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Dairy: an unenviable position

Dollars and Sense

GreenStone FCS | June 6, 2017

Ben Spitzley

 

 

By Benjamin Spitzley, Vice President and Commercial Lending Group Manager, GreenStone Farm Credit Services

The dairy industry is facing a challenging time, a cyclical downturn that’s lasted longer than in previous cycles, and is expected to continue for at least the near-term. The predominant factor behind the current status is simple market mechanics: there is an abundance of supply relative to demand.

This situation arose from increased demand in the years leading up to 2014, which raised prices and encouraged dairy operators to expand their herds to increase production. In Michigan, for example, the dairy industry has grown by 72 percent since 2004, and the industry added 12,000 cows in 2016 alone, a year when the average producer was losing money.

Nationally, the USDA reports that herd size is continuing to increase, despite the lack of profitability, from 9,328,000 cows in 2016 to 9,385,000 in 2017. While supply has increased, and continues to increase, demand has not kept pace, creating a surplus of milk in the market.

There is also a glut in the global market as other nations increased their production to meet demand; combined with the strengthening of the U.S. dollar and trade uncertainty, there has been reduced demand for U.S. dairy exports, which traditionally represented 15 percent of our nation’s dairy production.

Exacerbating the situation in Michigan is a dearth of processing capacity, which has not increased in line with milk production. This puts producers in the unenviable position of needing to market their milk out-of-state, where processing is available, adding transportation costs and additional marketing costs to their already challenged cash flows.

The erosion of revenue is significant. In 2004, Michigan’s dairy farmers were being paid 25 cents more than the U.S. average per hundredweight; last year, they were paid $1 less than the national average. Adding processing capacity will be paramount to protecting dairy producers against these additional costs.

Over time, the market will balance itself out, as supply and demand draw closer together and processing capacity is added. In the meantime, producers need to take a hard look at their operations and their financials. Producing a high quality product with good components will support a better price and better marketing options.

Producers should strive to tighten overhead with a careful eye to reducing costs and streamlining operations. Every asset should be examined to determine if it is producing enough revenue to justify keeping it – whether the asset be surplus heifers, or a two-year inventory of feed.

In short, if you cannot afford the asset, scale it back or sell it off. Any capital investment needs to be carefully scrutinized, with a complete Return on Investment (ROI) analysis to ensure it will add to the bottom line.

It is also critical to maintain good records to support effective management decisions. These will help producers manage their working capital, identify potential cost savings, and know whether they have the resources to take advantage of opportunities when they arise.

Also supporting effective decision making is an advisory team, on which producers should include key employees, vendors and financial advisors. This team should be tasked with helping to proactively develop not only a plan, but also a backup plan, for managing through this cyclical downturn.

Such plans will need to be individualized for each operator, and may include steps like finding additional sources of income, implementing specific cost-savings solutions, or changing the overall scale or scope of the business.

Lenders, like GreenStone Farm Credit Services, will strive to find methods, such as interest-only solutions or increased access to operating funds, to support customers who can demonstrate they have thought through their specific situations and have developed a plan for moving things in the right direction.

Looking forward, there are bright spots on the horizon. It is anticipated that milk prices will begin to rebound by the fourth quarter of 2017, though the increase is expected to be modest given the processing dilemma.

Producers who manage to reduce their costs and streamline their operations during this period of belt-tightening will be optimally placed to benefit from any improvements in the market. And, there will continue to be a demand for milk; the Great Lakes region, with its abundant forage and water supply, will remain an ideal location to produce milk for the benefit of a growing world population.

 

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