Canadian farmland has a long track record of producing steady, equity-like returns that are uncorrelated with the ups and downs of other financial assets. Bonnefield’s research has shown that long-term farmland returns are highly correlated with, and are primarily a function of, the long-term improvement in the productive capacity of farmland. Simply put, as crop yields have improved over time, and as farm operations have become more efficient through consolidation and technical improvements, the “earnings power” of the underlying farmland itself has increased, leading to an increase in both farmland values and farmland rents.
An analogy is to think of farmland like shares in a public company. If the productivity of a company improves, one would expect its profits to improve and the price of its shares to increase accordingly. But if, in management’s drive to improve the company’s productivity and profitability, they take on too much debt or weaken the company’s financial liquidity, then its profitability (and, therefore, share price) is put at risk.
The same is true of farmland. If the farm sector’s debt load were to increase to the point where farmers’ financial liquidity deteriorates substantially, farmland prices and rents would potentially be at risk. Such was the case in the early 1980’s when a debt boom coincided with declining crop prices and skyrocketing interest rates, resulting in a rare period of widespread farmland price declines.
So the obvious question is: How financially sound are Canadian farmers? Most farmers rely on debt to capitalize their operations. Are they sufficiently liquid to withstand a period of crop price stagnation and/or interest rate increases? Are we potentially at risk of a 1980’s-style farm crisis?
Statistics Canada’s most recent Farm Financial Survey suggests that the clear majority of Canadian farmers are in sound financial shape.
Recent analysis by Farm Credit Canada concluded that in 2015, 82% of Canada’s grain and oilseed producers had debt-to-equity ratios of less than 0.3. 77% of vegetable producers and 63% of potato producers had similarly low debt levels. More importantly, Canadian farmers appear well positioned to continue to service those debt levels as indicated by healthy debt-service ratios (net income divided by annual debt service payments). More than 2/3rds of all grain, oilseed, vegetable and potato producers in Canada had debt service ratios greater than 2.5, the result of several years of strong cash receipts and low interest rates.
FCC’s analysis also concluded that the “overall liquidity position of Canadian agriculture is strong”. The average current ratio (current assets divided by current liabilities) of all Canadian farmers was 3.0 in 2015, with the grain and oilseed sector especially strong at 3.6. To put this in perspective, FCC considers a farmer’s financial liquidity to be adequate if they have a current ratio of 1.5 and most Canadian farmers have current ratios well in excess of these levels.
The healthy financial liquidity of the Canadian farm sector stands in contrast to that of US farmers who, according to FCC, have experienced a decline in their current ratio from 2.87 in 2012 to 1.55 in 2016. Unlike their US counterparts, Canadian farmers have been insulated to some degree from lower corn and soy prices by a favorable USD/CAD exchange rate and a more diversified mix of crops (especially canola and pulses, the prices for which continue to be strong).
Indeed, Statistics Canada released figures in late November showing that Canadian farm revenues (“farm cash receipts”) for the first 9 months of 2017 were up 3.3% versus the same period in 2016. This increase is the 7th year in a row in which Canadian farmers have experienced year-over-year increases in revenues. Moreover, Canadian farm profits, as measured by realized net farm income, were up 4.2% in 2016, the 6th such increase in the past seven years.
The bottom line is that we are reassured by Statistics Canada’s most recent Farm Financial Survey showing that the clear majority of Canadian farmers, particularly grain, oilseed, potato and vegetable producers (the sectors that Bonnefield focuses on) are in sound financial shape.