The dairy industry: Who will weather the latest storm?

by Dean W. Moreau, president and CEO, Yankee Farm Credit

2002 is stacking up to be the worst year that I've seen in the dairy business since I started with the association in 1988. Some with longer histories say it's the worst they've seen since the early 1970s. Almost no one will make it through this year unscathed, and some dairy farmers will go out of business this year — or early next year when they can't get spring operating money.

"The farmers who will prosper in this economy ... {understand} that a volatile income statement needs a stable balance sheet as a partner.”

Surprisingly in this environment, many dairy farmers will actually prosper. Who are they? Are they the biggest farmers? The most efficient? The ones that produce the most milk per cow? Or are they the farmers with the lowest cost of production?

Actually the answer is, "None of the above." The dairy farmers who will prosper in this economy are "balance sheet managers."

These farmers have strong balance sheets. They figured out a strategy to make it through the downturns before the bad times hit. They avoided overborrowing to eke out the last bit of short-term efficiency or productivity. Some learned from a past of too much debt, while others just innately understood that a volatile income statement needs a stable balance sheet as a partner.

Whatever their motivation is, these managers recognize that long-term prosperity and surviving through the down cycles is the only "right" business model for them to follow.

Some farmers kept their debts on a short-term schedule, and paid loans down rapidly during the good years. Some reined in their capital expansions, refusing to let net worth fall below a certain comfort level. Others used custom hiring, land rentals, partnerships, LLCs, etc. to limit capital spending requirements, and therefore, debt obligations.

The methods that farmers use to survive the bad times are varied, but the outcomes are the same: these are the farmers with staying power. They "bought" some downside risk protection before they needed to use it.

Today many Yankee customers are borrowing back on their revolving capital lines of credit, as well as alerting us that they will need additional time to repay 2002 operating advances. Neither of these options is very pleasant for our customers because they feel like they are taking a step backward.

The vast majority of our customers however, have repaid considerable debt since 1998, making their actions fundamentally sound, practical "safety valves" to manage their businesses through tough times.

The basics still work

Yankee is committed to two fundamentals that we've followed for years: First, we analyze your requests for loans based on probable future cash flows, not theoretical maximum future cash flows. Second, we attempt to structure your loans so the blended term of all your debt is 10 years or less. Adhering to both principles makes us look conservative in good times, but, in a year like 2002, it allows us to be the dependable lender that you need to get you to 2003.

Milk prices will once again go up, probably higher and faster than most people expect. When they do, turn yourself into a balance sheet manager, if you are not one already. Sell your unproductive assets to reduce debt, critically analyze your future capital spending and pay back extra principal when times are good.

Experience is an unforgiving teacher. The hard lesson: low levels of debt on short-term schedules will get you through the downtimes.

This letter appeared in the Fall 2002 issue of Financial Partner (F.P.) magazine, Yankee Farm Credit's customer publication. Click here if you would like to start receiving FP magazine in the mail.

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