“It’s not the down-cycle years that do farms in; it’s those boom years.”
That wise comment was tweeted to me by intelliFARM analyst Brian Voth in an online discussion I was having about the sour mood across Canada today.
That sour mood extends deep into farming, where years of lacklustre returns combined with challenging (to say the least) crop production conditions have created a generally morose feeling.
As I wrote last week in this column, that sour mood is typical — for a country that benefits disproportionately from commodity booms — when a commodity boom ends. It’s especially true for commodity production industries such as oil and agriculture.
Many farmers are now coping with “duration risk,” and it’s a concept worth thinking about. Beyond suffering poor returns since 2014, some farmers are grappling with debt servicing costs and operating costs that might have seemed eminently manageable during the 2006-14 boom, but now make profitability elusive. They also bring up the very real risk of financial crisis if a crop wreck occurs.
For some, there isn’t enough profit in the years of decent yields to cover a disaster year. Many are just treading water in “good” years, so getting pulled under in a bad year is perilous. The financial cushion is growing thin.
That’s duration risk: long-term fixed debt and cost structures that have to be covered by volatile short-term revenues. When the long-term and short-term are mismatched the wrong way, problems occur. Even the fear of that happening in the future can make creditors pull back, unlike the way many lenders behaved during the boom.
You can see a great example of that danger in the stock market today with the disaster of the aborted WeWork initial public offering. The company, which leases large amounts of office space from property owners and then rents and subleases pieces of that out to thousands of self-employed people and tiny businesses, tried to go onto the market with a $47 billion valuation.
For a while the company was a darling of the venture capital world, even though it lost US$1.6 billion on $1.8 billion of revenues, with many instead focused on the company’s incredible growth.
Then worries about the company’s duration risk came to the fore, and most prospective investors fled. If there’s a recession, will WeWork’s customers just go back to working from their houses and apartments?
The valuation of the company plummeted to about $10 billion, at which the IPO was scrubbed.
Farmers had good reasons to be bullish about the long-term prospects for agriculture prices during the boom years. After all, numerous speakers at farm conferences and prognosticators in the media preached a consistent message of “the world needs all the food you can grow.” Permanently growing demand seemed to support the case for aggressive expansion.
The problem is that the speakers and prognosticators had less skin-in-the-game than the farmers who they were encouraging to be bullish, and now it’s the farmers who are feeling a little naked.
Booms can be great to live through, and they’re a godsend if they allow businesses to build up financial strength to face the inevitable bust.
But for some, the euphoric projections led to decisions that created farms best suited for maximum production in boom times rather than surviving the lean times we’ll likely be living through for the next decade.
With any luck, farmers will get a few, unbroken years of better growing conditions that will produce enough steady profitability so that everyone can ride out the cost pressures that have been exacerbated by the recent combination of droughts and terrible harvest weather.
But in the long run, it’s always worth keeping in mind the concept of duration risk and remembering that the obligations we take on in the booms go on to live through the busts.