13 Jan Opportunities and Challenges for Farmers in 2022
Around 2,250 years ago, the Sicilian Greek mathematician, physicist and astronomer Archimedes was given the solemn task of determining whether the King’s crown was made of pure gold as it was claimed, or if it was blended with silver. His moment came when he sat naked in a bath and noticed the water displaced spilled over the top and flooded the floor. It was his “Eureka” moment and it launched him into good fortune and eternal stardom. (The conclusion of this newsletter will explain how Archimedes worked this problem out).
A large swathe of farming enterprises are in the enviable position of potentially experiencing their own “Eureka” moment in 2022. Favourable seasonal conditions, strong commodity prices, strong cash flows, strong balance sheets and low interest rates continue to prevail. But there will be challenges as well. This article will go onto the explain how three of these may play out over the next 12 months.
- The Tail Wagging the Dog. The evolution of banking has created the necessity to homogenise credit decisioning that can overlap substantial enterprise variations and national credit volumes within acceptable default ranges. In its most simplistic methodology, a considerable weighting is applied to the three-year historical performance to support the underlying assumptions of future performance*. It is a hindsight analysis, the tail of the dog credit analysis, but effectively favours farmers who transition from drought to strong production and profitable years. FY22 will present the second or third above average financial outcome. Coupled with strengthening balance sheets, the credit risk rating of farmers is on a trajectory of strength which leans strongly towards leverage and credit opportunities – whatever form that takes.
- Succession and Creative Expansion. Australian farming is a continual cycle of asset rotation. For family run farms, the succession event is an evolutionary process with an outcome that entails new ownership and stewardship of the farm. New ownership can take the form of the next generation coming through the or new entrants entering the industry. Australian family farms are now transitioning into their 6th generational (some higher). For those families exiting the industry, other existing farmers or new entrants are taking advantage to expand or gain exposure to the industry. For most part, the balance of supply and demand for farms is stable, predictable, and linear. On occasions when there is a ‘goldilocks event’ and demand for farming assets far outweighs supply, more creative means need to be applied for farmers or new entrants to enter the market. This could be investing into new geographical areas, diversifying into new agricultural enterprises and expanding the traditional financial structures to achieve these means.
- Emerging New Industries. Colin Packham’s headline in the Australian Financial Review (11/1/2022) stated “Carbon offset credits set to soar on net zero ambitions…”. Farms are akin to a hay shed to store carbon. Some have the capacity for large storage (depending on technical soil profiles, enterprise practices and rainfall) and some are less so. None the less, farmers as an industry have the capability to research and take part in a rapidly growing industry that is currently founded on voluntary participation but driven by both strong social and risk governance for corporates (and businesses) to engage. You just need to review the swathe of ASX listed companies announcing their pledge to be net zero by 2050. Many of which cannot achieve this outcome without participating in third party programmes like carbon credit acquisition.
- Labour. Generalising, most family farming operations are staffing self-sufficient which is satisfied internally with the family members. But there are critical times when additional staffing is required and outsourced – shearing, crutching, sowing, spraying, harvesting, picking, weaning, mustering etc. Some industries like horticulture and viticulture, these pressure points are time critical. Living with the COVID landscape, at any given time, is knocking out a percentage of the workforce. In addition, lack of “backpacker” supply layers another pressure point to the equation. Farming businesses will need to be well prepared with their labour logistics leaning into 2022.
- Supplies and Supply Chain Disruption. Mainly due to COVID related bottlenecks with imported goods and domestic supply chain disruption. “Just in Time” inventory business models have broken down and long wait times are now part of the logistics of business dynamics. Farmers that have established long deep relationships with their suppliers may naturally be favoured over those that relentlessly “shop” their requirements. Solid advanced planning is paramount to avoid disappointments and inherent production risk.
- Inflation. Significant farming inputs are imported and are subject to supply and logistics constraints (point 2). Any capitalist framework allows for pricing dynamics to be dictated by the economic forces of supply and demand. As such, significant cost appreciation has already been noted for key inputs (energy, fertiliser, plant & equipment). There is no sign of this fundamental landscape changing anytime soon. Albeit offset by higher commodity prices, it still does not guarantee production with next seasons crop or production in general.
The Secret to Archimedes Mastermind
How did Archimedes formulate the purity of gold in the King’s crown by his naked overweight body in a bathtub?
The secret lies within the physics relating to density. Allow me to explain. When an object is immersed in water, the displaced volume of water is exactly the volume of the object that displaced the water. This, in the first instance solved the problem of working out the volume of the crown. Now each metal has its own density. Gold is denser that silver. Knowing that the crown’s weight was the same weight of gold that was given to the goldsmith, and the density of gold is a known quantum, then the water displaced should reconcile to the basic displacement equation. If silver was mixed with the gold, and silver being less dense than gold, then the crown will displace a larger volume of water to compensate for the lower density of silver knowing that the crown’s weight needed to be that of the gold initially provided.
Outcome – the goldsmith did cheat the king and mixed gold with silver. The goldsmith was in hot water for his efforts
*note: the reality of commercial credit decisioning by lenders is a lot more complex and sophisticated than that stated, but for the purpose of discussion it holds some relevance.