Even the dullest sluggard can increase revenues when inflation rates drive up the price of the product they're selling or owning, and the number of buyers increases. Magnify the raw volume with easy credit and folks can look even smarter, on paper at least.
That's one reason why the housing market appeared so lucrative for so long. Arguably, that's also a key reason commodity markets acquired such luster during the past 18 months as speculators shoved more dollars at them than fundamental value could support. In both cases, folks collectively tried to will the market into something it wasn't.
Both are cause and symptom of what some are describing as the most severe financial crisis since the Great Depression.
“You can defy the markets for a while, but ultimately the markets win,” says Derrell Peel, Oklahoma State University livestock marketing specialist.
Ag's strong position
Though there's anecdotal evidence that lenders to the cattle business are beginning to increase equity requirements, and it's early in the game, agriculture is strongly positioned. According to USDA's Economic Research Service (ERS), sector net worth — producer equity — is expected to reach over $2.1 trillion in 2008, up about $133 billion from 2007.
ERS forecasts the value of U.S. farm business assets to increase 6.7% this year; it grew 7.9% in 2007. The value of farm business real-estate assets, which comprise about 85% of farm-sector assets, is expected to rise by 7.3% this year, following an 8.9% gain in 2007. By historic standards, each measure represents astronomical year-to-year gains.
Perhaps more important, producer solvency continues to improve.
ERS forecasts the agricultural industry's debt-to-asset ratio at 8.9 this year, compared to 15.2 in 1998. That measures the debt pledged against farm-business assets — an indicator of overall financial risk.
Similarly, ERS forecasts the industry debt-to-equity ratio at 9.8, compared to 17.9 a decade ago. This is the relative proportion of funds invested by creditors (debt) and owners (equity). In other words, creditors own less of the industry's equity than they used to.
Re-evaluate your lenders
Even though the industry overall is positioned so favorably, your relationship with your lenders could change depending on who they've depended on and how they've invested money. As too many investors and credit customers have discovered, the credit reselling and consolidation of financial institutions that helped wreak the current havoc have brought some state, national and international institutions to their knees.
Peel points out smaller, independent rural banks could emerge from the current financial maelstrom even stronger. Such lenders are less likely to have invested in the high-risk paper trade.
Irregardless of who your lender is — how solid you think they are — it may pay to make sure you know how your primary lenders are structured, who owns them, and what their balance sheet looks like these days. Peel points out two of the poultry industry's key players find themselves on the financial ropes because of their reliance on short-term credit that has evaporated due to the straits of their lenders.
If short-term credit gets tougher to come by in the cattle business, Peel says it could accelerate the structural changes taking place in the industry. Think here in terms of feedlot and packing capacity being shelved faster than it would be otherwise.
Bottom line, Peel says, “You may not be able to assume that your operating loan will continue in the manner that it has.” For example, it could be a previously lenient lender is forced to hold customers more tightly to equity positions.
“You need to be prepared and consider the alternatives,” Peel suggests. “This is certainly a time to be cautious about taking on a lot of new debt.”
Peel equates the market to steering your pickup down the road. You either make lots of correct, minor adjustments along the way or you wind up having to make a huge and jarring one to avoid the ditch.
But, this isn't the end of the world.
“This is a correction, not a meltdown or fundamental unraveling of everything,” Peel emphasizes. “Out of this will come lots of opportunity for some folks. None of us know what those opportunities are yet, but I know they'll be there because they always are in these situations; that's how business works.”