It's no secret that dairy producers are facing a steep deterioration in milk prices. Class III milk futures have fallen about 45 percent from a peak of $24 per hundredweight in 2014. Though this decline is consistent with milk price cycles, the drop is more pronounced than usual in monetary terms.
Like other businesses that find themselves facing financial constraints, the initial reaction among many dairy producers is to inquire about a larger line of credit. But that's a duct tape solution at best. In some respects it’s akin to someone struggling with a personal financial burden looking to increase his or her credit card limit. Simply put, a larger line of credit is usually not the solution.
Instead, the current environment suggests it’s time to batten down the hatches and focus on positioning your dairy business to weather the downturn while setting it up for future prosperity. You can’t control milk prices, but you can craft strategies to make sure you're poised for more favorable climates. That means working in concert with your partners, including your CPA or financial consultant, your marketing specialist and, of course, your banker.
A team effort
To start, you'll need sound financial information to make informed decisions. My colleague, Sam Miller, has noted the importance of creating a financial dashboard to provide a clear picture of your operations.
Among other measures, it’s imperative to understand your cost of production. To do this, however, you’ll likely need to enlist the help of your financial consultant or CPA. Working with financial metrics is only valuable if they are accurate and current. I know some farmers who, once comfortable with their numbers, will look at each line item and determine how they can eke out a 10 percent savings. It's a good strategy, one that further underscores the importance of good financial reporting.
Working with your marketing specialist is essential from a risk management perspective. In a depressed milk price environment, you'll need to protect your margins. This does not always necessarily mean preserving a positive margin. In some instances, it can even mean limiting negative margins. Suffering a small and predictable loss is almost always better than exposing one’s farm to a severe one. In a tough marketing environment, it’s time to play it safe, not swing for the fences. It's important that your marketing specialist shares your objectives.
Get ahead of the game
Before thinking about any specific financial tools, one of the most important things you can do is to be proactive. Your banker should be your partner, so reach out early and communicate often. Your banker knows it’s a difficult time. Frequent communication keeps the channels open for you to ask what it is you need to do to get your fiscal house in order. The earlier you have these conversations, the more time you and your banker have to develop solutions. Waiting until you’re in a corner limits potential options.
No one has a silver bullet. Nonetheless, there are a few strategies to help you negotiate a depressed pricing environment.
- Re-lever your capital assets to move debt down the balance sheet, thereby creating much-needed working capital.
- Explore leasing new equipment instead of purchasing. This can help accelerate your asset turnover. Or, forgo new equipment altogether.
- Consider selling capital assets that aren’t essential to your core operations, particularly now when land values are strong.
- Examine your interest rate structure. Employ risk-management tools to make sure you're not exposed to possible rate increases.
- Complete what-if scenarios or stress tests to determine how changes in milk prices, input costs or interest rates could affect your operation.
- Renegotiate contract terms with your suppliers. This can help offset the effects of margin contraction.
As you have discussions with your banker and run through these options, they may spark additional conversations with your financial and marketing teams.
The good news for many is that the peak in milk prices (and the buildup to it) provided producers with adequate opportunity to bolster their balance sheets and build working capital reserves. Additionally, an overall deterioration in commodity markets has reduced input costs. This has helped offset low milk prices.
But that doesn't mean dairy producers should be complacent. Those reserves won't last forever as reduced margins begin to eat into working capital. What’s more, producers shouldn't depend on the vagaries of the commodities market to keep their costs down.
Dairy producers will face financial challenges during the current pricing headwinds. But by taking proactive steps to prepare yourself for tough times, you can put yourself in a position to take advantage of future tailwinds. PD
For more agriculture industry insights, visit the BMO Harris Bank website.
- Regional Manager of Agriculture Business Banking
- BMO Harris Bank
- Email David Rinneard