How farms can prepare for a possible recession
Recession – A business cycle contraction when there is a general decline in economic activity (Wikipedia).
The term recession has crept back into the spotlight as interest rates and inflation both continue to rise. What does this mean for primary producer agriculture?
On one hand we are facing the highest cost of production on record as both inputs and operating expenditures fall victim to inflation and geopolitical policies. Crop inputs started their historical rise in late fall and other than a few softens continue to push higher. Fears of war and logistical supply continue to fuel the supply and demand curve which most believe will push them higher throughout the following months. Outside of growing costs we also have rising fuel costs and with minimum wage increases the labor force competition continues to strengthen. Overall, Western Canada may see the highest cost of production ever on grain farms.
Now, on the other hand, we are currently marketing into the highest commodity prices in decades. Although volatile week to week, the overall value of crops continues to be strong and provides farms with multi-generational opportunities to generate wealth. In addition to this, most areas of Canada are also seeing moisture after the prior year drought conditions. Overall, not considering any coming perils or weather issues, the overall gross revenues of farms may come in at the highest on record.
So, what does this mean in terms of recession? Well, historically farming has shown to be cyclical on both revenue and expenses. However, the risk associated is that commodity prices and revenue will in most instances fall prior to the expenditure curve following. This is where primary producer agriculture will see the worst financial outcomes. The biggest risk to farms comes after good years, not bad years as most would assume. The industry inflates costs and does not use profits to replenish working capital. Most often cash flow and liquidity are used to expand or upgrade equipment and buildings. This does not provide the financial blanket that many will need when, not if, the industry falls back.
So, the common question is how do we prepare for the “recession” once it hits agriculture? There are multiple steps that can be taken but the following are the main concepts of risk mitigation:
- Expand working capital – Many producers refer to it as a “war-chest”; you increase your liquidity and working capital in the good years so that you can sustain downward pressure in the bad years. It provides a security blanket so not only can you weather the storm the year that revenues fall, but you may also be able to take advantage of opportunities when some other operations cannot.
2. Tighten risk management – The positive about insurance programs in Canada is that they are driven by your own operations. In the good years the goal is to continue to maximize your data to the insurance companies so that you increase your coverage levels. Whether yield amounts or gross margin insurance, your coverage levels are driven by you own historical information, so it is important to report correctly and make sure you use these programs to your advantage in the down years.
3. Strategically plan further out – In strong years it is important to plan your financial strategy further out that one year. In our organization we go out three to five years as most capital and financial decisions today will still affect the business that far out. Taking on large debt or capital in strong years adds risk if you don’t identify what the effect is when the cycle turns back. By pushing out your projections further, and testing drops in yield and price, you can plan against when the industry does recoil.
4. Lock in margin further out – Opportunities in the current commodity market not only effect the current year crop but can also provide future gains. Many elevators currently provide the ability to lock in grain futures for the 2023 harvest. By looking out past the current year, you can start locking in strong margins for future years. Then, if the crop input market does soften during the next months (as we did see in June), you can book inputs as a hedge against your commodity futures. This way you have locked in a margin and not just one side of the equation.
5. Keep your eye on the prize – The last area of risk mitigation is making sure you do not get caught up in the numerous opportunities. With commodity prices where they are, the expectation is that the aging primary producer industry will start to sell off land into these strong times. The best time to drive up land prices are when farms have profit and liquidity. Although taking advantage of opportunities may be part of the plan, overpaying or getting caught up in the current environment will hurt the operation in the future. The goal should still be to have “optimized growth”, not just bidding wars.
Although we have not seen a large disruption in agriculture due to “recession” yet, the belief is that it will come. We are not oblivious to geopolitical and government concerns, and to assume the good times will never end would be naive. The main concern moving forward should be to take advantage of the current environment, but also to mitigate the risk for when the cycle continues back down.
