet professionals of any stripe who leave the matter there.  As to looming storm clouds—

1)      Whereas return on assets has been higher than interest, just, 1999-2023, much of that epoch was dependent on a ZIRP Fed policy.  What would it look like as credit lines crowd 9%?

2)      Liquidity could get very thin and that an operation is profitable on the average is irrelevant when illiquidity forces an untimely exit (illiquidity-driven exits are almost guaranteed to be untimely).

3)      Farms of all sizes tend to spend 100% of their free cash flow on capex, which is according to FINPACK is not land acquisition but dominantly building and equipment. 

#3 is worth charting:

What do we make of all this?  Farming’s recent history is one of resilience and relative profitability but we have some stiff headwinds which have more than a scent of the 80s to them.  History feels inclined to repeat, but the real question is, who of our clients is readiest for it?  It is not automatically those with the best risk metrics, but those who can demonstrate they’ve already considered the possibility of a $4 corn, 9% interest environment and can show you their plan for navigating it.