By John Haralovich CPA, CIRP, LIT, Senior Vice President, MNP LTD. and Stuart Person, CPA, CA, Senior Vice President, MNP LLP Agriculture
All industries have threats that will affect the success or failure of a business. The Agriculture (“Ag”) industry is no different and some would suggest it has more threats that could affect farmers than a typical manufacturing business.
In this article, we will go through some of the significant threats and provide a summary of the current market outlook in the Ag industry. (It should be noted the threats to the Ag industry are always changing and by the time this article is published, market conditions will likely have changed.) The article identifies issues a Licensed Insolvency Trustee (“LIT”) should consider when being retained to assist a farmer or Ag industry stakeholder.
Currently there is a worldwide oversupply of grains, and there is no indication this will change in the near term.
In Canada, 2019 production appears to point to an average year for grain. Weather in Ontario was wet in the spring, which delayed planting — and with the early frost, the growing season was shortened. In the prairie provinces, the summer was dry which damaged crops and reduced the overall yields for 2019. The world markets are also having problems harvesting crops. However, these instances have not increased prices for grain and the impact on the supply of crops is not yet known.
Understanding why there is an oversupply of grains, even with world population increasing is important. African Swine Fever has wiped out a significant amount of the hog production in China and other countries. Typically, China would be a major importer of feed grain and canola meal. With this reduction in demand, Canadian farmers are stockpiling these grains in hopes the market demand increases to allow them to sell on the world market at a much higher price. This strategy only works for farms that can afford to harvest the grain and hold it. Farms who are operating at the maximum level of available credit are forced to sell their grain at lower market prices.
Politics adds to threats for the Ag industry. Canada is in various disputes with China, India and the USA. The effects of the political differences create tariffs on Canadian grain and livestock and complete border closures are preventing their movement. The Canadian government operates the AgriStability program as a form of insurance for farms which is administered by the Provinces. These subsidies may not be enough, or timely enough to allow farmers to operate at a profitable level. This risk is live and always changing, making it difficult for farmers to manage their business and for stakeholders to properly manage the lending relationship.
Farmers do have access to a claims process where losses in a given year are subsidized by a Federal agency called AgriCorp. This process takes the average costs and revenue over the last five years and compares them to the current operating results. In a low-income year, a subsidy is paid to the farmer. In some situations, these rebates could be significant. This process is complicated, and most farmers rely on their external professional services firm to assist in the claims process. In the event an LIT is acting in a formal farm restructuring, inquiring as to the whether the farm participates in this program could provide a significant realization for the engagement.
To add to the issues farmers must navigate, the price of machinery has increased to a 100 percent over the past five years. This has increased the cost of production (“COP”) for farmers and increases the yields they must obtain to at least break even. Successful farms are those that have the lowest COP. Farmers are leasing machinery to help them manage their costs efficiently. If the residual values of the equipment are higher than the market value at the time the leases have expired, farmers are likely to return the equipment and lease newer machinery. The financial institutions who fund these investments or dealers could find themselves with a surplus of used equipment that have lower market values, resulting in losses. Lenders or manufacturers could find themselves in a similar situation experienced by auto industry in the early 2000’s.
To offset higher machinery costs, land values have tended to increase about 10 percent year over year. Based on industry analysis, it appears land prices are reaching their maximum value across the country. Farmers have used the equity in their land to help leverage their borrowings with stakeholders. The effect of land values stabilizing creates pressure on farms who are at their maximum lending limits to lower their COP to increase profits on crop sales. In the event COP cannot be lowered, farmers will find themselves providing additional security to support their indebtedness or face the potential of lending limits being capped or reduced. In the absence of positive cash flows, some farms may not be able to respond effectively to the demands from their lenders.
Despite farms becoming larger and working with increased debt, farmers struggle with financial literacy, record keeping and reporting. In addition, profitability planning, cash flow projections and monitoring are not typical management tools utilized by farmers. Stakeholders who become concerned about the viability of a farm will require farmers to produce these reports. If the farmer is unable to generate this information, LITs could be engaged to provide lenders with the information they require to determine the ongoing viability of the farm.
Finally, farms struggle with succession. The small farmer may not have the next generation waiting in the fields to take over the business when the farmer is ready to retire. This will likely lead to farmers selling to larger farm corporations creating megafarms. This consolidation will narrow the farming risk from many to fewer number of farms. If a global adjustment to the crop market was to have a negative impact on the Ag industry — and if debt fueled the consolidation of farms — Canada could find itself with a significant amount of farmland in the hands of lenders.
Farmers will need to pay more attention to the business as it is not simple anymore. Those farms who do not utilize the tools and strategies noted in the previous paragraph will find themselves in difficult situations which could lead to farm failures. On such failures, LIT’s will need to look at maximizing crop values, land values, insurance claims and equipment realizations.
In Canada, 44 % of the domestic beef is exported, generating $3.7 billion in revenue. Livestock farms have seen increased demand, mainly driven by the reduction of lower trade tariffs with Asia as a result of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (“CPTPP”) trade deal. As well, demand is projected to continue to increase over the next several years as beef tariffs continue to drop.
Western Canada is now competitive for pen space because of the changing market. Walmart, for example, has switched to providing Angus Beef, resulting in a surplus of Holsteins cows which are now being fed in Canada. Canadian feedlots are expanding into the U.S. to act as a natural hedge against currency risk and because the cost per pound of grain is cheaper.
For pork, African Swine Fever in China is the big disrupter in the market, and it is estimated that it could affect upwards to 40 percent of Chinese production or 20 percent of world pork supply. In China, the preferred protein is pork with approximately 50,000,000 tonnes consumed annually. With the Chinese Government recently removing restrictions on Canadian pork imports, Canadian hog producers should see stronger prices and positive margins moving forward.
The Canadian producer can take advantage of the lower Canadian dollar to sell its product on the world markets. As well, if the farmer had locked in their yield prices when the price for hogs was higher, it is possible for them to have a profitable year.
For dairy, the United States-Mexico Canada Agreement (“USMCA”) which replaced the former North American Free Trade Agreement (“NAFTA”) trade agreement will have an impact on this industry. Current Canadian milk pricing will have to be adjusted to agree to the new trade agreement and this will likely impact overall milk prices. As well, domestic growth in the milk market will likely be absorbed by allowable imports from the U.S. The tariffs and quotas pursuant to this agreement will only impact farmers in the coming months after the trade deal is ratified. The Canadian government will provide some level of support to these farms. However, the net effect is not known and will evolve over the coming months.
Today milk and dairy pricing are stable. However, the dairy farmers’ COP is going to increase. Without increases in revenues, either by federal subsidies or increasing quota price, farmers will find themselves looking at reduced profits or increased losses. Lenders in this space will be closely monitoring the tariff impact and assessing the ongoing viability of the dairy farm.
The poultry industry in Canada is the fastest growing animal meat market. The effects of USMCA have not been significant and the poultry industry remains relatively untouched.
The risk to these farmers center around the significant changes to their barns to meet the new animal treatment and market diversification requirements. As well, the increased COP for free range livestock will result in periods of lower revenue as the farm converts to meet the demands of this segment.
Farmers today are impacted by more than mother nature. Global warming has changed weather patterns, resulting in warmer or wetter periods that affect crop yields.
The effect diseases have on livestock and the demand for crops effects all farms in Canada — either livestock based, or grain based. The banning of Canadian livestock to be sold on the international market will negatively impact farmers as Canadians consume less and less meat.
Farmers are also thrown into Canada’s political disputes. Farmers are dependent on politicians to navigate through these and to protect the farming industry. If politicians fail to resolve the dispute, increased tariffs or outright banning of Canadian crops or livestock sends ripple effects through the farming industry.
Stakeholders within the Agriculture Services team will look to LIT’s to assist in assessing the lender risk. LIT’s could be in situations of managing and liquidating a farm-based business and should be aware of the significant hurdles it will have to navigate to successfully manage the engagement. Some issues the LIT will need to navigate will likely be imposed on them, rather than negotiated, depending on various trade deals between countries and the current political environment.
John Haralovich CPA, CIRP, LIT is a Licensed Insolvency Trustee and Senior Vice-President with MNP LTD. For more information, you can reach him at 613.691.4262 or [email protected]
Stuart Person, CPA, CA, is a Senior Vice President with MNP’s Agriculture practice. For more information, you can reach him at 780.969.1409 or [email protected]
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