As margins tighten, risk management comes into focus

January 27, 2022 | Bethany Baratta

Strong profits from high commodity prices, record yields, government payments, historically low interest rates and increased demand for land drove Iowa land sales in 2021, according to data from Farm Credit Services of America.

Jim Knuth, senior vice president of Farm Credit Services of America, shared the results of the benchmark study in a presentation to the Land Investment Expo in Des Moines recently.

Farm Credit Services of America’s benchmark farm data showed a 37% increase in the average value of farm ground in Iowa in 2021.

“This was the largest one-year land value increase ever, and 25% of the increase occurred in the second half of 2021,” Knuth said. Farm Credit services 60,000 customers in five states.

Knuth expects 2022 to be another profitable year, but says risk management is critical.

“We’ve seen this economic boom cycle before,” Knuth says. “Higher commodity prices, wider profit margins, escalating land values—it was the ethanol boom. We thought that party would never end, and it did. This party’s going to end, too.”

In a recent report, economists at Iowa State expect the per-bushel cost of raising corn and soybeans will be more costly in 2022, no matter the rotation.

“Get ready for the margin squeeze because everything is more costly,” Knuth said. “Fertilizer, seed, fuel, rent—it really means that risk management decisions are going to continue to be really important.”

Though he expects the interest rate environment to remain accommodative to agriculture in 2022, Knuth says farmers should learn from lessons during the ethanol boom.

Here are some lessons Knuth noted during his presentation:

1. Cost structure always matters.

“Sometimes during significant upcycles it seems like there’s nothing we can’t afford and still make it work,” Knuth says. “But we’ve learned time and again in agriculture that high leverage, high cost, high breakevens don’t work in the long run.”

He says being thoughtful about capital expenditures and expansion will benefit farmers in the long run. Ask yourself what a purchase will do to the cost structure. Will it impact working capital?

“Remember,” Knuth says, “the goal of every grain producer is to have a high-revenue, low-cost operation.”

2. Working capital is balance sheet risk management.

The past two to three years have been advantageous to rebuilding and restoring working capital, so maintain it in 2022.

“We all know that cash is king. Your working capital is always your first risk shock absorber,” Knuth says.

If you have working capital, it means you have flexibility because you can margin your own borrowings, he says. If you don’t have working capital, your lender is going to ask you to replace it with collateral.

“It’s hard to run any business without working capital,” says Knuth.

3. Your holistic financial position should drive your decision making.

Knuth says instead of thinking about your business farm by farm or by piece of equipment, think of it holistically in per-acre costs. Farm Credit recommends grain producers have working capital in the $150 to $200 per acre range at a minimum.

“Below that, your risk-bearing ability really goes down,” Knuth says.

4. Understand your financial position after your expenditures.

Begin with the end in mind. Carefully think about what will happen to your cost structure and working capital after you make a purchase. If you’ll have adequate working capital after paying cash for a piece of machinery, the decision is good for the business. If you buy several pieces of equipment but are left with almost no working capital, it’s not a sound financial decision.

“It is the after state that we will have to live with for years to come,” Knuth says.

5. High margins are not permanent; they tend to last for short periods of time.

We’re seeing a bigger revenue pie, and everyone wants a piece of that.

“As we are in this up cycle again, remember that high margins aren’t going to be permanent,” Knuth says. “Those margins are going to normalize.”

6. The business of agriculture will continue to be the dividing factor between those who thrive and those who struggle, not the color of their machinery or equipment, seeds, chemicals, fertilizers, or even production.

Iowa’s 40,000 soybean farmers grew a record 621.86 million bushels of soybeans in 2021, up from 505.98 million bushels in 2020.

“Here in Iowa, the upper Midwest, we’re already first-class producers. So excellent production is table stakes. It’s more of an equalizer versus a differentiator,” Knuth says.

The diving line is how producers manage their operation from a business, financial and marketing perspective.

“What they do is fairly simple: they spend as much time in their office as they do their shop and field. And as much time running their business as they do running their tractor,” he says.

Rick Kimberley, a fifth generation farmer and ISA farmer member near Maxwell, says he’s making some calculated moves to prepare for the margin squeeze.

“We need to do a little forward selling and take advantage of some of these prices,” says Kimberley, who has been farming since 1972.

He’s locking in input prices, taking advantage of some pre-season bookings.

“With the cost increases we’re going to have to do a better job of protecting our margins as far as profitability and doing some hedging to protect against potential losses,” Kimberley says.

Kimberley was excited to see strong soybean and corn productions on the farm in 2021 after the August derecho limited crop production in 2020.

“We do the best we can in raising a good crop, but some of that is out of our hands,” Kimberley says.

As he’s learned from decades of farming, the cure to high prices is just that: high prices.

“Marketing is going to be very important this year and next few years because high prices normally don’t last very long; we typically go back to 2, 3, 4 years of tight to negative margins,” he says.

He expects crop insurance to be costly this year, so he’s tying his marketing into crop insurance to cover his sold crops as a risk management strategy.

“We have to weather downturns and be attuned and ready when the upcycle starts,” Kimberley says. “We do run in cycles, it’s just inevitable.”

Hear more from Matt Erickson, ag economic and policy advisor for Farm Credit Services of America at ISA’s Innovation to Profit Conference on Feb. 17 in Ankeny. You’ll also engage with ISA’s Research Center for Farming Innovation (RCFI) team as they dive into research results, explain how to integrate in-field and edge-of-field strategies on the farm, and provide ideas to improve profitability.

Contact Bethany Baratta at bbaratta@iasoybeans.com.  

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