Profit margin compression, part 3 – Price reality

There is an old saying that high prices cure high prices. In reading my last two columns, one can quickly observe that profit margins measured by return on assets (ROA) and operating expense to revenue ratios moved into an area not seen in nearly a decade and only a couple times in the past 20 years.

The great commodity super cycle, which lasted from 2003 to 2012, bestowed considerable profits and prosperity on producers, particularly on the grain side of the equation. However, this prosperity brought with it higher cash rents, doubling and tripling in some cases, as landlords attempted to increase their share of the pie.

Inflation, while benign in the general economy, has been running full steam ahead in input and operating costs in the agriculture industry ranging anywhere from 5% to 10% annually. Combine this with increases in real estate taxes and the fixed cost component of equipment and machinery, and one can quickly observe how profit margins have quickly disappeared with lower commodity prices.

Granted, some producers were able to increase yields and gain efficiency in equipment and technology, but not enough to offset the aforementioned inflation and, of course, the moderation of some of the commodity prices.

 

Crucial Conversations

This fall and early winter, many producers will be required to have crucial conversations with landlords and to some extent with suppliers. Marginal or inefficient land or resources that have limitations, such as distance or proximity to markets, may have to be reevaluated. Of course, the marketing and risk-management programs will need to be dusted off to find scenarios that build in profits, even if profits are marginal at best.

The super cycle transition will require focus and efficiency if Mother Nature cooperates and bestows abundance through moisture and growing degree days in both hemispheres. These will be the financial facts of life. However, many will confront confusion, conflict and emotional behavior that the downside of the cycle ultimately brings to the table.

 

Special Note: Those who are involved in livestock are in the window of profit for a few years; however, remember: high prices will cure high prices!

TAGS: Soybeans Corn
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