A Hard Working Capable NZ Farming Couple
OPINION: Perhaps it's time for us all to back off a bit on our dreams and strengthen our balance sheet.
If we look over the last year and the next 10 years ahead of us I would suggest this is done sooner than later.
Did you know that the average pre-tax income for individuals last year was $51,375. For New Zealand households it was $104,583.
How much did the average household pay last year in mortgage interest? The answer is $13,208. If we use an average house mortgage rate of about 4.8 per cent that would suggest the average mortgage is about $275,166. About 18.3 per cent of households - almost one in five - are spending 40 per cent of their disposal income after tax on mortgage interest or rent. This figure is too high when interest rates and inflation are historically so low.
What is the single biggest risk for New Zealand agriculture apart from Mr Trump and Mr North Korea? Almost certainly a major biological breakthrough at our border. Over the last five years there have been several outbreaks and we have managed to cope with them. However, we must never argue with the amount of the border biological budget - this is much more important than the government budget.
If land value inflation in New Zealand is going to fall back to just a normal overall inflation figure of perhaps 2 per cent, then generating more from the farm business somehow is going to get more important.
Let's say that a real return of 6 per cent on your net farm capital employed is the minimum acceptable aim - provided by 2 per cent from inflation and 4 per cent from farm profits. Maybe being self-employed and being your own boss is worth 1 per cent although this would disappear quickly during droughts, low payouts, seven day weeks, labour issues and losses.
Australian banks control close to 90 per cent of our NZ farm debt - if they wanted a financial stress test for New Zealand dairy clients, they would probably want to use a term loan interest rate of perhaps 6.75-7 per cent, a milksolids payout including any dividend of say $6-$6.20/kg and a bank term loan capable of being 100 per cent repaid within maybe 25 years.
We would not enjoy the suggested interest rate, but it is below those of 10 years ago and the payout would be workable for some farmers depending on their interest rates. The suggested 25-year bank loan term would be a long way from workable as it would represent a 4 per cent mortgage principal repayment after tax each year. Even 35 years would look unworkable for 90 per cent of farmers. Anything is possible in good years, but agriculture is only good seven years out of 10 at best. My guess is these stress tests would take place across a wide range of businesses and not just farming. Farming is vulnerable because of its often low profits and high relative debt.
The core issues in farming tend to be price, cost and yield. Many farming couples are right on top of yields, costs are also an area that involves never ending focus and the weak point of the triangle is price. We are spending a fortune on irrigation which to some extent is to increase yields because prices are weak - this is a doubtful business approach.
If you asked me where I saw agriculture placed in 10 years, I would suggest:
- You would have to feel that interest rates and the inflation rate would be higher in the next 10 years than it has been the last 10 years. Over the last 10 years economists have been wrong about half the time when it comes to interest and exchange rates. These are two areas we cannot estimate with any degree of certainty.
- At the moment our Agriculture Terms of Exchange are as good as they have been for many years. You would have to be something of an optimist to think things will continue at this level as they tend to cycle.
- We now have in power a 'social capitalist' type Government and farming is going to receive less support, less time and probably less money. This could be the case for much of the next six years and you will have to deal with a water tax/water levy, emissions tax/levy and a capital gains tax of some kind – hence three may be called an environmental tax but this is just a camouflage. There are likely to be more problems with finding suitable farm labour. The list of these issues will come from your farm bank account and likely creep up gradually.
- What could turn things economically in our favour are a milk solids payout, including dividend and sales of surplus stock, of about $7.50/kg. It's been there before, but $6.50 kg will not be enough for farmers with farm working expenses of $4.25/kg, plus interest and rent of $1.85/kg or more. Couples in this group will be praying for inflation every night.
- Expect there to be a possible drop in farm land values over coming years. Remember though that a fair proportion of your present net equity will have come from farm land value increases not related to your borrowing or what you have developed. A decrease will take some of that not earned equity back from you.
- Don't underestimate changes to the way the Overseas Investment Office will operate - large New Zealand farms of all types will now have a slightly lower bench of buyers.
- My advice is to keep yourself on the bridge, not down in the engine room when it comes to cash management and monitoring. Every time you read the word liquidation in the media think of no cash and no cash flow. The next 10 years is time to have top people at both shoulders and be prepared to pay for them.
- Marketing our agricultural production will be crucial because we export 85-90 per cent of it and our population is small. Farmers will need to take more interest in the marketing side of organisations selling their products.
- If you can, always sell into an up cycle. The laws of demand and supply are clear cut, but farmers do not always follow them. Throughout my life I have watched as farmers increased production as much as they could to decrease the resulting loss or low profit if the milk solids payout was low. In times of a higher payout they increased production as much as they could to maximise their profitability.
- Fear and greed are key parts of the world wide investment scene and have been forever. Do not let yourself get dragged down into this scene. Never forget that things cycle, people change and what was cast iron last year can melt.
- Debt reduction is always positive - for the right business investment. In the future most banks will re-lend the repayment back to you. Banks love lending you money but when the weather clouds over they also love getting it back.
- The New Zealand economy is heading towards a cooling mode and we need to plan accordingly – pull back a little on the dreams and spend a little more time on strengthening the business.
Pita Alexander is an accountancy and agribusiness director at Alexanders.