After what turned out to be a relatively strong year in 2017, the U.S. farm sector was poised to experience a pivotal year financially in 2018. Growth that reemerged for U.S. agriculture in 2017 was at risk of losing momentum as farmers endured a multiyear slump in crop and livestock prices. Interest rates and energy costs have been on the rise with the economy warming up, resulting in increased borrowing costs and tighter credit conditions for farmers. Many key indicators that measure debt repayment ability and liquidity reached unsustainable levels. All of these concerns emerged prior to the escalation of trade disputes with China and other major trading partners.
In late July 2018, the Trump Administration announced a $12 billion trade compensation package to make up for farmer’s market losses due to the ongoing trade war. Specific details of the program implementation will not be known until after Labor Day. For purposes of the 2018 Authoritative Analytics forecast, the assumption is that the $12 billion will be paid out in the 2018 calendar year. Since it is direct compensation, the impact of this highly criticized maneuver can be assessed on the U.S. farm sectors financial outlook.
The Authoritative Analytics August forecast for net cash income would have been below $100 billion in the absence of any trade compensation. Monthly values for net cash income forecasts have ranged from $98.2 billion to $107.8 billion since the first prediction in October of 2017. The initial impacts of trade disputes were estimated by Authoritative Analytics to be between $3.5 to $5 billion. With the $12 billion trade compensation being paid (assuming all payments go to production agriculture) in calendar year 2018, government payments would jump to $21.4 billion and net cash income reaches $111.7 billion. This would represent a 6 percent increase over what is estimated as the final 2017 value for net cash income and the second consecutive annual increase since falling 11 percent in 2016.
The dramatic difference in these alternative income trajectories is further amplified by examining how liquidity and debt repayment for the sector change. In each case, values of these critical measures would revert to 2016 levels. This would represent a challenging situation for maintaining cash reserves and timely repayment of debt.
Liquidity is vital to any business, but may be even more critical to agriculture depending on what is produced, the length of the production cycle, and how it’s marketed. Two measures that are often associated with liquidity are the amount of working capital and the current ratio. Working capital is calculated by subtracting total current liabilities from current farm assets. One rule of thumb, is that a business should have enough cash available in working capital to cover 5-8 months of operations expenses; although this will vary with the type of business. Liquidity as measured by working capital divided by cash expenses reached its lowest level at 0.21 (reserves of less than 3 months of expenses) in 2016 and would gradually rise to 0.26 in 2018 with trade compensation payments.
Leverage and Debt Repayment
Even though debt can become more challenging to acquire when low levels of income are sustained for extended periods of time, borrowing has increased noticeably since 2013. In addition to real estate transactions, much of the recent rise in debt can be attributed to short-term loan conversions and efforts to refinance and lock in fixed interest rates. As incomes have been declining or stagnant; operating costs have not fallen by the same amount, thus depleting cash reserves. Farm sector debt divided by earnings before interest and taxes (EBITDA) provides a leading indicator of leverage and repayment problems. The value of this measure exceeded 3.0 for the first time since the 1980’s in 2016. Much like liquidity, debt repayment would show gradual improvement through 2018 as trade compensation payments would help reduce debt divided by EBITDA to 2.79.
Uncertain Path Forward
Since some uncertainty remains regarding the specifics of trade compensation payments and the short- and long-term prospects for agriculture exports, 2018 remains a pivotal year for financial circumstances. Trade compensation payments represent, for the sector, an opportunity to sustain some of the economic growth that began in 2017 and ward off potential liquidity and debt repayment problems. Without trade compensation payments (or reinvigorated export potential), several key financial indicators will revert to 2016 levels and trigger some difficult financial adjustments for many participants in U.S. agriculture.