Cycle opportunities are to be found in the troughs
Go West, young man! That was the 19th-century power phrase that inspired many an enterprising young man to go forth and reap riches. While you might not be inclined to go West, Farm Journal columnist Moe Russell transfers that same kind of energy and can-do spirit when he says, "There’s tremendous opportunities in the years that lie ahead for farmers!"
He speaks of global demand, the growth of middle-class consumers seeking new high-protein diets and the incredible ingenuity and innovation being displayed in cultures around the world. Opportunities presenting themselves are one thing; making the right decisions in hard times to take advantage of them is another.
Mapping the DNA of successful farmers, Russell weaves into his matrix real farm numbers and comparative accounting. Like the sun burning off an early morning fog, the results help him start to see and appreciate the entrepreneurial skills of his clients’ decision making and hard work.
"One thing I try to communicate is that their greatest asset is not their equipment, land or livestock—it’s their entrepreneurial skills," Russell says.
"Every year, I track farmers’ returns on assets and equity and I compare that to the top 20% of the Fortune 500. These farmers are more profitable than the top 20% of those listed in Fortune magazine. A lot of farmers don’t believe that. They think they’re price takers instead of price setters. Well, you can forget all that," he says.
In Russell’s world, it’s the numbers and the decisions based on their interpretation that separate the very successful from the plodders. This is the reason he focuses on the management of agriculture’s cycles. His takeaways are eye-opening.
"There were only three times in the last 100 years when it got really good: 1917 to 1918, a seven-year period in the 1940s, and 1973," Russell says. "This tells me that good times don’t last and to watch the cycle trends starting in 2014 or 2015.
"As long as we have the two human emotions of fear and greed, we’ll always have cycles," he adds. His premise is that you have to plan for the downturns by "bulletproofing" your balance sheet. This is ensured by having working capital equal at least 50% of your gross revenue.
Russell says farmers need this level of working capital when they enter the trough of a cycle, so they can operate until the cycle starts trending upward for better profit margins.
"I urge farmers to remember that they are in the commodity business," he adds. "One thing unique about commodity production is that over the long run, price will level out at the
cost of production."
Russell uses Iowa State University data that charts the corn price received per bushel and the cost of producing that bushel every year for a 40-year period. He plots regression lines, one for price received and one for cost, which show an amazing 9¢ per bushel difference (see chart above).
"How do you survive in a business where, in the long run, there’s no money in it?" he asks.
Uh … sell the farm? Wrong answer! Russell says that based on his research, farmers should 1) concentrate on better marketing and get their product sold in the top third of the price range;
2) watch their machinery cost per acre; 3) watch their labor cost per acre; and 4) improve agronomic management.
Shaving the copper off a penny when buying crop inputs is like chasing a small rabbit, Russell explains. It is the decisions a farmer makes in the down cycles that determine how profitable he will become over the long haul.
What about the decision to buy farmland? Russell’s research shows that land values have appreciated 4.2% on average during the past 160 years. "Investors like to see a 4% to 5% cash
return," he says. "With an appreciation of 4% for land and a crop return of 5% that’s a decent return of 9%."
The upshot? Don’t be blinded by the good times. Remember the history lesson. As Russell says, "Know your numbers. You can’t manage what you cannot see and visualize."
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- Mid-February 2012