What needs to happen for agriculture to remain profitable?

Join Cascade Partners Managing Director, Jon Doehr, and Tom Walker, Senior Partner at WalkerInsight, as they discuss the current state of the agricultural industry, the technology trends changing farming’s landscape and how mergers and acquisitions will accelerate as the industry strives to both feed 10 billion people by 2050 and remain profitable.

Transcript:

Welcome to Cascade Conversations. Join the team at Cascade Partners and their network of trusted advisers as they work to demystify details, terminal and strategies in the world of acquisitions, divestitures and financings.

 

Jon Doehr: I’m Jon Doehr, managing director with Cascade Partners. I’d like to welcome you to another edition of Cascade Conversations. I’m here this afternoon with Tom Walker, a senior partner with WalkerInsight Economics consulting firm focused on agriculture. We are here to talk about the global state of the agricultural industry and specifically how the world plans to feed 10 billion people by the year 2050. Tom welcome!

 

Tom Walker: Thank you, Jon. Actually, the senior partner is Tom Walker Sr., who is in fact my dad. He founded our firm in 1969. And involved us—I should say—involved himself long before I was a law professional in the agricultural industry. I think he had judged it back in the seventies, at least 40 percent of business in our Federal Reserve district.

 

Jon Doehr: Right. So, your work is centered on both kind of data mining economics holistically and as it impacts the the farming industry. What are some of the key developments that you’ve seen in your recovery coming out of COVID? And of course, we’ve got significant inflation that impacts pricing the commodity cost for farmer, the were some of the key issues you’re looking at today.

 

Tom Walker: I think a lot of the factors contributed to making agriculture here in 2022, and that’s nationally true. We focused mostly in Minnesota, so, I can speak very specifically there. The most profitable year on record since 2012—which itself was kind of on the heels of the ethanol boom where the mandates a few years prior created a major bull market in corn, and that ran ahead of the costability to catch up. So, we had some wonderful net profits in 2000. The year 2022 bested that number. And you have to go back basically into much older of the data sets to find the last 10 years for us to find the last time farming has boomed as it did. It’s tempting to see how it correlates to the 1970s, which were a very profitable time in agriculture.

 

Jon Doehr: Okay, and can you tell us a little bit about land prices; how they soared to their current levels, how that’s impacting the farmer and how that’s going to impact the future of the industry as it relates to what is the best use of land? As we all know, labor is a big problem for all industries today. Is automation coming on to the farm? And then as you look at the supply chain, how is technology impacting the whole the whole supply chain?

 

Tom Walker:
Farmland, as recently as the 1970s in Minnesota, was about $1,000 an acre. And Minnesota—it’s not the major state corn producer—but certainly a decent proxy for overall profit. In the US, farming was maybe 1,300 acres. Recently, it’s 97 depending on the rumor mill and what sales are there. And I am aware of an appraisal that was just conducted that placed quality farmland at $10/12,000 an acre. It is very, very high and it is still high in spite of the fact that since last year we’ve seen some real major uptakes and interest rates.

And I mean, you have a very powerful negative correlation, so, you talk about farmland once done since the 90s. Certainly interest rates until recently have been very distinct in the downward trajectory that tends to boost asset prices. Additionally, we’ve seen technology—particular—chemicals and hybrids pushing corn yields up really miraculously, and that plus less ethanol mandates and whatever else you want to throw in the mix from the COVID era—whether it’s sort of over Ukraine production or whether it’s just what the M2 did in the period in chasing after, well, commodities is going to services, which inevitably happens. Inflation, the first effect on farmers who do benefit. And I think that’s really driven…I can only call it speculative price.

 

Jon Doehr: So, as we look at how do we create resilient food production going forward? There’s a lot of new technologies. A lot of money has come into what they’re calling the “agri-food tax” space—I think it’s over $200 billion since 2012 and $30 billion in 2022 alone—although that was down from 2021. As you look at concerns over supply, of course, ESG, climate, carbon and then new technologies, internet of things, precision ad…How do all those factors influence what a farmer is thinking about in terms of what is best for their business and how the consumer should be thinking about where they should go and buy their products?

 

Tom Walker: I mean, the farms, it’s obviously a very full time job just to keep up with with technological advancement. And it it results in a really high capital spend in order just to keep up. It’s interesting that what I find that farming is their cap x essentially accounts for every single dollar free cash flow that comes in every year, which is always is a bit disturbing. You’d like to see a little bit of payback over.

 

Jon Doehr: It was very capital intensive.

 

Tom Walker: It is, exceedingly. And keep in mind in terms of land ownership, farmers own perhaps a quarter of the land, but it’s under management. So, there will be an interesting shift in terms of where the capital resides, as the population ages out, that involves farmers retiring, landholders, passing their land over the next generation.

Sometimes the next generation does not want to be in a land management situation, and so they’re looking for professional third party management or they’re looking to sell it and cash out. So, that whole landlord and farmer relationship is probably going to evolve in the next 10 years. In fact, if you can guess, it’s going to be more professional.

 

Jon Doehr: That’s interesting. One of the new issues that’s coming to agriculture is advanced technology greenhouses or a controlled environment, situations where you’re growing product indoors. Correct?

 

Tom Walker: Yes.

 

Jon Doehr: And we’ve seen a lot of money in the venture capital space going to these vertical farms, which seem to have had mixed success in the last year. Some are still growing, but others have certainly failed. What is the situation where the farmer has to decide, “I can keep doing this outdoors, but I have these environmental considerations I’m having. I have concerns with the weather,” versus potentially going to an indoor environment?

 

Tom Walker: Yeah, it’s I mean, obviously animal husbandry has moved a lot of it inside anyway. It’s got production exclusively inside. Dairy the actual production is inside. I mean, so much of agriculture is still producing very commodity level of undifferentiated product. Number two, yellow USDA, yellow corn soybeans a lot of it’s going into seed oils, some of it is going into biofuels—a lot of corn goes there.

So, in terms of the higher quality food question versus where most of our acres are being devoted, it’s hard to say where that’s going to evolve. So, some of the more interesting—more direct to consumer food items—I sort of hypothesize have been pushed aside a little bit.

 

Jon Doehr: So, you’re still still trying to get to that low cost of production. I know it’s a little different space, but in we’ve done a fair amount of work in the horticulture space where they’re not growing food so much as plants, trees and shrubs. But I know in that sector of the H-2-A program, which is a program where workers are brought up from Mexico in a very organized system, has been a great way for some of those companies to increase productivity and efficiencies in their in their various sectors, which is important as pricing has been under pressure with with COVID and consumer demand has has kind of waffled a little bit.

So, it’s still about being that low cost producer in the farming sector, in agriculture in general, correct?

 

Tom Walker: Yeah, That’s not a question. I mean, if you can maintain quality and cut cost—and that is a bit of a trick because people are cutting costs, I think, sometimes it’s a bit of a knee jerk because in the end they undermine their quality and their productive profile in the longterm. But that’s definitely there, a regard—and I don’t see enough of it—primary opportunity, whether you’re in crops or animals or both, is definitely organic farming just because it’s differentiated, it’s consumer driven, it’s not dependent on subsidies or other forms of economic management you’re going to get.

 

Jon Doehr: I know data analytics are critical in what you do, it’s important in a lot of different industries that we see, and it’s becoming more and more important every day. Can you talk a little bit about how you mined data and how you use that with your clients to help them improve their operations?

 

Tom Walker: Agriculture is really data rich. I don’t know who isn’t anymore. But that’s because, with the government involvement, there’s public data set. So, you really get a good sense of what the economic reality is. So, you’re trying to understand how you’re really performing. We all want some basis comparison, and so I’m able to access that data and give my clients a little insight. Basically looking over their neighbor’s shoulder—which is kind of a kind of big brother, I guess—but anyone could do it if they wanted to.

And the perception and reality are kind of divergent there. What people sort of assume is the nature of reality, and just driving around, looking at what is going on in agriculture ends up being very different if you get behind the numbers. It’s a challenging industry, our margins are razor thin. Capital cost has been low, but that is driven asset prices up very high, offering up a transition where we’re going to see asset prices tail off and and capital costs rise.

It’s always the people—and this is the big standard that’s using the data—is what’s the nature of that transition and don’t get cut out. The stupid example—except for the people who are doing it—is don’t buy $12,000 an acre of land in Minnesota that presumes that you’re always getting 220 bushels of corn at $7 and 3 percent of the cost of funds.

Have they happened? Yeah, they just did. Are they persistent? Well, they’re gone. And looking at history, to what extent is history controlling when you find the numbers for these prices to remain? What other things have to be true? And do we think those assumptions are reasonable? Usually from the answer is “no.” We have to assume, or at least be prepared in the financial arrangements, that corn is going to be cheaper when I was going to get 200 bushels, interest rates were in fact 6,7,8 percent, which if you take a broad sweep of history, it’s a middle of the road. So yeah, the short-term regret.

 

Jon Doehr: I think for our last topic of today’s conversation, we’re investors, right? We obviously do a lot of work in mergers and acquisitions. You’ve alluded a little bit to consolidation in the sector with the big corporate farms that have come in and acquired a lot of the land. And I know that we’re expecting a lot of m&a with the rise and fall of capital funding in the agrifood tech sector, particularly around some of the technologies and the vertical farm that there’s going to be some winners and losers, and m&a is going to be a part of that.

How can you speak to consolidation, in general, in the sector as it’s a finite pie? It’s not really growing. I think it was Mark Twain that said, “Buy land, they’re not making you any more of it.” How do you how do you see m&a consolidation playing a role the next few years?

 

Tom Walker: Farming, traditionally, has been untamable. It’s very decentralized and maximum efficiency tends to be around 5 to 10000 acres—and I’m working from Minnesota assumptions. We’ve seen the most consolidation definitely within animals—beef, especially hogs, poultry, dairy and I’m not sure what to make of some of that because it’s very undifferentiated, not quality-driven necessarily in consumer-driven product.

There’s likely to be opportunities in land acquisition, land holdings and, actually, to be a professional holding source serving farms to work with. I think what we’ll always see is application of ownership and management there. But I don’t think that $10,000 an acre is a good play based on the current crop mix in Minnesota.

So, if someone figured out how to grow really good cabernet grapes in Minnesota, I think that you’d be happy with 10,000. Although, I was I was at another event. I was talking to a vintner from Central Coast and unplanted a suitable ground for the wine production of those $25,000 an acre. Fully planted and ready to produce was maybe 40/50, which you think about the value of production there and you think about how that compares to 10,000 for the Minnesota number to your corn. Our numbers are some kind of crazy. So, I wouldn’t tell everyone to rush out and buy land if they’re not making more of it.

And there’s something important you shared with me, I think about your total production. And we’ve gotten very productive. There’s a lot of land that can become more productive. There was a theory that was advanced a few years ago and I’m really sympathetic or curious about it. It was peak farming where we’re going see it land and pull out production because the efficiency of production so great. So if you’re going to buy it, make sure it’s good.

 

Jon Doehr: Right, right. Well, I think what I hear you saying and what we’ve seen as well is that it’s a highly competitive sector, whether it’s agricultural or horticulture—there’s a finite pie. You have to be very efficient in your means of production. And as a result, there’s consolidation because economies of scale just leads you to more profits. So, it only makes sense that some groups are getting out of pork and into beef, or out of beef and into other areas. And I know in horticulture it’s the same, where it’s just more efficient to have larger operations where you can generate economies of scale and increase your bottom line.

Well again, thanks for being here, Tom. Appreciate it. And thank you for joining us for another episode of Cascade Conversations.

 

Tom Walker: Thank you.