Trouble in Agriculture
In a recent visit to downstate Illinois, I stopped to talk to some farmers I know. First, I heard from a neighboring farmer who had lost his ability to obtain funds from the bank for seed, fertilizer and equipment. He was trying to pay down what he owed to suppliers and keep going for a while on cash only. After farming lots of acres successfully for decades, he was now in his last year.
Next, I heard about the foreclosure by the local bank of a family-owned farm supplier. The supply company had a huge number of unpaid accounts by local farmers. It went under too. A large global farm supply company bought what was left and paid less than the bank expected in its final sale of foreclosure assets.
Another small machinery dealer also closed this summer. Demand had come down so much that it was unable to remain in business.
So many signs of financial distress within twenty miles of each other reminded me of the early days of the 1980’s farm crisis. Over 400 banks failed amid a cascade of farm bankruptcies. Why? Farmers were doing very well in the mid-1970s thanks to a huge increase in global exports. Unfortunately, the lending rate skyrocketed from about 7% in 1976 to more than 20% by 1981. At the same time, Jimmy Carter placed an embargo against the Soviet Union in 1980 when it invaded Afghanistan. Grain prices plummeted and farmers could not pay their huge debts.
Agriculture’s Place in the Modern Economy
Fast forward nearly 40 years later. Agriculture, food and its related industries contribute just over $1 trillion to our Gross Domestic Product (aka GDP, defined as the total value of everything produced in the U.S.). That is just over 5% of GDP. Farms alone are just $132.8 billion (or 1% of GDP) and shrinking amid lower prices exacerbated by the trade war. Most farms are small family-owned businesses, but agricultural processors and suppliers like John Deere or Archer Daniels Midland are huge multinational companies that add further to the agriculture-related economic activities.
More than 20% of ag production overall and over 50% of soybean production is exported, contributing to a more favorable balance of global trade. Ag-related businesses contribute 9% of our total exports outside the United States, which is higher than its 5% contribution to GDP. For American consumers, food is an even larger portion at 13% of average household budgets.
In recent years, China has imported about $16 billion a year in soybeans alone. Between 2018 and August, 2019, total Ag exports have declined about $6 billion. Therefore, if the trade ware continues, further declines are likely. Although some expect that a trade deal with China will turn this trend around, others are aware that changes in export flows develop over time and are not the result of one single catalyst. Once a new export flow is established, it runs the risk of becoming part of a more permanent trend. Corn and wheat, the other two major exports besides soybeans, mainly go to Japan and Mexico as leading buyers. The effects there are far more modest.
Net farm income to farmers has also declined for the last five years, driven by lower prices and over-production – the result of more productive seed hybrids, more precision in applying fertilizer and chemicals, and more efficient equipment. The advances in technology have been almost too good. Now production far exceeds domestic demand.
U.S. corn crops now routinely amount to 15 billion bushels annually; but domestic use for feed to cattle, hogs, chickens, etc. amounts to only 36% of this total. The ethanol market utilizes another 40%, making biofuels the biggest domestic user of U.S. corn production. That leaves a 24% excess over-production, most of which is exported. Similar excesses affect the soybean and wheat markets.
Impact of Crop Production Outside of Farms
Agriculture is unique in that it is unable to capture excess profits from increasing productivity. Grain is fungible with prices developed by global demand, supply and trading volumes that the producers do not control.
Investors, like many of our clients, who have ownership interests in companies like John Deere (DE) and Archer Daniels Midland (ADM) are affected by this contraction in agriculture as are our rural areas of the United States that rely on these companies for their livelihoods. Deere is an industrial company that produces primarily agricultural and construction equipment. Its five-year revenues have declined just under 1% in a growing economy. It is lowering its production below sales in the second half of 2019 due to weak demand from farmers. Its share price has been flat the last two years; and on September 12, 2019, Wells Fargo downgraded the stock.
Archer Daniels Midland is a consumer staple in the ag products sub-group. The company merchandises and processes grains and is a major producer of ethanol, both for domestic consumption and export. Its revenues are down about 6% over the last five years. Its stock price has declined from the $50’s to the low $40’s in the last five years. Analysts are hopeful that soybean sales will improve after suffering from low demand thanks to African Swine Fever, which has ruined hogs around the world, including in China.
How Do We Respond?
It is clear that the global economic environment and expanding technologies have a serious impact on the success of modern-day farms and related industries. In the short-term, we anticipate the trade war that the United States has waged against China and other countries will continue to negatively impact our farmers and consumers for some time. However, long-term food producers and processors will continue to exist, even if that means drastically altering the way they do business. The world’s population is not getting smaller, and the demand will remain, if not expand.
When we think of corporate investment, we prefer to think with the long haul in mind. We know that ag-related companies are well-aware of the danger they face if they do not evolve. We invest in companies that have shown resilience and innovation. Tough markets may be frustrating, but these challenges keep pushing humankind forward to create and rebuild.