Ted Tice, Wells Fargo Agribusiness Consultant
With the outlook for corn and soybean prices decidedly bearish for the remainder of the 2014 – 2015 crop season and into the 2015 – 2016 crop season, the economics of corn and soybean farming have become a challenging proposition. During the recent era of high grain prices, cash rents, input costs, and equipment purchases followed commodity prices up, as suppliers sought a piece of the farmers’ good fortune. Now in the face of much lower grain prices, farmers are facing a higher cost structure relative to revenues, necessitating focused cost control.
While the outlook for profitability in 2015 is bleak, over the long term the market will adjust. Capital expenditures will halt, cash rents will decline, input costs will abate, and ultimately, land values will soften. As in previous times of financial stress, financially strong managers will view this period as an opportunity to expand, while financially weak managers will exit the business.
Table 1 illustrates what an Illinois corn and soybean farmer will face in 2015. Assuming average yields and using prices as of February 4, 2015, for fall delivery of grain, the estimated prices required to break even, and the projected losses per acre1 are as follows:
In the chart below that presents Illinois corn revenue and break-even per bushel since 2007, it is clear that the recent downturn in profitability is more a function of lower revenues per acre than increasing cost per acre. Nevertheless, costs followed revenue up.
After a loss in 2014, many farmers have curtailed capital expenditures, a fact that equipment manufacturers’ finanical results confirm. So far, crop input suppliers have not reduced prices for the 2015 crop year as fertilizer, seed, and chemicals remain stubbornly in line with 2014 costs. However, there is anectodal evidence that cash rents are beginning to fall. According to the Creighton University Rural Mainstreet Index, bank chief executive officers (CEOs) in the Midwest are seeing a 16% drop in cash rents. The Illinois Society of Farm Managers and Rural Appraisers expects a 9% decline in cash rents in 2015. These projected declines, however, will not be enough to help the farmer in 2015. Using Table 1 as a model, a central Illinois farmer that rents all of his land would need a decline in cash rent from the current $300 per acre to $185 per acre to grow corn profitably. If commodity prices do not strengthen appreciably (and it appears unlikely they will), expect cash rents and input costs to decline in both 2016 and 2017.
A farmer that owns land free and clear of debt will experience a tremendous advantage during this period of financial stress. A hypothetical 2,000-acre farm illustrates that benefit. Following are three scenarios for returns to a 2,000-acre Illinois farm with average yields.
- If a farmer cash rents all land planted, the farm will incur a $249,090 loss.
- If a farmer owns half of the land planted with no debt and cash rents half of the land planted, the farm will generate a $50,910 profit.
- If the farmer owns all of the land planted with no debt, the farm will generate a profit of $350,910.
This simplistic rent versus ownership analysis illustrates that during this period of duress, there will be some “haves” and some “have-nots,” implying that further consolidation will occur. During the recent high grain price era, many young farmers entered farming while other more established farmers expanded aggressively by purchasing farmland or bidding top-dollar for cash-rented land. It’s unclear whether these farmers will survive.
High-productivity land in central Illinois is currently selling for approximately $10,000 per acre. Capitalizing the $350,910 profit of the 100%-owned land in the above example at a rate of 2.79%2 yields a land value of $6,288 per acre. This implies that given the projected 2015 income for a 2,000-acre farm with the land owned free and clear, that land is overvalued by approximately 37%. Should interest rates rise as expected, land prices could be even more vulnerable to a decline.
With the average age of a farmer at 57, this analysis begs the question as to why a farmer nearing retirement age should continue to farm with what appears to be a few years of sub-par returns and watch the value of equity decline. Rather than operate the farm and generate a profit of $175 per acre, shouldn’t the farmer retire and let someone else pay him or her $300 per acre cash rent?
Clearly some economic changes are in the offing, but the question is when. How long can a famer hold out until the adjustments occur? Thanks to record-high profitability from 2007 to 2013, famers today have a strong working capital position and low debt levels. These strengths will carry the farmer through 2015, but watch out for the 2016-2017 crop season. If costs don’t decline during these years, working capital will be depleted and require more borrowing at a time when land and other asset values are declining. Operating losses and lower land values could quickly wipe out equity for the operator that rents most of his land, or for one with long-term debt secured by land and equipment. Without question, a farmer’s strong financial position could quickly evaporate during what appears to be an extended grain price downturn.
1. A drought and subsequent crop insurance proceeds account for the extraordinary revenue per acre in 2012.
2. 10-year treasury plus 100 basis points risk premium
Ted Tice, Wells Fargo Agribusiness Consultant, joined Wells Fargo and the Agricultural Industries Group in 2011. He has responsibility for a diverse range of agribusiness processors across the entire Wells Fargo footprint.
Ted possesses extensive experience in Agribusiness lending and farm management. He is a graduate of Iowa State University, where he earned a BS in Ag Economics, and of Washington University, where he earned his MBA. While a member of the American Society of Farm Managers and Rural Appraisers, Ted also earned his Accredited Farm Manager designation.