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June 11, 2020

Is Your Dairy Business Ready for COVID's Wave?

 |  By: Jim Dickrell

Most dairy farmers are breathing a lot easier as dairy commodity prices rebounded from almost record lows in March and April to record highs, in some cases, in the past few weeks.

While that stress relief is welcome, dairy lenders say now is not the time to relax and assume all will be well. Their biggest fear is a second wave of COVID-19 this summer or fall. Their next biggest fear is a slowly recovering national economy that has been in recession since February.

“I see more head winds going forward than tail winds,” Sam Miller, managing director and head of ag sector lending for BMO-Harris Bank. He and Steve Schwoerer, senior dairy lending specialist with Compeer Financial, participated in a Dairy Signals webinar hosted by the Professional Dairy Producers of Wisconsin in early June.

“What will the second round of the virus look like?” asks Schwoerer. “What did we learn from the first round of coronavirus that we can use moving forward?”

Even though most states are re-opening their economies, there are already reports of a second wave of COVID-19 infections that are affecting early-opening states. States could clamp down again if the infection rate soars and hospitals are over-whelmed with new patients.

You also have to look at why commodity prices are where they currently are, says Miller. Restaurants and institutions are opening back up, but they may only be doing short-term buying to refill inventories. Unemployment is also at level not seen since the Great Depression some 90 years ago. So consumer buying power will also likely be depressed for months to come. Dairy exports have been fairly robust to date, but a strong dollar will weigh on those markets—especially if the economies of importing countries are weak.

So you really need to look at the third and fourth quarters and project where your financial situation will be. The first order of business is to recalculate your cost of production (COP). “It’s really important to know your COP and what your basis is,” says Schwoerer. “That will help you to know if a $16.50 price is a good number to lock in,” he says.

Don’t assume your COP is static. Declining feed prices can lower that number; rising labor and other costs can increase it, he says.  “COP is a number that changes,” says Miller. “Some of our clients’ COP have gone down; some have gone up. COP is a real, live number and something you have to stay on top of.”

It’s also important to define what goes into COP. For both Miller and Schwoerer, a cash flow COP would include direct expenses and labor, principal and interest, and family draws.

Schwoerer says his clients’ COP will range from $15 to $19/cwt, with most coming in at $17. But each individual operation must know its number to effectively manage risk.

The next task is to have up-to-date financial statements. Core documents include a balance sheet, income statement and cash flow. Once you have those, you can forecast to see if you will have sufficient cash to cover expenses moving forward. What is your working capital? What is your burn rate? Where will you have shortfalls?

Also stress test your budget. What happens if milk prices rise $2/cwt—or fall $2? What if you have a variable rate loan and interest rates rise or fall a percentage point? All of these scenarios would have an impact on your bottom line, says Schwoerer. Stress testing your business better prepares you for the uncertainty and market volatility that lie ahead.

Frequent, on-going communication with lenders, vendors and your milk processor is key. Will you require additional operating money? Will you have trouble meeting a vendor payment? If the milk supply chain tightens again, will your processor require you to cut production? How much warning will you have?

Once you’ve done all of that, look for opportunities. If you know you have sufficient cash on hand, now may be the time to buy grain while it’s relatively cheap or contract for more corn silage this fall. With interest rates at near all-time lows, now may be the time to lock those in—or have a plan in place to lock at the first hint of rising lending costs, says Schwoerer.

You can listen to the 53-minute Miller/Schwoerer Dairy Signals webinar here.