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Saturday, January 19, 2013

How Much Money Do Dairy Farmers Make-Part 2

How much money do dairy farmers really make?

Are they really that rich?

Do they really pay no tax?

One of my first posts was "how much money do dairy farmers make". It's one of my most popular posts too. The major source for this post is the google search, "how much money do dairy farmers make?".

I thought I'd go into a little more depth.

But first, what constitutes a dairy farmer? 

I'll just concentrate on owner operator farmers in this post as its simple and gives a good indication of dairy farm incomes.

Some quick facts:

76% of all herds are in the North Island

30% of all herds are based in the Waikato alone

The average herd size in the North Island is 325 cows and 596 cows in the South Island.

North Island farms are different to South Island farms, they tend to be smaller and owned by different types of farmers. So I'll look at two types of farmers. The first is your typical irrigated farm based in Canterbury and the second is your typical Waikato farm.

The Canterbury figures have been sourced from Brown Glasford and Co. The Waikato figures have come from Cooper Aitken Accountants based in Matamata (my old home town). The figures are from their 2011 farm survey for "owner operators".


Key points:

SI farms produce 60 kgms more per cow

Canterbury farms are nearly 3 times bigger than the waikato average.

Both regions have a similar income

Farm working expenses are higher in the Waikato. (Please note, this may be due in some part, to the data from different accountants being presented slightly differently)

Interest & Rent are the same amounts based on a per kgms at $1.48/kgms.

Farm surplus in Canterbury appears to be much higher

The total asset amount in Canterbury is a massive $14 Million dollars!

It appears on the surface that the combination of an extra 50 kgms/cow and economies of scale of the new modern Canterbury dairy farms results in greater profitability

The Waikato return seems unsustainably low, to the point where I am doubting the figures.

So back to the original question, how much money do dairy farmers make?

Personal drawings is one part of the answer. The drawings of both regions seem to be very similar at $80,000 to $90,000 per year.

I would think that if some one was running a business in town valued at over $5 million dollars, then they would be worth a package of over $100,000.

I read an article a year ago, where some accounting firm had worked out that an owner operator drawing $40,000/year is equivalent to a person in town earning $90,000/year. This article makes reference to these findings. 

Personal expenditure is about affordability, but Cooke says he often reminds farmers that drawings of $40,000, once everything else is paid, is equivalent to a town wage of around $90,000.

I assume this is because the farmer is able to claim or use the farm assets for personal use. For instance the farmer does not have to have a house mortgage as that expense will be included in the farm mortgage. (I know the personal residence is not tax deductible, but in real terms the house is included with the farm). Another area is vehicle use and fuel, if a car is used to get supplies for the farm then it is tax deductible. Its easy to buy some drench or pick up a few bolts on your way to the movies or dinner.

So there are tax advantages to being a farmer, but the same principles apply to any business owner not just farmers.

So if we assume that a farmer drawing $40,000/year is the same as a townie earning $90,000/year, then we could assume that a farmer drawing $90,000 is equivalent to townie earning over $190,000/year.

If you accept that logic (& you may not) then you could conclude that owner operator farmers are not doing too badly!

The remaining farm surplus of $726,614 for Canterbury farmers and $46,172 for the Waikato farmers will most likely go to the bank in the form of principle to pay down their loans. While this money doesn't end up in the farmers pocket, its still paying down debt.

The return on asset of 5% and just under 1% would suggest that farms make a very poor return. But the cashflow is only part of the profitability equation.

Capital gain is the other major aspect that determines how much money dairy farmers make.

I often hear that farm land has historically appreciated by an average of 10% per year for the last 30 years. This article written by the director of Gareth Morgan Investments says




The value of farmland has risen even faster (10.7 per cent a year) than housing over the past 20 years. That's a very healthy return given there's no tax to pay.
We're talking about a real after-tax return of something in the order of 7 per cent to 8 per cent a year.
A portfolio of world shares over much the same period would have yielded a real post-tax return of between 4 per cent and 5 per cent a year.

This article is a little more in depth and questions the true appreciation rate. But it does include this quote

Nartea and Basanta stated on Table 1 of their paper that the mean rate of
capital gain was 12.90% for dairy farms and 11.84% for farm real estate. The
period was 1966 to 1996.

So if a dairy farmers land is appreciating at a after tax rate of at least 8% (NZ has no capital gains tax) and is making a cash return of 5%, then the farmer is making a return of around 13%, which is quite reasonable. 

If your average Canterbury farm land is valued at $32,000/ha, then 270ha*32,000=$8,640,000 total land value. If this land appreciates by 8% then it gains $691,200 in one year!

Relying on capital gain is a risky proposition, but then again its worked for the past 30 years.


These figures are for owner operator farmers, these are the people who have "made it". They have either reached their goals of farm ownership through years of hard work and hard saving or they were able to inherit or "buy" into the family farm. The owner operator is becoming a rear breed in the South Island as the larger South Island farms are more likely to be in a corporate structure or some kind of syndicate. 


So to conclude, if I was sitting on an asset of over $5,000,000 and I was drawing in real terms, well over $150,000 per year and my business was paying off debt every year and my farm was increasing in value consistently. 

Then I would be pretty happy 

8 comments:

  1. Thoughtful note.

    Have you considered running the numbers using this years farm gate and dividend expected.

    Second thing to ponder is bank lending. They use $6 including dividend, $4 FWE, prefer a servicing ratio of 1.5 and over all equity position of 50% (and use plug rate of 9%).

    Third and of some interesting. Assuming the total farm asset value has not moved up (as payout expectations down) look what the change in fonterra share value - 4.5 going to 7.3 - has done to value of land and buildings, or per ha basis.

    ReplyDelete
  2. Yes I'm very interested to see if the share price has affected land/plant values. I haven't heard if they have decreased, but time will tell.
    Also many farmers budgets are looking very tight for this year. A $6 payout leaves no room to move, especially as you say FWE are at $4.

    Cheers
    Glen

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  3. In the table you have the return on asset looks out of wack.

    Return on asset should be EBIT plus drawings. so closer to 10%

    There is no mention of debt amounts, so break up of return on equity can not be calculated. But hey, if debt is 40% to 50% then return on equity would be 10 pa + maybe.

    All the returns are different if its a share milker on the job.

    ReplyDelete
  4. Hi
    I'm sure you are correct and drawings should be added to EBIT in order to calculate ROA. But even when you do add drawings it doesn't change the return dramatically.

    I could find consistent debt data in the time i had, so I left it out. But a good estimate would be 50% debt. An interest bill of $500,000/yr would indicate a total debt of about $6-7 million.

    The return on capital would be around 10%-11%, which is not to shabby.

    I'll do a post on returns with and without sharemilkers on another day.

    Cheers
    Glen

    ReplyDelete
  5. Sorry previous comment should be I "couldn't" find consistent data.

    ReplyDelete
  6. Opens your eyes doesn't it.

    Where does the $32,000 per ha come from for lan in Canterbury. Is that with irrigation. I was looking on trademe and some places round Southbridge looked to be asking for more.

    Do the numbers include Fonterra shares ($7.00.kg)

    Thanks

    ReplyDelete
  7. Hi
    I worked backwards to get to 32k/ha. But as you say, that figure may be a bit low now. I have heard of 40k being paid last year.
    Figures were based on financial data uptown march 2012, so share were at $4.52.

    Cheers
    Gken

    ReplyDelete
  8. Good insight. People who think of going into dairy farming because of the reported amount of money to be made often overlook farm location, herd size, surplus and other expenses. It’s a lot to consider even if you have a lot of money on hand to start.

    ReplyDelete