Dairy farmers are rapidly exiting the business. More than 2,700 dairy farms shuttered operations in 2018, a 6.8% decline, according to the USDA. It’s not a surprise given the industry has suffered five years of below break-even production, and supplies have outstripped demand, which has put downward pressure on prices.
As a result, land and buildings are more readily available, while replacement cattle prices have declined nearly 46% since reaching record highs in October 2014, according to the USDA National Agricultural Statistics Service. Inventory asset values, such as feed and machinery, have also fallen. The question for existing dairy owners is whether this is the time to buy and expand their operations, to downsize or sell off the business completely.
Questions for buying
Declining cattle prices and farm real estate values could provide the right operation with a buying opportunity. But a good deal alone isn’t a reason to make an expansion-driven acquisition. The first – and most important – question farmers should answer is: How does a buying opportunity fit into your overall business plan? Is acquiring more land or cattle something you had already planned on doing now, or a few years from now?
It’s also a matter of determining why you’re considering an expansion. Is it to bring in another family member? Is it because you don’t have adequate land to supply feed or spread nutrients for the business? Maybe it’s because you can achieve a lower cost of production and gain efficiencies with additional land or cattle. Or is it that you can acquire land closer to your operation, substituting it for land you own or rent farther away?
These are just some of the questions that should come up as you consider acquiring land or additional assets.
Questions for selling
Similar to the buying scenario, it’s not necessarily a good idea to sell simply because the industry is struggling. You have several questions to consider here, including: Where are you in the business cycle? Are you close to retiring without a successor in place? Is it financially more feasible to accept a good offer on your assets now rather than wait another year or two?
Maybe you don’t want to sell the business outright, but your financials are unfavorable. In this case, do you need to sell nonproductive assets to recapitalize the business or pay down debt, improving your cash flow in the process?
If the operation hasn’t had cash flow over the last three or four years, what are you doing to change course? Selling some of your assets could be a solution, but it should be part of a bigger plan. It’s not a good idea to sell when asset values are low, but if it’s the difference between being in business or out of business, it’s something you might want to consider.
Weighing your options
One tool that can be effective in helping you decide is a partial budget analysis, which includes looking at “either-or” circumstances. For example, if you’re not buying land, what are you doing instead to maximize your output and efficiency? Are you buying land to expand the business, or to give up paying rent? What are the benefits of buying the land versus the benefits of what it’s substituting? I would recommend visiting the University of Wisconsin Center for Dairy Profitability website (click on “Decision Tools,” then on “Budgeting”) to find a partial budget template that you can use to aid in your decision-making process.
It’s also important to look at the rate of returns on your investments. Before making a decision, take a look at what investments you’re making and how quickly you can expect a return. Land, for example, represents the longest return cycle, while livestock is the shortest. In between are investments in machinery and buildings. In every case, you’ll need to handle the increased costs to pay for an asset over the number of cycles it will take to do so.
The current dairy environment requires taking a serious look at income, expenses and the capital structure of your business. In this environment, the most efficient or those that have differentiation can survive and seek opportunities. You need:
- A strong equity position
- To keep your costs under control
- Differentiation in your business model
- A good risk management plan
If you have all these elements, you’re likely in a position to take advantage of opportunities. And whether you decide to buy or sell, it’s a good idea to involve your key partners early, including your veterinarian, nutritionist, crop consultant and your bank. They’ll all bring different perspectives to help you determine what the right move is for your long-term financial well-being.
In the end, the current state of the industry isn’t an excuse to throw out your long-term strategy. If an opportunity arises that fits into your strategy, great. But the key is making sure your goals are in line not just with potential opportunities, but with your current financial position as well.
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