Facing rising dairy farming costs and low milk prices? Discover how to build resilience amidst surging dairy sector debt and prepare for potential challenges ahead.
In its latest Financial Stability Report (FSR), the Reserve Bank of New Zealand (RBNZ) delved into the vulnerabilities and strengths of the agri sector, with a special focus on the NZ’s dairy sector. Among all sectors, the dairy industryattracts significant attention regarding bank exposure, making its challenges a crucial concern for the RBNZ.
Interestingly, the findings presented by the RBNZ echo analysis from earlier this year. Just as forecast, dairy farmers are grappling with falling prices and increasing costs. Here’s a snapshot of the situation:
- Weaker Chinese demand and an ample global supply have combined to depress dairy prices. The RBNZ attributes some of this depression to the low Chinese consumer confidence which has negatively impacted demand for agricultural produce. Consequently, USD dairy prices plunged between 10-15% during the early spring and winter months. Presently, the prices are approximately 15-20% below what they were last season, notwithstanding the recent rebound.
- Farm working expenses over the past 12 months have seen a significant surge. The bank reflects on this, pointing out that the prices of key inputs – like feed and fuel – remain high in the wake of strong inflation in 2022, even with some easing recently. On that note, “cost inflation in other inputs such as labour, electricity and insurance has picked up pace, putting pressure on dairy farmers’ cash flow.”
- Debt servicing costs continued to rise, reaching our predicted range of $1.40-1.45 per kgms. These costs have more than doubled from their mid-2021 trough of under 60c per kgms, a development we also forecast earlier this year. Aiding in cushioning the impact of these increasing interest rates has been the significant amount of debt repayment between 2018 and 2022. The dairy sector’s debt burden saw a 15% drop during this period.
Previous projection pegged the $1.40-1.45 per kgms range as the peak in average debt servicing costs, with an expectation for these to start declining from mid-2024. However, these costs may surge over the coming months and that they could remain high for an extended period beyond our earlier timeline. Rural debt servicing costs hitting the $1.50-1.55 per kgms range by mid-2024, with a significant drop not expected until the middle of 2025.
Several previously noted strategies for farmers aiming to build resilience remain pertinent.
Maintaining Appropriate Debt Levels: Leverage can often bolster the expansion of operations or upgrade farm processes and infrastructure. Obviously, the disadvantage is that a higher burden of debt means farmers have a greater exposure to rising interest rates and would hence face higher debt servicing costs per unit of output. This can put margins under strain when commodity prices decline and offer little wiggle-room to deal with unexpected challenges, such as a prolonged drought or a new regulatory change. Stronger balance sheets are better equipped to withstand financial shocks.
Diversifying Revenue Streams: Just as smart investors hold a variety of asset classes to mitigate their risk exposure to a fall in the price of any one security type, farmers can choose to diversify their options when it comes to commodities. Branching out into unfamiliar sectors should, of course, be considered carefully given the initial costs and specialist knowledge required.
Utilising Hedging Instruments: To manage uncertainty in cash flow, using Fonterra’s fixed-price monthly offering or hedging directly through the NZX futures/options market are recommended. Where there is an opportunity to ‘lock-in’ a portion of output at a price above breakeven, that certainty of income can be valuable.
By implementing these strategies and maintaining a disciplined approach, dairy farmers can better prepare for the challenges ahead and build increased resilience into their operations.
