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

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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.