Payout Below $5.00 For Coming Season?

Keith Woodford has written an interesting post. Essentially at current prices with the exchange rate at its current level, farmers should expect a commodity price of below $5.00. 

John Penno the CEO of Synlait, is estimating their final payout for the 2012/2013 season will be $5.00.

In recent years Fonterra, economists and general commentators have been saying that milk prices will be volatile in the future.

Questions:
Will cows still be selling for $2,000 a cow?
Will land prices fall?
Will this effect the share price of Fonterra shares once TAF is implemented?
When you combine milk price volatility with the recent environment court rulings re: nitrate limits. Will farmers still be paying $40,000/ha for land?
Are we going to see a reduction in farm working expenses for this next season? 

Last time the payout dropped from a record high was in 2009. The payout reduced to $5.00 but farm working expenses didn't fall. The result was cash losses accross the board for the 2009 year.

Lets just hope that farmers are no longer over extended and are able to handle this reduction in payout. 

Organics

Research out of Stanford University has shown that organic produce has no greater nutritional value than non-organic produce.

That’s not news to me, but I don’t think people buy organic food because they feel it is has a higher nutritional value, but rather because it is not covered in sprays and pesticides.

Jacqueline Rowarth points out repeatedly that organics generally produce 20% less yield than conventional farming methods. These farmers need to receive the premium that organics provides in order to stay profitable. But as the world begins to meet the needs of a growing population, all the figures I’m seeing require more product being produced from less and with a lower environmental impact. I’m doubtful that organics can achieve this.

The debate whether organic produce is worth it or not is irrelevant, in my mind. Consumers are buying organics because it means something to them and they are prepared to pay more for it.

None of us buy products based on logic; many people pay an arm and a leg for RM Williams clothing. They then try and justify their purchase with logic, like “its great quality clothing, it lasts such a long time” or “I struggle to find pants that fit me and these RM Williams jeans fit perfectly”. The fact is they buy RM Williams clothing because that’s what outback cowboys wear and they identify with the lifestyle and the image of the cattle rustlers from the outback.

People tell themselves that they buy European cars for the safety, but we all know it’s for the image.

When I was a kid at school in the 80s, Adidas three stripe tracksuit pants were the fashion item of the day. After pleading for some months, my Mum went and bought me some tracksuit pants that were the same in every respect to Adidas tracksuit pants except they had 4 stripes not three. What a tragedy!  Everybody would know that I was wearing the cheap knock off version. My poor parents couldn’t understand why I wouldn’t wear them, logic would suggest that they looked almost the same but were 50% cheaper.

It’s all about the image and what that image says about us.

Consumers or should I say middle aged, mothers put a value on the term “Organic”. To them it means natural, environmentally friendly, small scale, local, animal welfare, wholesome and safe. Many consumers are attracted to an image of a simpler time and this is compounded by a mistrust of corporates who, in their minds do “things” to their food in order to make it last longer on supermarket shelves or cheaper to process. These are all factors in their decision to buy organic.

Many people attach attributes to the term “organic”, which are simply not true. In the case of milk, an organic cow is farmed in almost the exact same way as a non-organic cow. They still walk to and from the cowshed and get sore feet. An organic cow leaches just as much Nitrogen as a non-organic cow, organic cows produce just as much effluent as traditionally farmed cows. The only difference between the two systems is, traditional dairy farmers use antibiotics and Nitrogen fertilizer.

Organic farmers will dispute what I have just said; they will say that their soils are much improved due to the additional organic matter in their soils. Therefore more Nitrogen is absorbed and not leached. I am sympathetic to biodynamic farming practises, but I’m not sure some of the claims have been proved.

Organic dairy farmers will point to excessive Nitrogen fertilizer use, as the modern farming industry promotes a short term view with an emphasises on more production. They will also point out irresponsible antibiotic use by farmers.

I have to say that I can’t disagree with the points they make on fertilizer and antibiotics. But I doubt very much that the milk from an organic herd is in any way different to a non-organic herd. Will the milk be in any way contaminated if a farmer sprayed the gorse at the back of the farm or if a farmer applied 25kg of Nitrogen fertilizer behind the cows? I doubt it very much.

But it’s not about the features or the facts of a product that matter. Is someone really that better off buying a $60 Rip Curl T shirt with the logo on the front as opposed to the same colour shirt at Hallenstiens for $15? Are those RM Williams shirts that cost $319 really so much better than the $80 ones at your local menswear store? They certainly are in the eye of the purchaser.

I think the average middle class person in New Zealand wants food that is produced ethically and sustainably. They want to know that the farmer puts a high priority on animal welfare and that the product is safe to eat. “Organic” is not necessarily the term that needs to be used. Organic has become the generic term for produce that is ethically produced and safe to eat in the minds of many customers. They only want organic because they think it has to be organic to meet their needs. Henry Ford made the famous quote "If I had asked people what they wanted, they would have said faster horses.". If you ask many customers what they want, they will say “organic”, because they don’t know any different.

If a farmer can show the average customer that their particular product meets the standards that they require, such as animal welfare, environmental impact and food safety, then they can receive the premium that is paid for organics without being certified organic. That’s because farmers can meet these high expectations without being organic. They just need to communicate the promise better. For a brand to do that, it requires total transparency with the consumer and open communication, which is easier to do these days.

When the debate arises about whether it is a sensible choice to buy organic or not. We spend most of the time discussing the logical facts. One side will point out how much pesticide is on your carrots the other side will show how organics produce 20% less yield and therefore have a higher carbon footprint, which will no doubt be rubbished by the other side and round the debate goes. But we forget that it is very rare that the logic or the facts are what drive us to purchase. It’s our emotional beliefs.

If I was selling milk to consumers, I would be communicating how my product meets the emotional beliefs that are satisfied by the term “organic”. Which is quite different to pointing outing out the differences between organic and non-organic milk.

Dairy Farming New Zealand Can Be Proud Of

I've changed my header to the Milking On The Moove logo. My goal is to create a dairy farming system that New Zealanders can be proud of.

I'm passionate about dairy farming and agriculture. While I have blogged about aspects that I think should change, I'm a fan of the industry. I'm concerned that Fonterra seems to get so much flack from the New Zealand public, which includes individual farmers.

I can understand left leaning environmentalists having a dim view of Fonterra, as that would be in keeping with their attitude towards corporates and big business in general. I'm concerned by the attitudes of middle New Zealand. It seems that many view Fonterra as a money hungry corporate giant that is screwing New Zealand consumers. I'm prepared to be a little understanding of a middle of the road New Zealander, who knows nothing about farming being influenced by the media.

But what really concerns me is the negative attitudes from business people, who I would have thought would lean towards Fonterra and farmers. But even these people seem to have it in for Fonterra. The comments in this  NBR article are a good example. 

I want to do my little bit to try and change the way dairy farming is viewed in New Zealand. So I hope to be helpful to non farmers, by being informative about issues like the price of milk and other industry matters.
But for the New Zealand public to be proud of dairy farmers, they need to change too. I don't want to be a negative voice against dairy farmers, but I want to highlight where farmers can do better. I'm not going to be an armchair farmer, preaching from my keyboard either. I'll practice what I preach (once I get my act together) and I will don a pair of gumboots and trial my ideas. I'll do it in full view, via my blog. So I will succeed or fail in full public view.

Please view all my utterances from the angle of, creating a dairy farm that New Zealanders are proud of.

Horizons One Plan, Farmers Opportunity To Innovate

Retailers have been facing two major challenges in the past 15 years. The first is the big box retailing giants and the second is the rise of internet retailing.

The big box stores generally have a high volume, low margin business model. Due to their high volume they are able to receive the lowest possible wholesale price for their goods. The small retailers struggle to compete on price and try to compete on service and the personal touch.

Box stores with a nationwide footprint need surety of supply from their suppliers. They can only buy from large suppliers who can meet the level of volume that is required. This tends to mean that all the stores sell the same sort of stuff. They go to the same trade fairs where they are approached by the same vendors. Even if a single retailer does pick up a unique product, it’s very easy for their competition to stock the item or a similar item. This is where the independent retailer has a chance to shine, but sadly many have not seen this opportunity.

Example.

When I went hunting for a tricycle for my son, I found that most nationwide retailers all sold the same model trike. When I popped into a few independent toy stores and bike shops, I was frustrated to find that they too sold the same Triang tricycle, which happens to be the same model that all three of my sons friends have too. 

A small retailer can’t stay in business by selling the same stuff as their box store competition.

Spotlight, the craft and sewing box store opened in Invercargill in about 2006. Within a year, one of the three sewing shops my wife frequented closed, stating they could not compete. The second tried to sell up, but after three years it still had not sold. The third shop which is run by nice old ladies is still there. Having spent countless mind numbing hours minding children, while my wife shops in spotlight and these small sewing shops, I feel I know the craft/sewing business.

They all stock the same patterns by the same big brands, the same materials, the same wools, all the “safe” items that are sure to sell. After an hour of trying to stop two kids pulling every display down or fondling every bolt of material or ball of wool, my bride announces “Let’s go, they don’t have any material like on my blogs”. Which gives me mixed feelings. I’m overjoyed to be leaving but somewhat frustrated that the last hour appears to be a complete waste of time.

The point is, to compete against the large retailers; small independent stores need to be unique, stocking totally different items. My wife instead turns to the internet to get the truly unique items she wants.

Which brings me to the next major threat to traditional retailing, Internet shopping. Now days anyone can buy from anywhere and can get the best price. But price is not why people turn to internet shopping. Its selection, the internet gives people the chance to buy the unique things they can’t get locally.

On the surface, this is a threat. But it is actually the greatest opportunity for small retailers, as it gives them the chance to source and stock truly different stock.

The craft/sewing store owners should be following the thousands of craft and sewing blogs, which are filled with bright new designs and ideas. These blogs are run by housewives, budding fashion designers, small cottage businesses and just true enthusiasts. They sell many of their designs and products on Etsy.com. Etsy is Trade Me or ebay for the craft and sewing world.

If I was running a sewing shop, I would be wading through Etsy.com sifting through the 80% which is rubbish and finding the truly outstanding products that are made by small producers or hobbyists. These producers can't supply big retailers as they don't have the volume. But they can quite easily produce enough for my little shop. When your retail store is filled with products that the public don't see everyday, you then become a destination store. Further more discounting is out of the question, as no one has stock like I do.

If I was in the toy or bicycle business, I’d ban the Triang tricycle from my selves and instead stock a tricycle inspired by Vanillabicycles.com or ifbikes.com. Both these tricycles are custom built, but I'm sure a local business would love to build you something similar without the expensive custom components. 

The internet gives small business the opportunity to find and stock truly unique products, in doing so they can become the tiny powerhouse retailer of their district. But most don’t as they prefer to just order stock from the sales rep that pops in every month and continue to sell the same old safe stuff that everybody else does. In Australia retailers are lobbying the government to put GST on imported internet purchases under $1,000, as if this will stop consumers from buying online.

What has happened is the business conditions that retailers operate in have changed. The internet and the large corporate retailers have dictated that business needs to be done differently in order to survive. The prospect is far from doom and gloom for small retailers, it’s simply a matter of these business owners operating differently and gaining the new skills required to be successful in the new environment.

I read on Friday, that the environment court had ruled on the Horizons Regional Council One Plan. I promptly read the reaction from Federated Farmers. 

One aspect of the One Plan is to make farming in certain areas a “controlled activity”. This will put a limit on the amount of nutrient losses that can take place under a farming system. I assume farmers will have to apply for consent to farm in these areas and put forward proposals as to how they will achieve the nutrient limits.

These proposals are similar to those put forward by the Southland District Council and Environment Canterbury. These proposals have not gone down well with farmers, as you can imagine. Currently for farmers to continue to farm as they are on these areas can only be achieved by reducing the effective stocking rate, which equates to less money.

It’s no wonder farmers are worried. When/if these measures are put in place, it will equate to a loss in farm profitability, which will flow onto land price reductions as well.

These changes will put some farmers out of business.

But farmers are just like any business, they need to adapt to the changing business environment that they operate in. Just as the retailers have needed to change in order to combat the threats they have faced, so to do farmers. Farmers aren’t the only ones who have invested in their business and stand to lose money. Business owners all over NZ invest money in their businesses, only to find a major competitor opens up next door or the government changes some law or regulation. I had to make a major change to my equipment rental business in 2005 when the credit contracts & consumer finance act was rewritten. We continue to change our practises as it becomes clearer how the revised law is interpreted.

When Roger Douglas removed the subsidies paid to farmers in the 1980s. Some farmers lost their farms, which is regrettable and sad. The rural sector was forced to become efficient very quickly or go broke. I was a child when that happened so I accept I may not understand how painful that period was for farmers. But now 20 years on, the prime minister of New Zealand is telling the world how we have no subsidies and we are the most efficient producers in the world.

New Zealand agriculture has already adapted to a massive change in the past and is better off for it. No farmer would have volunteered to remove subsidies, it had to be done for them.

The rural sector can adapt to the change in environmental practises, it just needs to be committed to doing it. Many people are critical of Roger that he made the changes so quickly and did not phase the changes in over time. The signals are being sent loud and clear to the agricultural sector that change is coming. The sector says that they are “committed” to environmentally sound practices. I get the feeling that the meaning of the word “committed” will change somewhat when the district counsels announce an effective start date for nutrient limits. Farmers shouldn't leave it too late or they will find themselves scrambling to become efficient again, this time it will be environmental efficiency that has to improve.

I respect Federated Farmers and I particularly like Bruce Wills, their advocacy has no doubt brought balance to the debate. But I will have to respectfully disagree with their stance. Fighting this issue is like retailers trying to fight the internet. 

This is not a time of doom and gloom for farmers, its a time to think radically and innovate. Its a time to become better farmers and business people.

Sharemilking & The Progression To Farm Ownership

Federated Farmers has a report on their website called “Ensuring a viable progression path in the dairy industry”.

It raises some interesting observations.

35% of farms are managed by sharemilkers (2009/10), 20% by Herd Owning Sharemilkers (HOSM). Although there has been only a minor reduction in the percentage of dairy farms managed by sharemilkers, there is a more noticeable trend in the declining number of HOSM, particularly in the South Island.

 It’s important to know the difference between a herd owning sharemilker and a contract milker/variable order sharemilker. Obviously a herd owning sharemilker owns the herd and they receive 50% of the milk cheque. They are responsible for most costs except capital fertilizer and R&M on the farm & infrastructure.

A contract milker is a contractor who receives a percentage of the milk cheque but does not own any cows. A variable order sharemilker may own some cows and the percentage of the milk cheque they receive is in line with the size of their herd.

Only 20% of farms have a traditional 50:50 sharemilker on them.

The report states the reasons.

Key reasons include higher debt levels onfarm, more corporate farm ownership, and the difference in financial returns to the farm owner between using a herd owning sharemilker and a Variable Order Sharemilker or Contract Milker.

I've had a few farm owners say to me, that they feel they would give away far too much of the revenue to a herd owning sharemilker. Therefore they employ a contract milker or mangaer instead. Many corporate farmers prefer to employ managers.

Market forces of supply and demand are at play, and the balance of power is currently in the hands of the farm owner. If the herd owning sharemilkers cannot accept there may need to be rebalancing of clauses within the traditional herd owning agreement, farm owners will make the decision to recruit contract milkers, lower order sharemilkers or farm managers.

Essentially farm owners are saying sharemilkers need to make a lower return or we will employ contract milkers instead.

Equity partnerships have become popular in the last 15 years. This is where people buy a share of an entire farming operation. The managing shareholder may choose to do this rather than go sharemilking.

Financially, logic suggests that in the long run, returns will be similar to those of the average farm owner (3-7% cash return on assets plus 5-10% capital gain per annum). In comparison, a HOSM agreement will generate on average a 20%return on assets, although there is a greater degree of annual variability in this figure.

The equity partnership option gives the managing partner exposure to capital gain of the land, but it also give them exposure to the interest bill that goes with land ownership.

If the land is not increasing in value, then they will not match the returns of the 50:50 sharemilker.

Equity partnerships are in my opinion not the way to wealth generation.

As you can see in the table above, sharemilkers make good returns. The graph below shows the profitability of sharemilking as opposed farm ownership.

Historically, 50:50 sharemilkers have always done better production than farm owners and other management structures. The table below indicates that this is no longer the case, with 20-29% sharemilkers showing better production in every period.

I had to take another look at that table, as it didn't show what I expected. But the graph below clarifies things

.

The traditional dairy regions of the Waikato and Taranaki have approximately 20-25% of their herds run by 50:50 sharemilkers. Southland and Canterbury have around 16% of herds run by 50:50 sharemilkers.

The average South Island production for 2010-11 year was 1030 kgms/ha. The North Islands average production was 866 kgms/ha.

The South Island has fewer 50:50 sharemilkers but more lower order sharemilkers. When you combine this with the South Islands higher average production. It distorts the figures to make it look like lower order sharemilkers produce more. When it is simply the South Island produces more.

This Graph below, really sums up the situation in regard to progressing through the dairy industry to farm ownership.

Ten years ago 10 cows would buy 1 Hectare of land. Today it requires 20 cows to buy 1 Hectare of land. That's even with cow values been at record highs for the past 8 years.

In 1994 my parents were sharemilking 400 cows in Tirau. They progressed to farm ownership in 1995, when they purchased a 140 Hectare farm in Southland. Based on the above graph they would need to have 800 cows to purchase the same farm in 2012.

In 1996 seventy per cent of sharemilkers intended to purchase their own farm once completing their sharemilking career. By 2011 this had reduced to 55 per cent.

I have a lot of respect for the sharemilkers of today. Its a tough business and due to the competition for sharemilking jobs, the current crop of sharemilkers are top operators and very competent. They face a lot of challenges, such as banks not really wanting to lend to sharemilkers, a shortage of jobs, combined with pressure to give up some of their profits and the cow value to land value ratio increasing every year.

I think it is unfair to blame farm owners for not employing sharemilkers, as the decision not to, makes financial sense. But I can't help but feel that, many of the farm owners of today got there by sharemilking and making 20% returns for 10 or so years. But now that they are farm owners they seem reluctant to give the next generation the same opportunity.

The pathway to farm ownership has become more varied, and there are more options to choose from. The pathway to progression is no longer linear. This should not necessarily be seen as a negative factor. However with more diversity in the industry there is a much greater need for adequate due diligence on each individual opportunity. In many cases this is not occurring to a sufficient degree, and professional advice is not being sought.

Either way, there is still plenty of opportunity in the dairy sector and the industry as a whole may have to look at other ways of progressing to farm ownership.

I've got a few ideas that I'll share at some stage in the future.