Farming is often the art of managing the uncontrollable.
The past decade, with the Global Financial Crisis, dairy price shock, severe weather events, shifting consumer preferences and regulatory change on a number of fronts have highlighted the need to have effective risk management strategies in place.
Individual farmers, and
sectors, have navigated these in different ways. Some have been more successful than others in creating a more sustainable and consistent business model.
Some of the key strategies utilised by the leaders have included the application of best practice management from farm through to end customer, and targeting of new market segments in Asia and higher-margin food categories (such as health and convenience).
New Zealand agribusinesses are generally in much better shape than they were a decade ago, but the strategies that put them in this position will need to be sharpened further as earnings are pressured from a new wave of challenges.
Tariff wars, continuing unstable commodity prices, competing with rapid technology advances, restrictions on foreign ownership and investment, global warming impacts and regulatory demands on a number of fronts can all provide new challenges that need to be successfully navigated by agribusiness over the next five years.
In New Zealand, the continued evolution of environmental regulation (many of these things have been in train, or effect for some time now), in particular, is expected to place significant pressure on existing business models and earnings. New requirements to address water quality and carbon emissions can be expected, but are as yet to be fully clarified.
Banking is facing regulatory pressure too. The agriculture and business sectors are seen by regulators as being higher risk than retail banking, the largest component of which is home lending. As such they're requiring banks to hold more capital, the effects of which will be reflected in borrowers' interest rates.
Some of these themes are new, while others continue to evolve. This means continual adaption and investment in a business is required to keep ahead of the game and minimise business risk. We see there will be more capital and/or investment required to help comply with regulations and transition businesses to best practice.
Historically, we see that those who have a dynamic approach to business and risk management have emerged from challenging trading conditions in the best shape. They are willing to make significant changes to achieve profits year-on-year, and are more willing to control the things that can be controlled to create certainty, and therefore protect future earnings.
Two complicating factors are that, today, farms are generally bigger and carry more debt. In dairy, for example, underlying term debt levels on the average farm have climbed from $2.1m in 2008/09 to $3.5m today (a 67% increase). Productivity has improved through this period, but debt per milk solid has lifted from $17.6 to $22.6/kg ms.
Lower interest rates have actually seen finance costs drop from $1.59/kg ms to $1.17/kg ms over this period (effective interest rate moved from 9% to 5.1%). But with interest rates having settled at historic lows and are set to gradually increase, alongside higher underlying debt levels, there are greater finance cost risks than have been seen for some time.
Around 55% of ANZ's agriculture customers have no cover against the risk of interest rate movements, which could be considered high (these customers tend to have lower lending – as lending increases, so does the fixing of interest rates).
A return of interest rates to historic averages isn't predicted, but even a moderate increase could be crippling for highly geared farmers. A 2% increase in interest rates would cost the average farmer around $70,000 additional interest per annum.
A balanced interest rate risk management strategy with a mixture of short, medium and long term fixed rates can help to reduce the impact of market movements, but – more significantly – build operating certainty at a time when there are many risks on the horizon and the costs of new regulation is unknown.
- Mark Hiddleston is Managing Director Commercial & Agri at ANZ Bank NZ.