US farmland prices, particularly in the Mid-West, are moderating and in some places actually declining modestly from their peak in 2013/14. US farmers have faced headwinds from a strong US dollar, soft USD-denominated commodity prices (particularly for soy and corn) and a continuing drought in some parts of the country. In contrast, the outlook for Canadian farmers continues to be bright. Farm Credit Canada recently forecast that farm cash receipts will increase by 5.8% in 2016 and increase further by 3.8% in 2017. Moreover, in a report released in September, FCC further highlighted the current financial strength of the Canadian farm sector relative to historical trends:
liquidity is strong with a current ratio of 2.40, in line with the sector’s 15-year average;
historically low debt-to-asset ratio of 15.5% vs a 15-year average of 16.7%; and
return on assets of 2.3%, not far off the 15-year average of 2.6%
Why is the outlook for US farmers so different than for Canadian farmers? And how likely is it that soft or declining farmland prices in the US will lead to a similar trend in Canada?
In previous blog posts I’ve discussed the primary reasons for continued optimism for Canadian agriculture, despite the difficulties faced by the US sector, such as: stabilizing crop prices, a favorable and stable USD/CAD exchange rate, and robust export demand for a broad range of crops produced by Canadian farmers (especially canola and lentils) and the strong financial position of Canadian farmers.
In addition to these factors, there are structural differences between the Canadian and US agriculture sectors that tend to insulate Canadian farmers (and, therefore, Canadian farmland prices) from declining corn and soy prices that are the primary cause of US farmer’s current difficulties. At Bonnefield, we frequently point out the competitive advantages of Canadian farmland in terms of access to water, a more benign outlook for climate change and less degradation of soils.
However, a less-well understood advantage of the Canadian farm sector is its broad diversification. Canadian farmers are far less leveraged to corn and soy prices than their US counterparts. A staggering 178 million acres, or some 55% of all US crop land, is seeded to either corn or soy. That’s a significantly larger land mass than the entire country of France, devoted to the production of only two crops. In contrast, only about 13% of all Canadian farmland is used to grow corn and soy. Phrased differently, the entire Canadian corn and soy crop, covers only 5% of the land mass used to grow these crops in the US, an area much smaller than the Province of Nova Scotia. This fact is the single biggest reason why US farmland prices are so much more heavily levered to corn and soy prices than Canadian farmland.
The charts above illustrate the greater diversification of the Canadian agricultural sector. Indeed, if the US acres devoted to cotton production (a crop not grown in Canada) were removed from these figures, it would illustrate even more dramatically how leveraged US farmland prices are to the market prices of corn and soy.
An additional factor that exacerbates US farmers’ vulnerability to declining corn and soy prices is the prevalence of mono-cropping in the US corn and soy sectors. A combination of unique climate and agrological factors enable some large-scale US farmers – particularly in the Mid-West – to avoid traditional crop rotations and pursue mono-cropping of a single crop year after year. This practice is virtually non-existent in Canada. Mono-cropping puts additional stress on soils and requires intensive farming techniques involving significantly higher use of fertilizers, herbicides and pesticides in order to achieve consistently high yields year after year. The higher costs involved in these intensive farming techniques are not much of a concern in times of high and rising crop prices. But in a soft price environment, higher costs contribute to tighter margins and less financial resilience – a trend we are currently seeing in much of the US farm sector.
So are softening US farmland prices a leading indicator of what could happen to Canadian farmland prices? Potentially, but not likely. US farmers are far more exposed to soft corn and soy prices than Canadian farmers. Canadian farmers benefit from (i) greater crop diversification, (ii) strong demand, high prices and less international competition for leading Canadian crops like canola and lentils, (iii) a favorable US/CDN exchange rate, (iv) strong financial fundamentals of the Canadian farm sector, and (v) a bright outlook for continued farm profitability. In our view, any softness in Canadian farmland prices would likely be short lived and represent a buying opportunity.
A more likely scenario is that Canadian farmland appreciation rates will revert to long-term norms after several years of outsized growth in the 2010-2014 period.
Water is a central component of the Canadian farmland investment thesis – indeed Canadian farmland (as distinct from US or other farmland) might be seen as a proxy for investing in water itself for several reasons:
Because the impacts of water shortages, droughts and climate change are anticipated to be less in Canada than in most other major Ag exporting countries, it stands to reason that Canadian farmland should, over time, attract premium values as compared to farmland that is more subject to these risks.
As relative yields suffer and/or even decline in other parts of the world, it is anticipated that yields will increase in Canada (along with Brazil and potentially Russia). We are already seeing this trend in a significant shift in the corn belt north and west into Ontario and Manitoba.
Some Canadian farming regions like Temiskaming and Grand Prairie should benefit disproportionately as compared to other countries and other regions that face climate, water and drought pressures.
It is becoming apparent that China has adopted a policy of effectively “importing water” from countries like Canada by increasing imports of water-intensive products like soy and corn and concentrating domestic production on more less water-intensive crops due to the serious drought and water pollution issues they face at home. This trend will benefit Canadian farmland disproportionately as compared to farmland in water-stressed regions.
We here at Bonnefield view water as a key competitive advantage of Canadian farmland as compared to farmland in many other parts of the world. This is not to say that farmland in some parts of Canada will be immune from periods of drought as climate change progresses. But drought-related risks in Canada tend to be location and property specific. It could be argued that for Canada as a whole, the bigger water-related risk over time will be too much water as opposed to too little, since much of Canada is expected to see increased precipitation as a result of climate change rather than less. The risk of excess water is as important a consideration as too little water, when Bonnefield invests in farmland. Do the soils have natural drainage characteristics or can excess moisture be mitigated through tile drainage and surface shaping? Conversely it may be best to avoid investment in properties and regions that face a significant drought risk that can not be mitigated through some combination of irrigation or high-quality, moisture-retaining soils, etc.
Overall, Canada can expect to suffer less stress from climate-induced water shortages than many other parts of the world. Canadian farmers will certainly face increasing challenges in some parts of the country from both drought and excess moisture, but on the whole, these risks should be manageable through careful farming techniques and proper risk mitigation.
Two back-to-back seasons of high crop yields in 2013 and 2014 increased world stockpiles of several important commodities – particularly corn and soy. Harvests in 2015 were uneven in different parts of the world, but were sufficient to maintain relatively high global stock levels. As a result, corn and soy prices have not rebounded to the highs of 2012. Is this a new norm? Not likely.
As we have pointed out in previous research, the 2013-2014 worldwide bumper crops were the first such back-to-back occurrence since 1991 – 1992; a once-in-a-generation event. And while current corn stockpiles are roughly in line with those experienced in the late 1980’s, worldwide consumption has more than doubled since that period, so on the more important measure of stocks-to-use, worldwide supplies are still at the levels of the early 2000’s and remain susceptible to supply disruptions (source USDA data).
It is also important to keep in mind that the weakening Canadian dollar has helped to insulate Canadian growers from declining world market prices that are quoted in US dollars. As we pointed out in our previous blog post, as at the end of Q3, corn prices were off only 8% in Canadian dollar terms since May 2014 (versus 24% in USD), wheat was off 11% (versus 26% in USD) and Canola was actually up 23% (versus 2% in USD). Canadian dollar price swings of these magnitudes are considered fairly standard intra-season volatility. The only major crop to experience a significant decline in Canadian dollar terms was soy (off 28% in CDN vs 40% in USD).
It is also important to recognize that corn and soy prices impact only a portion of the Canadian farm sector’s overall profitability. Prices for pork, dairy, vegetables and specialty crops all remain very strong and beef prices are at all time highs. So the net impact of lower corn and soy prices on Canadian farm financials is expected to be modest. FCC is predicting robust farm profits again this year only slightly below the records set in 2013 and 2014.
The current crop price outlook is analogous to the the difference between local weather conditions and a warming climate. Weather conditions are becoming more volatile – with extremes of both heat and cold – but our climate is inextricably warming with serious implications for agriculture worldwide. So too, future crop prices will be volatile – both up and down – around a steadily increasing trend driven by climate change, water shortages, changing diets and population growth.
So we view current grain prices as a temporary fluctuation around a steadily increasing long-term trend.
MCSI recently published their quarterly “Global Quarterly Infrastructure Asset Index” comparing the returns generated by both listed and private infrastructure classes with other asset classes such as bonds, real estate and equities.
The report also provided debt ratios for the components of the private infrastructure index. Using this information and some conservative assumptions for the debt ratios typical of the other asset classes, we were able to reverse engineer the unlevered returns of these asset classes and compare them to the unlevered returns generated by Bonnefield Canadian Farmland LP I and LP II over the same time periods.
The results (shown in the following chart) demonstrate that Canadian farmland is capable of generating superior returns without the risk and extra volatility that comes with leveraging your investment with debt.
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