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Is It Time to Expand?

January 11, 2012
By: Ed Clark, Top Producer Business and Issues Editor
is it time to expand
With the labor force in place and the margins to turn a profit, Kansas producer Lon Frahm (front) has expanded his land base by 4,000 acres in the past three years.   
 
 

Look to margins for answers on expansion decisions in 2012

Lon Frahm knows what he’s talking about when it comes to expansion. The 2009 Top Producer of the Year winner has added 25 quarter-sections, about 4,000 acres, in the past three years to his Colby, Kan., operation. Today he farms 20,000 acres. His expansion philosophy: "It’s not about whether the crop price is high or low, it’s about margin."

In Frahm’s view, you need excess machinery, capital or labor for an expansion to make economic sense. When nearby land becomes available and he can economically swing it, he’s in the market. Because the average quarter in his area comes up for sale only every 30 years, Frahm feels the year for potential expansion is irrelevant.

Determining whether expansion makes sense goes far beyond land and commodity cycles. Absolutely nothing will slow down expansion, in Frahm’s opinion. "I keep finding economies of scale. I don’t see anything to stop the growth of large farms," he says.

According to Dave Kohl, professor emeritus of ag economics at Virginia Tech, producers should have a working capital to revenue ratio of at least 25%. In today’s volatile environment, 30% to even 35% is ideal before pulling the expansion trigger, he advises. "It’s not an option but a requirement," Kohl adds. Maintaining a high level of working capital puts producers in a position to consider new opportunities, too.

Chief among the tough questions producers should ask themselves are whether an expansion leads to greater profits. Also apply the shock test, Kohl advises. Can you handle shocks of 20% lower prices and 15% higher costs?

Another question to consider is whether you have the right management systems in place. Does expanding stretch you outside your management ability, and if so, what will it take to handle it?
"Cheap money can be a trap," Kohl says. Low interest rates are not that low if producers have a hard time paying back the money or turning a profit.

For some producers, expansion might indeed make sense in the coming months. Several strong years’ worth of profits and cheap interest rates makes expansion cost less, says Mike Boehlje, an ag economist at Purdue University.

That doesn’t mean all producers should charge full speed ahead and expand this year, he cautions. "The biggest challenge is to think about how an expansion fits into the current operation."

In production agriculture, it’s common to think of expansion in regard to more resources, more machinery, etc., Boehlje says. "In the business world, it’s about revenue and sales. The emphasis is to get more revenue from the current resource base, not a focus exclusively on getting bigger," he explains.

Typically, the lowest-cost way to expand is to get better at what you’re doing and reap more revenue out of your current resource base. Once you reach that point, you can concentrate on expanding.

"Now is not the time to leverage yourself up even if you can access credit," Boehlje says. "You have to worry about risk."

The Cost of Land. For grain farmers, justifying expansion comes down to one thing: "the cost of the land," says Gary Schnitkey, a Univer-sity of Illinois ag economist. When renting, it’s important to have the ability to adjust the price of land if commodity prices drop. Landlords might be reluctant to reduce rents, however, he says. "It will take more than one year of poor prices to get things to come down."

Purchasing land has been a good investment in the past, but it’s important to not make land
purchases by overextending on the debt side, he says.

"The way I look at rented land is that rent is a variable expense in the long term—it can go up and down—while land ownership [payments] is for the most part a fixed cost, although in a declining interest rate environment there are opportunities to roll the cost down," Schnitkey adds.

Money Tree. Cash flow is essential when in expansion mode, stresses Mark Winger, senior vice president of administration for Farm Credit of Western Kansas. "An operation can be very profitable but yet not be able to generate sufficient cash flow, often as a result of tax avoidance," he says.

"Margin hits the nail on the head," Winger adds. In the past few years, the farmers who made
a profit in spite of the wide swings in commodity and input prices are those who understand costs and lock in profits, rather than those who just produce a crop and hope the market will allow them to cover costs, he explains. "In the short run, the ‘grow, then sell’ strategy can work great if commodity prices increase after the cost of production is locked in, but sometimes it will go the other way, Winger says.

Price Outlook. In terms of budgeting, Schnitkey believes an average price of $4.50 for corn and $10.50 for soybeans is likely for the next five years, although prices will probably be higher than that this year.

It’s possible, however, that in an individual year, corn prices could be as low as $3 to $3.50, Schnitkey cautions. That said, "2012 is a fine time to expand if farmers can get a land base at a reasonable price."

In the Midwest, a good share of expansion is being paid for with cash-flow money. "Land priced as $10,000 per acre won’t cash-flow unless you put $5,000 down," Schnitkey says.

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FEATURED IN: Top Producer - January 2012

 
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COMMENTS (8 Comments)

jojames - Hamler, OH
Large farms have been getting smaller after two years of wet planting seasons and the bto taking the prevented planting option and letting farms growing up to weeds.
7:34 PM Feb 1st
 
jojames - Hamler, OH
Large farms have been getting smaller after two wet springs. Landowners that have rented to the bto do not like to see the prevented planting option taken two years in a row and watch there land grow up in weeds.
7:31 PM Feb 1st
 
NW Iowa Farmer - IA
Yet another worthless article from Ag Web. It's fairly simple. There are enough farmers out there and being competitive enough that if you are expanding at a rate like this, you'd better be ready to fail. Why, because farmers are willing to cut things so razer thin on margins that you're not gonna make a dime. Maybea nickel if you're good.

Look at land prices currently over $10,000 an acre. Is it time to expand. Heck no. The cost, risk, and finacials of the current land makes it a terrible investment. Not only that, if you don't have cash on hand or equity to pay for 60% you're not going to buy it.

This article is just another load of crap. It's simple if you have a lot of wealth and can afford poor investments that make lower returns you'll still be successful. If you don't have the wealth, look to the mess in Ill.

My Goodness Ag Web, why don't you do an article that actually shows what's going on. Not some B.S. on a former B.S. award winner of you're Top Producer.
9:38 AM Jan 23rd
 
BRYAN - BREESE, IL
when does need turn into greed? farmers are making good incomes now why not be happy with that? When you are farming 5000 acres and making money why do you need 6000 acres. To get that next 1000 acres you must take it away from someone else. If insurance subsidys were not around you may not be willing to buy or rent everything you could!
4:02 PM Jan 21st
 
Tim Gieseke - MN
Perhaps Lon has it figured out, but his expansion philosphy should also include subsidized crop insurance. Without that gigantic security blanket he might feel a (b)risk wind.
1:06 PM Jan 21st
 
polecat - covington, IN
It would seem that with the above Illinois mess that a better article should be a followup. My math shows that Rick Rosentretor lost over six thousand dollars per day since he expanded . Sounds like a very wise choice to me! Just change the name and location and you can find many more that are going to follow him down like they followed him up.If the coffee shop talk is any indication then the Bankers with ag loans will be buzzing too. How about an article that omits the words bigger or expand .​
10:23 AM Jan 21st
 
Cheman386 - IL
Ugh, taking nothing away from this guy but after the Illinois family farms Bankruptcy wondering about the economies of scale....."I don’t see anything to stop the growth of large farms," he says. If you look at ILLFFs website they talk about economies of scale and list all of their ways they do this.....or did this shall I say. Not sure how many Top Producers of the year will have to go bankrupt before this publication looses its credibility. Bigger is not alway better as has been clearly evident in the past couple months. We will have to wait and see how long it is before Top Producer recognizes this....I guess only the future will tell all of these answers.
8:41 PM Jan 20th
 
Cheman386 - IL
Ugh, taking nothing away from this guy but after the Illinois family farms Bankruptcy wondering about the economies of scale....."I don’t see anything to stop the growth of large farms," he says. If you look at ILLFFs website they talk about economies of scale and list all of their ways they do this.....or did this shall I say. Not sure how many Top Producers of the year will have to go bankrupt before this publication looses its credibility. Bigger is not alway better as has been clearly evident in the past couple months. We will have to wait and see how long it is before Top Producer recognizes this....I guess only the future will tell all of these answers.
8:41 PM Jan 20th
 



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