In a follow-up to this old mutt’s piece two issues ago about Fonterra directors getting to grips with the co-op’s financial state and loudly sharing their dismay in the Koru club, another of the Hound’s spies has passed on more news in the ‘Fonterra director watch’ category.
DairyNZ says its modelling shows that for the coming season the vast majority of dairy farmers will have to live in overdraft for the entire twelve months from June 1, 2015 to May 30, 2016 and possibly longer.
Wade Bell, DairyNZ regional leader, says the drop from a payout of $8.50 to $4.50 is massive, so his organisation is focusing on helping farmers sort out their cashflows, as posted on its website. Bell says they have done an ‘average’ cashflow for owner operators and sharemilkers for the next 12 months and the news is not good.
“You would normally expect farmers to be into overdraft by October-November and come out of overdraft early in the new year. But looking at the cashflows this year, not many, if any, will come out of overdraft for the entire season. This depends a little on what figure Fonterra sets for the payout next season but based on where we think things are at the moment, including the GDT, there is nothing to indicate the year will be exceptional. Maybe a few will have positive balances but the majority will still be in overdraft this time next year.”
Bell says this is based on the proposition that the average cost structure on a dairy farm is about $4.30/kgMS. But he says if a farmer has an average level of debt of about $20.00/kgMS that will add another $1.20 of debt servicing, putting the cost up to $5.50/kgMS. Even if farmers can trim their costs they will still need $5.00/kgMS or slightly more to break even.
“This is just to pay the farm working expenses and interest – there are no living expenses or anything else. It’s a crisis and that’s why a lot of commentators are saying farmers can possibly manage one year with the banks being supportive. But if it goes beyond that it would become a major concern. This is a very serious situation and it will obviously have flow-on effects into the wider community and the nation as a whole.”
Bell says it’s hard to tell whether dairy farmers on high input systems are more vulnerable than those on low input systems. But he says it’s well known that farm profit is closely linked to farm working expenses and what typically happens is that higher input systems have higher farm working expenses. It’s likely that those on high input systems will respond to the lower payout by cutting out expensive items and perhaps changing their type of feed to cut costs, Bell says.
“But there is a limit to what they can do given the infrastructure they have, the stocking rates and the machinery they own. But I don’t think we are going to see farmers chop and change from one system to another. Irrespective of the system a farmer is running, if he has a high cost structure he is very vulnerable at the moment.”
Cashflows will be tight
ASB's Rural economist Nathan Penny agrees with DairyNZ’s view that cashflows for dairy farmers over the next year will be ‘pretty tight’. And he predicts Fonterra will initially pitch next season’s forecast payout low. Some farmers may have to exit the industry if low returns persist, he says.
“This season the one group doing it tough will be those new to the sector. If you have come into the sector in the last year you’re going to be struggling. The same will apply to those who run higher debt or are higher leveraged than the sector average. The one counter to that is that interest rates are very low and have the potential to drift even lower over the next year or so.”
Penny says farmers are already cutting spending onfarm and looking at things they can control like fertiliser spend, feed, maintenance and capital expenditure.
“Obviously that has implications for the wider rural sector and we expect to see less activity in the rural supply businesses around the country. We also expect land prices to reflect that. They came off the boil towards the end of last year and we expect that to continue into this year.”
Penny says retail sales in rural areas are likely to be “softer” as the spending power of dairy farmers declines. This has implications for the whole country: lower export receipts and tax take.
“Finance minister Bill English has announced they will not hit their surplus target in this fiscal year. And the dairy story is part of, but not the only reason for tax revenue being down $4.5 billion over the next five years. So it does have wide implications and we are expecting a tough period ahead for the sector as whole.”
Penny says he believes many farmers paid off a lot of debt when the payout was $8.50 and that they were “restrained” in their spending. He says ASB will work with farmers to manage cashflows, set budgets and discuss their requirements.
“Our medium and long term view of the dairy sector is very positive. This is based on emerging markets’ demand for protein and the growing incomes in those countries. We see this as a long term positive story. We don’t think anything has changed there so in that regard it’s about managing proactively with farmers over the next 12-18 months.”
Penny says the present situation is quite similar to what happened when there was a good payout in 2008, then a huge drop in the following year then a price recovery.