What do the near-term economics look like for crops in 2015? What is a farmer or a landowner to do?
To begin to answer that question, we need to look at farmer finances. There is no doubt that farmer profits have been declining from 2013 to the present. 2013 resulted in overall grain farm profits in Illinois being less than half of the results in 2011 and 2012. Still, 2013 was the sixth most profitable year on record for Illinois producers.
Profits in 2014 were likely lower than in 2013, but are still being tabulated. Land values have fallen back a little since, but mostly remain steady. Farmers are still buying most of the land that is being sold. My observation is that at auctions, there are fewer active bidders, but those buying the farm are highly motivated to get the land they want.
Cash rents are basically mirroring what is happening to land values. Cash rent levels have remained steady to slightly down. Should cash rents be lowered to react to lower farm profits? The answer isn’t so simple. Prior to the ethanol boom, farmers were willing to give up profits in one year to make money on the next crop rotation. Again, farmers made money in 2013, but not as much as they’d become accustomed to making.
Low farm profits will take their toll if this lower grain price trend continues. The lower profit blip in 2009 didn’t create too many problems overall for most farmers, as profits came storming back in subsequent years. The answer to the question of where cash rent levels will settle for the next few years will likely rest with the farmer’s ability to generate cash flow or call on cash reserves. That is where farmers from one neighbor to the next differ vastly. Long-term, no farmer can survive operating at a loss. Short-term the financial pressures on farmers could be very different from neighbor to neighbor. A farmer’s current ratio helps us to see this.
The definition of “Current Ratio” is the liquidity ratio that measures a farm’s ability to pay short-term obligations. The current ratio formula is Current Assets ÷ Current Liabilities. The greater the current ratio number is, the more the farmer will have in cash reserves from which to pay cash rent. FBFM (Farm Business Farm Management Association) provides the details here in a report released in 2013. Note the Current Ratio of farmers at the median and those in the upper ¼ of their clientele base. The data is for grain farmers. One could assume that with lower profits, the 2014 current ratio figure will be lower than 2013.
Simply put, there is a huge difference between farmers in the upper quartile versus those at the median. The bigger the number (6 to 7), the more leftover cash they have to meet obligations.
Another chart shows the Current Ratio for the bottom quartile of producers was at 1.75 for 2012 and 1.46 for 2013. A Current Ratio of 1.0 means that the farmer has $1.00 in current obligations to pay for every $1.00 of cash they have available in the short term (operating year). A farmer with enough cash reserves to score a 7.0 Current Ratio has a lot more cash available as a percent of farm operation than does a farmer with a Current Ratio of 1.2 assuming the farms generate similar amounts of revenue. Other financial ratios show a strong difference between farmers as well. Farmers are not equal in their ability to use cash to meet cash rent needs. That is a big reason why some are more willing to pay higher cash rents than are others. Of course a farmer in a strong cash position may also not want to pay higher cash rents in order to preserve cash as well.
Why farmers have a wide variance in their cash position is complex. It could be due to management ability or lack thereof. One neighbor may have reinvested in machinery while another did not. Some farmers are just more frugal than their neighbors. Medical hardships and labor expenses can also be deciding factors. Paying high cash rents can also lead to a diminished cash position. A number of farms are going to have to re-evaluate how many family members their operation can support.
The bottom line is that in the next few years if grain prices don’t go back up, there will be major differences between farmer neighbors in their ability to pay higher cash rents. Farmers and landowners will have to make hard decisions on whether or not to bid or accept a bid on cash rent. Long-term relationships and family finances will come into play.
If your farmer is balking at cash rent increases, you likely can find someone who can and will pay more and do a good job on your farm. As a farmer, you might want to make sure your relationship with the landowner is in good shape and not take that relationship for granted. Technology has changed and many farmers do have the capability to expand. The hard fact is that we’ve been losing farmers due to technological changes for about a hundred years already and this trend will probably continue as agriculture technology improves. One farmer will be able to operate across more acres as time marches on.
Some landowners are fearful that their tenant will cut back on fertilizer and deplete the soil if cash rents are too high. My personal experience tells me that there is little correlation between cash rent levels and fertility levels. I could probably make a case that the farmers that are paying high cash rents know that they need to keep fertility up to make the operation work for them. Requiring soil test information, yield data and fertilizer records can help to alleviate that fear and risk. Many farmers now provide that information to their landowners.
The next several years may be the perfect storm to decide who can and will stay in business due to cash flow and securing production acres. Cash reserves will be a big determinant of that equation.