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National Penn Bank’s Ag Financial Seminar
Good margins seen in cautious forecast
Expert suggests rules not to break, especially with record milk prices and moderating feed costs

By SHERRY BUNTING
Special for Farmshine

EAST EARL, Pa. – “There’s a huge market for dairy in China, and that is part of what is driving higher milk prices today,” said Gary Sipiorski of Vita Plus to the crowd of over 250 farmers attending National Penn Bank’s Ag Financial Seminar last Wednesday (Jan. 15) here at Shady Maple Restaurant in eastern Lancaster County, Pennsylvania. Sipiorski is a financial consultant and former ag lender based out of Wisconsin.

He and retired Penn State ag economist Lou Moore talked about the global and national factors affecting agriculture -- with Sipiorski focusing mostly on dairy and Moore giving a broad spectrum analysis of ag economic trends.

Sipiorski also shared his “8 rules not to break” for a healthy dairy farm business, which he said were important to keep in mind as margins increase due to record milk prices and moderating feed costs.

Both speakers mentioned California and the western U.S. in terms of future milk production. Sipiorski noted that California suffered through 2011 and 2012 – as did any dairy that bought-in all of its feed.

“California wants what you have,” said Sipiorski, noting that the economic advantage that used to be in the West has shifted in recent years toward the producer-model that is most prevalent in the East and Midwest, where farms tend to grow all or at least some of their own feed.

While a great crop in 2013 has alleviated feed costs in the milk cost-of-production calculation, the West has a drought and water situation to deal with, which is said to be worsening each day without precipitation or mountain snow cover.

“The drought isn’t over,” said Moore. “It has just moved out of the Corn Belt and further West. California is experiencing the driest conditions in the history of the state.”

Sipiorski also mentioned domestic fluid milk consumption. It’s no secret that Americans are drinking less milk, but his figures showed a dramatic drop: In the 1960’s, annual fluid beverage milk consumption was 30 gallons per person. “Today that number is 20 gallons annually per person. Consumers have too many choices,” he said. “Soda consumption is 55 gallons per person annually. That’s a 55 gallon drum of soda! That’s nuts!”

Despite the decrease in beverage milk consumption, overall dairy consumption annually on a per-person basis has increased due to the consumption of cheese and yogurt rising to fill the void.

“Butter consumption is also way up -- all of a sudden -- because we’re finding out that oleo is just not good for us,” Sipiorski noted.

In his annual “crystal ball gazing,” Moore, too, brought positive news for dairy and livestock producers. He showed how all ag sectors (crops and livestock) used to see their net farm income trends follow similar paths until 2008, when the increase in ethanol mandates and production began to fuel crop prices. Dairy and livestock producers fell behind, while net farm income from crops rose, and high grain markets were compounded by drought and exports.

“I think we’ll see those paths coming back together over the next few years,” said Moore, alluding to a softening of EPA’s stance on mandatory inclusion of ethanol, a predicted good crop in Brazil and last season’s healthy corn and soybean crop harvest in the U.S.

On the farm bill, Moore was not hopeful. He noted that continuing resolutions have kept farm programs on auto-pilot while Washington ignites over the dairy policy battle on whether or not supply management should be part of the dairy title safety net. “I don’t think they’re going to get it,” he said. “It certainly doesn’t look that way.”

Moore described the national economy in neutral terms, with GDP at 2.3% and inflation (consumer price index, CPI) up 2.2%. “The Federal Reserve likes to see CPI at 1 to 2% so they aren’t likely to do a whole lot with interest rates. Rates are very low and even as they go up a bit, they are still historically very reasonable.”

He cited the recovery of the auto industry and rebound in the housing market as two positives for the national economy, and in his typical tongue-in-cheek humor, noted that “the best thing we have going for us is our ability to ignore reality.”

This was something Sipiorski alluded to as well when he reminded the crowd that the Great Depression was not brought on by the Stock Market Crash. Instead, it was preceded by folks spending more than they could repay. “That, too, was a ‘bubble,’” he said.

Moore cited some of the economic negatives, including unemployment at near 7% (on paper). He also noted the “pitiful antics” in Washington keeping businesses on the sidelines waiting to invest, but seeing the promise of more taxes and regulations standing in the way of that investment.

In the ag economy, Moore noted that escalating land values have eased and that the grain vs. livestock divergence in profitability is coming back together. He showed that the U.S. portion of grain exports is slowing and that China is pulling back on its U.S. corn purchases -- citing GMO’s as the reason. Moore stressed that given China’s “terrible history with food safety,” it stands to reason that their “GMO concern” is aimed at keeping U.S. corn imports down so their prices can go up with the objective of getting more of their own people to grow more corn at home.

While he noted U.S. corn beginning stocks are large at 13.92 billion bushels, usage is also large. “There won’t be much carryover,” he said, adding that the 2012-13 crop usage showed ethanol use of corn (40%) topping animal feed use (39%).

For Pennsylvania, Moore noted that yields were close to the national average at 155 bushels per acre with total corn production at 164.3 million bushels. “That’s good for our basis,” he said, speaking of the basis paid by buyers of corn for dairy and livestock feed. “When Pennsylvania has a big crop, there’s almost no basis, maybe 10 to 25 cents. When we have a small crop, that basis can go to 80 cents or $1 per bushel.”

Moore said dairy farmers will continue to see high prices for cull cows as the nation’s smallest beef herd since 1952 will take time to rebuild. On the milk price side, he said exports are the vehicle, and China is driving.

“The people in China don’t want to drink their own milk,” he said, referencing the history of food safety troubles in China’s dairy industry, most notably the melamine issue in 2007 that resulted in deaths and kidney failure from melamine-tainted infant formula.

Sipiorski also noted the runaway milk prices and milk margins from both export and domestic dairy usage. But he also introduced seeds of caution about spending during these times of good margins. He credited lenders like National Penn Bank for having Ag Financial Seminars so their customers understand how bankers must do things with today’s regulations, but more importantly so ag customers can learn and be more successful.

In his “8 rules not to break,” Sipiorski focused on giving farmers guidelines for spending, investing, borrowing, and saving. He urged producers to “do a balance sheet at the end of the year for your loan officer and for yourself – to see how your assets are growing.”

Assets include cash on hand, savings, receivables, feed on hand and value of market animals (dairy cattle). Liabilities include payables, past due rents and taxes, principle and interest for the coming year, and lease costs for the coming year.

In short, Sipiorski gave these 8 guidelines

1. The balance sheet of assets vs. liabilities should show $2 of assets for every $1 of liabilities.

2. No more than 20% of farm income (milk check or pay check) should be used for interest and principle payments… and 15% is even better.

3. The farm business should have no more than an 85% ratio of expenses to gross income… and 65 to 80% is even better.

For this item, Sipiorski showed farm records analysis of how a 5% difference in feed expense made a $1.08/cwt difference in the farm’s income over feed cost.

“Is that a big deal?” he asked. “It’s $197 per cow per year. For a 100-cow dairy, that’s almost $20,000 a year.”

He broke this down to be not a straight reduction in feed cost. Instead, the savings of the top one-third of the farms in the analysis were due to producing higher quality and quantity of feed on the farm. He stressed that the quality of the feed was particularly important, helping those producers in the top third save in purchased feed costs while having good production and healthy cows.

4. Debt per cow, he benchmarked at $3000 to $5000, depending on the unique aspects of the dairy operation. He stressed that a debt per cow of $7000 is the absolute maximum and would fall into a “special terms” category. Sipiorski also urged producers to get used to thinking of debt per hundredweight of milk, and that figure he pegged at $20/cwt. “Less is always better,” he said.

5. “Borrowing is okay as long as you can gain $1 of gross income annually for every $1 invested,” said Sipiorski. He gave the example of cows being a good investment because (using today’s milk and cattle prices) a cow would generate $4000 per year after the initial investment of $2000 per head.

High priced land was on the minds of the farmers in the room from Lancaster and surrounding counties. Getting high priced land in Lancaster County’s development-pressured areas to generate $1 of income every year for every $1 invested was tough math for the group.

6. On equity ratios, Sipiorski benchmarked 30% equity on the balance sheet (40% is better). This is a farm’s “net worth” as a percentage of the farm’s total assets.

7. An 8% return on assets (ROA) is a good benchmark, said Sipiorksi, adding that the higher the better. This net earned income as a percent of total assets. This does not include appreciation and it is net earned income after deducing for family living.

8. A primary key to financial health, said Sipiorski, is to “know your cost of production.” He urged farmers to know their expenses per hundredweight of milk shipped (not per cow). He said this can be figured on a flat cash cost of production basis using expenses, principle and interest, and family living or on an accrual basis where expenses are allocated to the income produce and depreciation is included as well as family living in that cost-of-production calculation.

If you grossed $160,000 and you shipped 9,150 hundredweights of milk, your cost of production would be $17.49. Cost of production ranged from $16.50 to $21.00, with the average being $17.50 in the farm group analyses he showed. The point is that there’s a big difference in that range, which is not reflected in looking just at the average.

After going over his 8 rules, Sipiorski said they can be bent “a little,” but urged producers to use caution in today’s volatile markets and margins.

“I know your dairy farms are family businesses, and they are your lifestyle; but it’s important to not just work hard, to work smart and know your numbers,” he said.