December 28, 2017

DrKohl_color The Ag Globe Trotter

Dr. Dave M. Kohl

Welcome to the weekly edition of The Ag Globe Trotter by Dr. Dave Kohl.

With the close of 2017, it’s important to examine the trends and events that are impacting the agriculture industry. It’s time to raise the periscope to view the drivers of change next year and beyond. Thus, let’s follow the cycles.

If compared to the seasons of a year, agriculture is currently in a state of transition from one season to the next. The industry enjoyed the summer season from 2006 to 2012, or the great commodity supercycle. The economic stars aligned to give agricultural producers record profits and rapid increases in the balance sheet in both earned and appreciated net worth. The confluence of strong demand from growing, emerging nations and the low value of the U.S. dollar exploded exports. This, along with record low interest rates and the ethanol boom, created an economic period replicated only three other times since 1910. Of course, strong managers also capitalized on the acceleration of technology use, which brought wealth even to inefficient managers.

Next, the summer turned into fall in 2013 through 2017, when increased production efficiencies turned into a surplus of commodities worldwide. As a result, margins are suppressed and cash flows are stressed. Working capital that was built up during profitable years is now being used to bridge the profit gap, particularly among businesses in the lower one-third of farm profitability. In many of these businesses, managers will seek to refinance their debt, using the appreciated land values as leverage. Specifically, these producers want to create financial liquidity on the top half of the balance sheet. Of course, some need to refinance but no longer have the core equity - or excess equity in land – to leverage as it has already been used to cover losses in earned net worth or asset values. At the same time, businesses in the top 40 percent of farm profitability are selectively picking growth opportunities that align with the strategic direction of the farm business.

Over the course of the next few years, 2018 to 2021, agricultural producers will move from the fall season into winter. Stronger managers will proactively adopt production and cost efficiencies, and capitalize on marketing and risk management programs to realize a profit, even if small. Others who persist in denial will operate and manage from a hope that economics may improve, or that some adverse situation elsewhere will sweepingly change their reality. During this season, working capital will become a top priority. Some businesses will use working capital to bridge the losses in profit. However, some may find that bridge becomes unstable when refinancing and other requests are denied. For those unwilling to make the necessary adjustments, partial or total liquidation may be the best option. In winter, marginal land and other assets will decline in value. For example, land quality will be measured not only by fertility and water access, but also by what management possibilities exist either through technology or local and specialty markets.

Of course, the promise of winter is that spring will eventually bloom. Often, this is a period of regeneration and creativity. Occurring in the first half of the next decade, spring will bring managers who are both profit and market oriented. They will grow the business perhaps to a larger scale, or diversify streams of income by capitalizing on various markets. During this spring season, there will be stout competition between the equity and tenure of the senior generation and the younger profit- and market-oriented managers. An ideal situation would be a family business that integrates new members (inside or outside of the family) with new strategies and ideas to position the business for increased domestic and global market opportunities.

The spring season will be consumer-centric. Markets will be fragmented and highly influenced by the younger demographics that expect advanced technology as well as customization in delivery. In addition, this season will rely on data. For example, more producers will measure profitability by the field or individual animal unit. Systems to manage water are already being used in Israel, Australia and other water-challenged areas. In the spring season, these types of systems will become the normal standard even in the U.S.

Finally, the power of robotics and mechanization will expand and normalize its way into all production systems during the spring season. Labor is one of the areas that will continue to see direct impact, but as we have already seen, the data collected will drive efficiency in a powerful way. In the dairy industry, robotic milkers led to the detection of illness and other trends in the animal before even the best of human managers could recognize symptoms or change. The data stream could stem from the field or animal directly to the consumer, which may be a desire in future marketplaces. In fact, soil, plant and animal health will be elements for which the market pays a premium, especially for the younger generation seeking a quality experience and timely delivery. Of course, as with any progress, it may bring its own set of issues such as cybersecurity, privacy and others.

Today, the gap between the U.S. economy and that of agriculture and rural American is most definitely widening. Similar to previous economic cycles, the Coastal urban and suburban corridors are doing well, but the rural sectors and agriculture in the flyover states are struggling. Of course, the opposite can also be true as evidenced by the recent commodity supercycle, 2007 to 2012, when the agricultural industry and flyover states did quite well. The sustainability of the domestic economy depends on consumers, technology and continued growth in the equity markets. And as long as today’s euphoric attitude persists, it will perpetuate the wealth effect on consumers. If consumer confidence continues for a period of time, the impact on rural America needs to be assessed. Will agriculture retain and attract quality workers and managers, or will agriculture’s workforce flee to the suburban and urban areas and interests? Will rural America retain and attract the younger population that is so vital for growing and thriving communities? These potential trends will impact how the industry positions businesses for success.

Whether it is next year or beyond, the world of agriculture will be laden with opportunities and challenges. To navigate the change in seasons, a focus on the following will be necessary:

One. Transition management in a business will require the merger of tenure and equity with youth and the focus on growth and management. This type of business must promote an open work culture and conduct planning to capitalize on strategy and trends. The ability to prioritize, develop processes and execute strategies and systems are foundations of success. However, the key is to monitor performance through transparent data and implement needed changes. These elements combined will move any business to another level.

Two. As the domestic and global marketplaces grow more competitive, every organization will drive toward financial and operational efficiency. Terms such as asset-lite, collaboration and interdependence will be discussed in board rooms and meetings throughout America.

Three. The ability to grow and minimize losses of working capital will become the strategy for those who have historically relied on hard assets including land equity.

Four. Education and the commitment to lifelong learning is critical. In addition, agribusinesses will seek those who adapt quickly to data and information. America’s youth will be in direct competition with those born in a skills-based population integrated with technology and emotional intelligence.

The cycles of agriculture are much like the seasons of nature; for each one there is a different focus and strategy for success. The season drivers can range from population growth to a market crash, making information and trends important to watch. As one navigates the different cycles, rely on openness, efficiency, adaptation and education to realize the next season.