PURDUE CENTER FOR COMMERCIAL AGRICULTURE · Fall 2016 Crop Outlook This webinar focused on the...

PURDUECENTER FORCOMMERCIAL AGRICULTURE

ANNUAL REPORT 2016

KNOWLEDGE FOR FARMERS LEADING P R O D U C T I O N A G R I C U L T U R E

Photos by John Lai, Ph.D. candidate, Department of Agricultural Economics, Purdue University.

Center for Commercial Agriculture | 3 2016 Annual Report

Programming and content provided by the Center for Commercial Agriculture continues to grow rapidly and 2016 was another eventful year for the Center. In the short five-years the Center has been in existence, it has rapidly evolved into one of the leading sources of in-depth farm management education and analysis. I hope

you’ll take a few minutes to review highlights of the Center’s recent activities to become more familiar with the Center for Commercial Agriculture.

Over the last several years, the Center has engaged in several key partnerships as it continues to focus on delivering top-flight management information to the nation’s commercial farming operations. During 2016, partnerships with Farm Credit Mid-America and 1st Farm Credit Services made it possible to developand deliver strategic management workshops to both beginning farming operations and established commercial scale farms. These intensive multi-day workshops focused on improving farm managers’ financial management skill sets and on developing business plans for their farms. Over the last two years, nine workshops were delivered to farmers with operations in Illinois, Indiana, Kentucky, Ohio and Tennessee.

During 2016 the Center also partnered with CME Group to launch the Purdue-CME Group Ag Economy Barometer, which provides producers and agribusiness firms with the nation’s only monthly measure of the agricultural sectors’ health. Research to develop the Barometer was conducted in 2015-2016 and the monthly Barometer was publicly released in spring 2016. The Center launched a new website for the Barometer, purdue.edu/agbarometer, which provides detailed results from the monthly surveys in addition to describing the methodology used to generate the Barometer.

Assisting farmers grappling with the effects of the downturn in agriculture continued to be a major focus for the Center in 2016. In addition to providing information via articles and decision tools on the Center’s web site, the Center also provided webinars, financial management workshops in conjunction with Purdue Extension and the Indiana Soybean Alliance, and joint programming with Purdue’s Agronomy Extension faculty to help farmers fine tune their production management practices.

CCA initiated a webinar/video series in fall 2014 to provide agricultural producers and agribusinesses contemporaneous information from Purdue’s agricultural economists. Since October 2014, CCA has provided 26 webinars/videos with over 14,000 viewers (live plus YouTube viewings). Topics covered include long-term agricultural business climate, commodity outlook, farm management strategies, and farm policy.

The Center also organizes and hosts one of the nation’s leading farm management conferences, the Purdue Top Farmer Conference. The 2016 two-day conference, attended by approximately 100 farm managers, focused on improving commercial farmers’ managerial skill sets, and covered a variety of management, finance, and marketing topics.

During 2016, the Center also jointly managed the Purdue Farm Management Tour with Purdue Extension. The Tour is the longest continuously operating tour of Corn Belt farming operations, with a history dating back to the late 1930’s. The 2016 Tour featured innovative Indiana crop and livestock farming operations in Jasper and Newton counties.

The Center also continues to sponsor the “Introduction to the Business of Commercial Agriculture” class on campus. Each spring semester, the class provides students with a broad perspective of career opportunities available in the commercial agriculture sector by visiting a variety of farms and agribusinesses and having business leaders visit campus to meet with class members.

Thanks for your interest in and support of the Purdue Center for Commercial Agriculture! We’re excited about the many programming opportunities the Center for Commercial Agriculture will have in the year ahead. As always, if you have suggestions for future programs, research or just want to chat, we’d love to hear from you.

Sincerely,

James Mintert Director

LETTER FROM THE D IRECTOR

4 | Center for Commercial Agriculture 2016 Annual Report

WEBINARS DEL IVERED IN 2016 WEBINARSWebinars are a key information delivery technique for the Center. Webinars make it possible to connect with a broad audience on a variety of timely topics. From 2014 through 2016, the Center delivered 26 webinars on a wide variety of farm and financial management, agricultural outlook, and strategy-related topics. Participants unable to view the webinars live have the opportunity to view them at their convenience via the Center’s YouTube playlist.

The Financial Downturn: Back to the Future (Reversion to the Mean)Nearly 500 people registered to hear Mike Boehlje present his Distinguished Professor Seminar on the Purdue campus. Mike discussed the downturn in the U.S. agriculture sector, applied research he has conducted

with Purdue colleagues related to this topic and programming provided by Purdue. In addition to thelive views, this webinar has had nearly 250YouTube views.

Reducing Corn Production Costs in 2016Purdue Agronomists Bob Nielsen and Jim Camberato discussed research based fertilizer and seeding rate recommendations to reduce corn production costs with Michael Langemeier & Jim Mintert of the Center for Commercial Agriculture. Nitrogen, P & K recommendations were reviewed in addition to a discussion of corn seeding rates. Timing of fertilizer applications and application techniques were also discussed. Purdue Agronomy's seeding rate recommendation publication along with nitrogen rate recommendations were referenced during the webinar. This webinar had 499 registrations for the live viewing and has had nearly 800 YouTubeviews, the largest of any webinar deliveredin 2016.

Making Your 2016 Crop Insurance DecisionsPurdue agricultural economists Michael Langemeier and Jim Mintert reviewed the 2016 crop insurance alternatives and provided suggestions with respect to crop insurance selections that farmers should consider using in 2016. More than 580 people registered for this webinar and it has had 350+ YouTube views.

Reducing Soybean Production Costs Purdue Agronomy's Shaun Casteel and the Center’s Jim Mintert discussed with Hoosier Ag Today's Gary Truitt how using soybean seeding rates based upon field scale research conducted throughout Indianacould help reduce soybean farmers cost per bushelin 2016.

2016 Crop Outlook – Pre-PlantingNearly 650 people registered to hear from Chris Hurt, Michael Langemeier and David Widmar as they discussed the revised Crop Outlook in light of new information provided by the USDA's Prospective Plantings and Grain Stocks reports, both of which were released onMarch 31, 2016.

Webinar Title Registrations YouTube views

Dec. 2015 576 664

Jan. 2016 – The Financial 489 241Downturn

Feb. 2016 499 730

March 2016 581 359

April 2016 644 217

July 2016 167 278

Aug. 2016 (Land values) 194 507

Aug. 2016 (sweat equity) 95 201

Sept. 2016 222 367

Nov. 2016 227 152

Dec. 2016 (not yet aired) 296 N/A

AEB* 1st qtr 2016 377 495

AEB* 2nd qtr 533 275

AEB* 3rd qtr 651 193

AEB* 4th qtr (not yet aired) 255 N/A* Ag Economy Barometer


2016 Crop Outlook – Post-PlantingAs a follow-up to the spring outlook webinar, Chris Hurt, Jim Mintert, and David Widmar from the Center for Commercial Agriculture discussed the corn, soybean, and wheat outlook following the release of USDA’s Grain Stock Reports on June 30, 2016.

Land Values in IndianaPurdue agricultural economists Craig Dobbins, Michael Langemeier and Mike Boehlje presented and discussed results from the 2016 Purdue Farmland Values Survey. This webinar has been very popular on YouTube with more than 500 views.

Putting a Value on Sweat Equity in the Farm BusinessPurdue agricultural economist Michael Langemeier along with Purdue Extension's Denise Schroeder, discussed how to divide business income between generations on a family farm and provide a simplified approach to valuing "sweat equity" in the family farming business.

Fall 2016 Crop OutlookThis webinar focused on the outlook for corn and soybeans following USDA's September 2016 Crop Production and

Supply/Demand reports. The webinar featured a review of factors influencing prices and provided marketing and management recommendations. This presentation by Purdue economists Chris Hurt, Michael Langemeier and Jim Mintert was quite popular with more than 500 total views.

Farm Bill DiscussionPurdue agricultural economists Michael Langemeier, Jim Mintert and David Widmar discussed how the 2014 Farm Bill is working with an emphasis on the ARC-County & PLC programs. The recorded version of this webinar was used at Indiana Farm Bureau meetings this fall.

Ag Economy Barometer WebinarsIn 2016 the Center for Commercial Agriculture in partnership with the CME Group, launched quarterly webinars featuring insights from the Ag Economy Barometer. Three webinars have been delivered to date with more than 1,500 live registrations and 1,000+ YouTube views.


In addition to educational sessions, conference participants had multiple opportunities to network with their peers from across the country. Plans are underway for the 50th Top Farmer Conference!

1st Farm Credit Services – Strategy and Business Planning for the Commercial ProducerStrategy and Business Planning for the Commercial Producer is a series designed as a way for 1st Farm Credit to offer professional development to key clients. Families of progressive farm operations participate in classroom and webinar work over the course of six months, during which they study the business environment, strategy, risk management, financial performance, growth and more.

Farm Credit Services: Know-to-Grow (K2G)The Center for Commercial Agriculture and Farm Credit Mid-America (FCMA) partnered on several sessions of Know-to-Grow during 2016. Know-to-Grow is designed for young and beginning farmers enrolled in Farm Credit Mid-America's Growing Forward program. During the two-day program, Purdue faculty sessions were integrated with FCMA-led sessions. The focus was on taking business to the next level; shifting from being a tactical to a strategic manager; understanding farm financials, profitability measures and how they are critical in decision making; setting priorities; and thinking about the big picture for their farms. Sessions were hands-on with practical exercises and sharing in small group discussions. Professors Jim Mintert, Michael Langemeier, and Nathan Thompson led Purdue program segments.

Farm operations were represented at each of the foursessions, including farms from Kentucky, Tennessee, Ohio, and Indiana.

Association of Agricultural Production ExecutivesThe membership of the Association of Agricultural Production Executives (AAPEX), an organization that is now more than two decades old, is comprised of many of the nation’s leading agricultural producers and is devoted to ongoing executive education for its members. The Center for Commercial Agriculture delivered the 2016 AAPEX Annual Meeting in Ponce, Puerto Rico, February 3-6, 2016. Nearly 150 AAPEX members attended the 2016 meeting representing 30 states and three countries.

With 2016 being the first time the Center for Commercial Agriculture was responsible for the meeting, the team was pleased with a 95 percent Extremely Satisfied/Satisfied rating of the entire program. Working with this group of producers provides the Purdue faculty and staff with insights into the research and educational needs of America’s leading farmers and provides opportunities for further collaboration.

Purdue Top Farmer ConferenceNearly 100 farmers, agricultural lenders and agribusiness managers attended the 49th Purdue Top Farmer Conference where they learned how to remain competitive in an uncertain business environment. The conference was held July 7-8, 2016 at the Beck Agricultural Center in West Lafayette, Indiana.

Conference sessions included discussions on the business climate, consumer demand, key growth strategies beyond increasing acreage, and farmland values. Participants had an opportunity to explore how to compete for the best talent available and how to find value in information.

Conference speakers included agricultural economics experts from Purdue’s Center for Commercial Agriculture, the University of Illinois, and Nathan Kauffman from the Kansas City Federal Reserve Bank. Bruce Vincent, President of Communities for a Great Northwest, presented the keynote session, The Conflict Industry and You.

CENTER ACT IV IT IES


Purdue Farm Management TourMore than 300 attendees participated in the 2016 Purdue Farm Management Tour conducted in Jasper and Newton counties in northwest Indiana the third week of June. Each year several Indiana farms are highlighted to provide tour attendees with insight regarding innovative ways to approach the challenges facing today’s farming operations. The 2016 tour visited a major seed corn producer, learned how a large dairy and a hog operation are taking different approaches to manure management and heard how a corn-soybean producer uses cover crops to help manage their challenging soils. Tour stops included a Purdue faculty member interviewing key personnel to gain insights into the farm operation, plus several mini-tours that featured innovative individual aspects of each farm.

Purdue Tax Schools Michael Langemeier, the Center’s associate director, coordinates the Purdue Tax School program. In 2016, it was comprised of 10 two-day Indiana tax schools held in Fort Wayne, South Bend, Valparaiso, Muncie, Kokomo, Seymour, Evansville, Indianapolis (two schools) and West Lafayette.

Topics addressed in each two-day school included individual and business tax issues. Business topics included discussions of related party transactions, agricultural and natural resource issues, business entities, financial stress, rental property income, and casualty gains and losses. Michael Langemeier presented material pertaining to key agricultural tax issues including tangible property regulations, contributions of food inventories, bonus depreciation on vines and trees, cost recovery for hoop structures, conservation reserve program payments, and easements.

The Purdue Tax Schools were supplemented with an agricultural tax webinar targeted toward accountants, attorneys, and tax preparers in December 2016. Approximately 50 individuals participated in the

webinar that covered taxation issues pertaining to income and expenses, material participation, like-kind exchanges, depreciation, and repair regulations.

Introduction to the Business of Commercial Agriculture This undergraduate class provides an overview of U.S. commercial agriculture from an insider’s perspective. Each class features a presentation by a farmer or agribusiness executive focused on their firm’s position within the industry. Students enrolled in the course gain a better appreciation of the diversity among U.S. farms and agribusinesses in addition to gaining insight into business strategy from people in the field. Students also learn more about the wide range of career opportunities available to College of Agriculture graduates and how they can position themselves for future success. In addition to guest speakers coming to campus, this course also includes field trips to an area farm and agribusiness.

Although class presentations by farmers and agribusiness executives cover a wide range of topics, there were several common themes covered this year. First, understanding the markets in which the business operates is important. It is also important to gather information pertaining to market opportunities. Second, innovation was discussed by numerous speakers. Efficiency and technical change are very rapid in today’s agriculture. Innovation can lead to competitive advantage. Third, relationships are extremely valuable. Former classmates, colleagues and those we interact with in our daily business transactions provide a wealth of information and perspectives that can help us think through our competitive position and future strategy. Fourth, understanding financial management is crucial to success of managing businesses. A financial management background also helps access risk. Fifth, business culture is important. Many of the speakers look forward to going to work and interacting with their team.

Comments from students that have taken the class include the following:

“This was by far my favorite class here at Purdue. Learning about different aspects of agriculture helped broaden horizons on all of the career opportunities in agriculture.”

“This is a great course to take to learn about jobs in agriculture.”


Since harvest, producer sentiment has again turned higher. This jump in sentiment, likely driven in part by a rally in commodity prices since harvest, has mostly come from producers’ expectation about the future; specifically, an overall, less pessimistic outlook towards coming years.

Looking ahead, the Ag Economy Barometer provides some clues as to what producers are expecting for 2017. For example, consistently more than 60 percent of respondents have said they think the next 12 months would be “bad times” financially in the agricultural economy. Furthermore, many producers are making adjustments in their management decisions in light of tough financial times. In October, 46 percent of respondents indicated they planned to lower fertilizer rates in 2017. Additionally, 35 percent said they planned to adjust the trait packages of their seed hybrids and varieties.

Thinking about commodity prices in 2017, producers’ expectation of future prices varies quite significantly. When asked about the July 2017 CBOT Corn future contract, 34 percent reported in October they expected the board price to exceed $4.00 per bushel by Summer 2017. On the other hand, 27 percent expected the board price to fall below $3.00 per bushel over the same time frame. This highlights the optimistic and pessimistic groups of producers that have quite different views of where commodity prices would be headed in the coming months.

In May, the Center, in partnership with the CME Group, publically launched the Purdue University/CME Group Ag Economy Barometer. Based on a monthly survey of 400 agricultural producers from across the U.S., the project has been measuring producer sentiment about the general agricultural economy since October 2015. In addition to measuring producer sentiment, the monthly survey poses questions to producers about management decisions, perceptions of agricultural prices, and key agricultural indicators.

Over the past year, producer sentiment reached a low in March 2016. This was after several months of lower-trending commodity prices and a generally bleak outlook within the 2016 crop budget. However, after favorable planting conditions and a commodity price rally late in the spring, sentiment rose into the summer.

One feature of the Ag Economy Barometer is the framework to consider producer sentiment by the current conditions (the Index of Current Conditions) and future expectations (the Index of Future Expectations). Several months after the early-summer rally in commodity prices – which peaked in June - producers’ expectations for the future remained strong. This future-looking optimism, however, waned into the fall as the stubbornly low commodity prices and the prospects of record-large U.S. crop became reality.

AG ECONOMY BAROMETER


Survey MethodologyOn a monthly basis, 400 U.S. agricultural producers are surveyed to discern their attitudes and sentiments regarding the status of the U.S. farm economy. Specifically, responses to five questions are used to generate the Ag Economy Barometer value each month. The questions are:

1. We are interested in how farmers are getting along financially. Would you say that your operation today is financially better off, worse off, or about the same compared to a year ago?

2. Now, looking ahead, do you think that a year from now your operation will be better off financially, worse off, or just about the same as now?

3. Turning to the general agricultural economy as a whole, do you think that during the next twelve months there will be good times financially, or bad times?

4. Looking ahead, which would you say is more likely, U.S. agriculture during the next five years will have widespread good times or widespread bad times?

5. Thinking about large farm investments – like buildings and machinery — generally speaking, do you think now is a good time or bad time to buy such items?

Ag Economy Barometer CalculationThe first step in computing the Ag Economy Barometer is to calculate the relative score for each of the five questions, which is the percentage of favorable responses minus the percentage of unfavorable responses, plus 100. This gives each question a potential range of scores from 200 (100 percentage points favorable less 0 percentage points unfavorable, plus 100) to zero (0 percentage points favorable less 100 percentage point, unfavorable, plus 100).

The relative scores from each of the questions for that month are then added together and divided by the average value for the base period, which was October 2015 to March 2016. The result is then multiplied by 100, yielding the Ag Economy Barometer value for that month.

Interpreting the Agricultural Economy Barometer ValuesThe Ag Economy Barometer value for a given month is always relative to the base period (October 2015 to March 2016). A Barometer value of 100 implies no change from the base period. A value greater than 100

indicates an increase in producers’ sentiment compared to the base period, whereas a value below 100 indicates producers’ sentiment declined relative to the base period.

Survey DetailsThe producer survey collects survey responses from 400 producers whose annual market value of production is equal to or exceeds $500,000. Furthermore, to ensure that our survey results accurately represent this group of key agricultural producers, our survey respondents are stratified such that they correspond with USDA’s Census of Agriculture. To ensure consistency with USDA’s Census, we use phone sampling to establish response targets based on value of farm production as follows: 49 percent of respondents with a market value of agricultural production ranging from $500,000 to $999,999; 36 percent of respondents with production values ranging from $1,000,000 to $2,499,000; and 15 percent of respondents with a market value of production equal to or greater than $2,500,000. Stratifying our targeted responses in this manner helps ensure that survey results accurately assess opinions of the primary drivers of the U.S. farm economy. Furthermore, a stratified sample reduces sampling variability, which becomes critical to the reliability of survey results as we sample producers month after month. This approach helps ensure that changes in survey results over time are attributable to changing attitudes of farmers, rather than a change in the distribution of farmers surveyed.

In addition to response targets based upon value of farm production, we also stratify respondents to ensure that major agricultural enterprises are adequately represented. The key agricultural enterprises to be targeted include the following: corn/soybeans; wheat; cotton; beef cattle; dairy; hogs. These enterprises collectively account for 67 percent of all US agricultural production. Again, relying on USDA’s census data, we target a distribution of farms across these key enterprises among survey respondents.

Since a single farm can engage in multiple enterprises, and the categories are not mutually exclusive, the proportions represent a minimum. Minimum targets by enterprise for survey respondents are as follows: 53 percent corn/soybeans, 14 percent wheat, three percent cotton, 19 percent beef cattle, five percent dairy, and six percent hogs. Finally, our target of 400 respondents helps ensure results are reliable with a 95 percent confidence interval of +/- five percent.

1 0 | Center for Commercial Agriculture 2016 Annual Report

CROP Margins in a Boom-Moderation Price CycleBy Chris Hurt

A glance at a chart of commodity prices over say 100 or more years reveals periods of surging prices followed by a period of moderation in prices. Once prices moderate, they may stay relatively low for an extended time. Some have observed that this total cycle may be around 30 years, with the boom-moderation phase lasting 12 to 15 years.

The number of years in a price cycle will depend on how events unfold in each cycle and for each commodity. So while crude oil and corn prices have some common economic drivers that tend to cause a similar price pattern, they each have unique supply and demand forces that can make the magnitudes of price moves, the pattern, and the timing vary.

Some Economic Drives of Boom-Moderation CyclesThere are fundamental reasons why boom-moderation price cycles occur and have a common pattern. The price boom is often set off by some unexpected upward surge in demand. Starting with the 2006 corn and soybean crops the largest of these was the global biofuels policy shift to use much more crop production for fuel, and also the surging Chinese demand for soybeans. With world usage exceeding production for a number of years, world inventories were quickly drawn down and the words "food shortages" began to drive prices upward. Higher prices from basic supply and demand forces were complemented by other drivers such as some years of low yields, a weak U.S. dollar, and artificially low interest rates.

High prices immediately increased margins for the world's crop producers resulting in profits which mean revenues exceed all costs of production. A midwest crop producer might say it like this, "After I paid all my variable costs, paid cash rent, paid for depreciation on machinery, and paid all my family living expenses, there was still a lot of money left over." Revenues above all costs, especially over several years, stimulated global supply resulting in increased acreage and especially increased use of a broad range of yield increasing technologies.

Over a series of years, total global production rose enough to meet the global usage, especially when the rate of growth in that global usage slowed down. The slowing rate of global usage growth was a function of a general leveling off of the biofuels growth rate after

the 2010 crops and more recently as the economic growth rate began to slow in countries like China.

For the past three crop years (2013, 2014, and 2015 crops), corn and soybean prices have been falling. Why? Each year, world production has exceeded usage and world inventories have been rising. Also in the U.S. during the price boom, a weak dollar helped stimulate added exports contributing to the price boom. Now a strong dollar has a dampening impact on U.S. exports contributing to price weakness. In addition, artificially low interest rates during the boom period was an influence on a weaker dollar, on higher farm margins, and on higher land values. Now, higher interest rates are expected to have a dampening effect on farm margins and asset values.

Finally, commodities like oil and crops tend to have relatively high-fixed or overhead costs. This means that once prices moderate, producers are slow to reduce production. Continued high production can contribute to low commodity prices for extended years.

RESEARCH AND PAPERS

Center for Commercial Agriculture | 1 1 2016 Annual Report

Crop Margin ImplicationsThe figure provides Purdue estimates of the revenues and total costs per acre for an Indiana farm with one-half corn and one-half soybeans on average quality land. The chart begins with the 2005 crops, the last of the $2.00 per bushel corn era. Total revenues (market, crop insurance, and government payments) and total costs of production are similar. Then beginning with the 2006 crops, prices and revenues begin to rise, eventually more than doubling by the 2012 crops.

Total costs of production also rose over the boom period, but with a lag of one to three years. The sharp and immediate rise in revenues and the lagging nature of costs, set up large profit margins during the boom. By 2014, revenues dropped below total costs. Costs have been slower to moderate and thus margins are negative.

The 2016 crops are the first to have noticeable reductions in production costs with lower fertilizer, fuel and cash rents. Projected revenues for 2016, 2017, and 2018 are based on current futures market prices adjusted to a cash estimate. Unfortunately, those projected revenues are flat for 2016 to 2018. While corn futures prices do increase each year, government program payments drop as prices rise.

If revenues remain flat, then the drive to get costs back in alignment with revenues would need to come from lowering costs of production as shown in the graph.

In markets, it is all about timing. This illustration demonstrates the distinctly different farm strategies needed in boom and moderation periods. The boom period is dominated by surging revenues with costs more slowing adjusting upward. The moderation period is dominated by rapidly falling revenues with costs needing multiple years to adjust lower.

Part of the study of commodity price patterns is to understand the adjustment processes of getting revenues in alignment with costs. When those are aligned, we call it equilibrium. But in reality, most of the time is spent in disequilibrium with economic forces of profits and losses pulling in one direction or the other and with prices constantly adjusting to these forces as new supply and demand information enters the marketplace.

$850

$800

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$650

$600

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$3502005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

$367

$435$581

$664

$594 $594

$597

$592

$766$824

$728

$794

$624

$601

$399

$401$373

$550$540

$595 $729

$707 $714

$718$661$627

$609$603

Estimated Revenue and Costs/Acre on a 50/50 Corn/Soybean Farm onAverage Quality Indiana Land

C. Hurt, Purdue, January 2016 Cost/Acre Revenue


Farm Growth: Challenges and OpportunitiesBy Michael Langemeier & Michael Boehlje - August 2016

Farm size and growth are often discussed in the context of economies of size. Previous research suggests that the average cost curve in production agriculture is downward sloping or at a minimum L-shaped (Langemeier, 2013). Thus, in general, larger businesses have lower costs of production. Other motivations for farm growth include to provide opportunities to more fully employ the skill sets of managers, to add family members to the operation, and to receive better prices on inputs and products sold. In fact, farm growth is a "natural phenomena", in part because successful farm businesses have earnings that they must deploy, and using these earnings to expand the farm business is a logical choice.

Today's environment in which risk and uncertainty are dominant forces may seem like an odd time to think about farm growth. Risk is perceived by many individuals to be something that is "bad". However, entrepreneurs and business owners realize that without some risk and uncertainty, there is likely to not be much return or reward. Also, it is important to note that risk and uncertainty have both an upside and a downside (Boehlje, 2015). The key management challenge is to mitigate downside risk and try to capture the upside associated with risk.

This article discusses ten questions that should be addressed when examining the challenges and opportunities associated with farm growth. Future articles will delve into some of these questions in more detail.

Why Grow?There are numerous reasons why a farm may want to grow including the following: reduce costs, improve profit margins, improve asset utilization, bring in new family members, invest retained earnings, and more fully utilize the skills of key managers. Before growing, it is essential for an operation to think about their strategic direction. Is the operation interested in a commodity based strategy or a differentiated product strategy? A commodity product strategy focuses on cost control. In contrast, a differentiated product strategy focuses on value-added production or receiving an above average price for the farm's products. As an operation continues to think about growth, how growth impacts strategic direction needs to be addressed.

What are My Options to Grow?There are at least six growth alternatives available to farms. These include the following alternatives: focus or specialize, intensify or modernize, expand, diversify, replicate, and integrate. Specializing in one activity (e.g., grain production rather than grain and swine production) can improve efficiency, reduce cost, and increase profit margins. Intensifying pushes more production through the same fixed asset base, which can lead to spreading fixed costs over more output and an increase in the asset turnover ratio. Expansion, one of the most commonly used growth options, involves increasing enterprise size. This option should be explored only after exploiting all of the efficiencies associated with the current operation. Diversifying, the opposite of specialization, involves the addition of new enterprises. This option is typically considered risk-reducing. However, in many cases, this option can also lead to economies of scope (i.e., improved asset utilization and reduction in cost). Replication involves expanding the operation through the development of multiple sites or plants. This option allows for decentralized management in smaller units. Integration involves moving forward or backward into production or processing. This option can ensure access to key inputs or outputs, but can also lead to efficiencies and cost reductions.

What Strategic Issues Should Influence My Growth Choices?When evaluating growth options, it is important to conduct an internal and external analysis of your farm business. An internal analysis identifies key resources, capabilities, and core competencies. One of the ways to assess resources, capabilities, and competencies is to ask

RESEARCH AND PAPERS


yourself whether your operation has unique resources or core competencies that lead to a competitive advantage (see farmdoc daily June 3, 2016). As a farm grows, it needs to make sure that it is fully utilizing these unique resources and core competencies. It is also important to examine the external environment or scan the horizon. What is the social environment and industry environment that the farm faces? How does the current environment and expected changes in the environment impact my growth options? Another way to grapple with the external environment is to think about the key drivers facing the markets for the products being produced by your farm.

How Should Growth Ventures Be Evaluated?Successful farms have numerous growth options from which they can choose. The key question is how does a farm choose which growth option to pursue? The following eight criteria can be used in making the choice: strategic fit, expected returns, risk, capital required, the cost and ease of entry and exit, value creation, managerial requirements, and portfolio fit. Many of these criteria are self-explanatory, but we would like to briefly elaborate on the first and last criteria. Strategic fit refers to whether

the growth option being explored leverages the current resource base and core competencies of the operation. Does the new growth option require resources or skills that are currently not part of the operation? If so, how will these skills or resources be obtained? Portfolio fit refers to how the growth option being explored fits into the current farm activities. Does the new growth option increase risk or stretch the current management team too thin?

What Skills and Competencies Do I Need to Grow?This question elaborates on the importance of conducting an internal analysis of the farm business. In addition to identifying core competencies, it is important to conduct a skill assessment of the current employees. How strong or weak are the workforce's production management skills, procurement and selling skills, financial management skills, personnel management skills, strategic positioning skills, relationship management skills, leadership skills, and risk management skills? How will the growth strategy leverage these skills, or will new skills be required to be successful? For self-assessment checklists of skills see Boehlje, Dobbins, and Miller (2001).


How Do I Finance the Growth of My Operation?Besides using debt and equity (retained earnings), growth can be financed through leasing assets or joint ventures. Leasing assets rather than purchasing them can increase potential growth rates. However, when leasing assets, it is important to compare the relative impact of leasing on production cost and risk. Joint ventures or strategic alliances are a common business model used to combine the resources of two or more businesses. This business arrangement may involve entire businesses or specific business activities (e.g., machinery sharing).

In addition to thinking about the funds needed to acquire assets, it is important to examine working capital funding. Many growth opportunities lead to significantly higher working capital requirements, particularly in the start-up phase.

What Business Model Do I Use to Grow?There are numerous business models that can be utilized to implement a growth strategy. For example, the following models can be used to implement growth: organic or internal growth, merger or acquisition, franchise, joint venture or strategic alliance, service provider, asset or service outsourcer, agricultural entrepreneur, or investor. Traditionally, most farms have used the organic or internal growth model. With this model, assets are acquired and added to the business through purchases or leasing arrangements. More information pertaining to business models can be obtained from Boehlje (2013).

How Will Expansion Impact My Current Operation?When evaluating growth options it is important to try to gauge how each option will impact the farm's balance sheet and income statement. This can be done using pro forma statements or projections. It is prudent to use at least three scenarios (worst case scenario, most likely scenario, best case scenario) when evaluating each growth option. Particular focus should be given to how each growth option impacts the profit margin, the asset turnover ratio, and returns on investment and equity under each scenario. In addition to examining the impact of each growth option on future financial performance, it is also important to gauge how each option will impact managers' attention and oversight.

What are the Start-Up Challenges?Growth options typically face challenges pertaining to construction delays, cash flow shortages, depleted working

capital, and short-term operational inefficiencies and management bottlenecks. It is particularly important that differences in these challenges between growth options be explored. Cash flow and working capital requirements can vary substantially between growth options. If a particular growth option creates large cash flow shortages and depletions in working capital, a plan needs to be put in place to deal with these issues.

What is My Sustainable Growth Rate?The sustainable growth rate is the maximum rate of growth that a farm can sustain without having to increase financial leverage or look for outside financing. The sustainable growth rate can be computed using information on earnings, retained earnings or savings, and business withdrawals. Once this rate has been computed, it is often helpful to see how this rate changes with the use of borrowed funds. When computing a rate with borrowed funds it is extremely important to gauge how the use of borrowing funds increases risk.

Final CommentsGrowth enables farm businesses to increase revenue and earnings, take advantage of economies of size, and to more fully utilize the skills of current and future employees. This article briefly discussed ten questions that should be examined when thinking about farm growth. Future articles will elaborate on several of these ten questions.

Trends in Land Price, Cash Rents, and Price to Rent Ratios for Iowa, Illinois, and IndianaBy Michael Langemeier, Michael Boehlje & Timothy Baker

Farmland prices declined over much of the Corn Belt region during the last couple of years. However, farmland prices remain substantially above historical prices. For example, despite having dropped approximately 12 percent since 2014, average farmland prices in Indiana are still approximately six times what they were in 1990 and approximately double what they were in 2007 (Dobbins and Cook, 2016). Concerns are still being expressed that farmland prices are higher than justified by the fundamentals. One justification for this concern is that previous research has established the tendency of the farmland market to over-shoot its fundamental value.

This paper examines recent trends in cash rents and farmland prices for Iowa, Illinois, and Indiana, and examines the relationship between farmland price and cash rent for each state. We use USDA-NASS farmland

RESEARCH AND PAPERS


price and cash rent data for each state from 1973 to 2015 to examine recent trends, and to compute farmland price to cash rent ratios. To further examine trends in farmland prices and cash rents, we use data from surveys by Iowa State University (Ag Decision Maker), the Illinois Society of Professional Farm Managers and Rural Appraisers, and Purdue (Dobbins and Cook).

Trends in Cash Rents and Land ValuesTable 1 reports peak years and percentage declines from the peak to 2015 for cash rent and farmland prices in Iowa, Illinois, and Indiana. Using the USDA-NASS data, the peak years occurred one year later than that reported using state surveys. Also, the percentage declines, using the USDA-NASS data, were smaller for each state than they were using the state surveys. Using the state surveys, cash rents and farmland prices peaked in 2013 in Iowa and Illinois, and 2014 in Indiana. Percentage declines in cash rents from the peak year to 2015 ranged from 1.3 percent in Indiana to 12.3 percent in Illinois. For farmland prices, the percentage declines from the peak year to 2015 ranged from 3.8 percent for Indiana to 17.1 percent for Illinois.

State survey cash rent data for 2016 is available for Iowa and Indiana, and state survey farmland price data

for 2016 is available for Indiana. Percentage declines in cash rent from the peak year through 2016 were approximately 15 percent in Iowa and approximately 12 percent in Indiana. Farmland prices have declined approximately 12 percent since 2014 in Indiana.

The percentage declines reported above for the past two years are substantially smaller than those experienced in a six-year period of the 1980s. Using USDA-NASS data, cash rents and farmland prices increased dramatically during the 1970s. Peak farmland prices for the 1980s were reached in 1981 in Iowa, Illinois, and Indiana. Due to low earnings per acre and high interest rates, cash rents and farmland prices dropped significantly from the peak year through 1987. From 1981 to 1987, cash rent and farmland price in Iowa declined 30 percent and 65 percent, respectively. In Illinois, cash rent and farmland price declined 25 percent and 55 percent, respectively, while in Indiana the percentage declines were 29 percent for cash rent and 42 percent for farmland price.

It is important to remember that the declines in cash rents and farmland prices that occurred in the 1980s lasted six years. During the first year (two years) of the six year decline, average cash rents in the three states increased

2.0 percent (declined 1.0 percent), and average farmland prices in three states declined 5.3 percent (19.3 percent), respectively. From 2014 to 2015, average cash rents and farmland prices for the three states declined 2.1 percent and 2.2 percent, respectively.

What are the differences and similarities in the underlying fundamentals between the 1980s and the current period? We will start by discussing the similarities. In the 1980s, earnings per acre were relatively low for five straight years (1982 to 1987). Similarly, earnings per acre were relatively low in 2014, 2015, and 2016. Continued weak earnings currently appear likely and will put further downward pressure on cash rents and farmland prices.

Table 1. Peak Years and Percentage Declines for Cash Rent and Land Values in Iowa, Illinois, and Indiana.

2014 -3.8% 2014 -6.3%

2014 -2.6% 2014 -0.1%

2013 -8.9% 2013 -12.4%

2013 -12.3% 2013 -17.1%

2015 0.0% 2014 -0.1%

2014 -1.3% 2014 -3.8%

StatePeak

Cash Rent (CR)

% CR Declinefrom Peak

to 2015

PeakFarmlandPrice (P)

% P Declinefrom Peak

to 2015

USDA-NASS

Iowa State

Illinois Society of Profession FarmManagers and Rural Appraisers

Purdue

USDA-NASS

USDA-NASS

IOWA

ILLINOIS

INDIANA


One major difference between the two periods is the trend in interest rates. Figure 1 illustrates the interest rate on real estate loans, using data from the Federal Reserve Bank of Chicago from 1976 to 2015. Interest rates on real estate loans climbed above 10.0 percent in 1979, reached a peak of 16.5 percent in 1981, and stayed above 10.0 percent until 1992. In contrast, more recent interest rates on real estate loans have been below 5.0 percent since 2012. The result was much more cash flow stress on debt purchased land in the 1980s than today.

Inflation rates also differ between the two periods (Federal Reserve Bank of St. Louis). Inflation averaged 7.7 percent from 1973 to 1981, and exceeded 10.0 percent in 1980. Since 2009, the annual inflation rate has been below 3.0 percent. The percentage declines in cash rents and farmland prices in Iowa, Illinois, and Indiana this time are not expected to be as large as those experienced in the 1980s, unless earnings per acre collapse even more, or inflation and interest rates increase dramatically.

Some Decline in the Price to Rent Ratio?A standard measure of financial performance commonly used for stocks is the price to earnings ratio (P/E). A high P/E ratio sometimes indicates that investors think the investment has good growth opportunities, relatively safe earnings, a low capitalization rate, or a combination of

these factors. However, a high P/E ratio may also indicate that an investment is less attractive because the price has already been bid up to reflect these positive attributes. Using the work of Baker, Boehlje, and Langemeier (2014, 2015), we compute an equivalent ratio for crop agriculture, the farmland price to cash rent ratio (P/rent). Figure 2 shows the trend in P/rent values for Iowa, Illinois, and Indiana from 1973 to 2015 using USDA-NASS farmland price and cash rent data. As expected, the P/rent ratios for the three states are highly correlated. Over the sample period, the P/rent ratio for Iowa, Illinois, and Indiana averaged 20.3, 21.2, and 21.2, respectively. P/rent ratios

increased during the 1970s, peaked in 1980, declined rapidly from 1981 to 1987, and then started increasing in 1988. At the peak in 1980 (trough in 1986/1987), the P/rent ratio in the three states ranged from 20.0 to 23.3 (10.2 to 13.3 in the trough). It is important to

note that, even at the 1980 peak, the P/rent ratio for each state was well below the current P/rent ratios.P/rent ratios have been above the 1973 to 2015 average in Iowa and Illinois since 2005, and in Indiana since 2004. The P/rent ratio peaked at 33.7 in 2014 in Iowa, at 33.6 in 2015 in Illinois, and at 36.2 in 2014 in Indiana. As noted above, the current P/rent ratios are well above their long-run averages, and above the levels experienced in the early 1980s. This leads us to the following question.

RESEARCH AND PAPERS18

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076 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

Figure 1. Interest Rate % on Real Estate Loans

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073 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

Figure 2. P/rent Ratios for Iowa, Illinois, and Indiana.

Iowa Illinois Indiana


Will the P/rent ratios in the three states drop significantly during the next few years? The answer to this question is highly dependent on what happens to inflation and interest rates. Farmland is considered a good hedge against inflation over the long-run (Baker, Boehlje, and Langemeier, 2014). If inflation increases, there could be less downward pressure on farmland price and the P/rent ratio, assuming the inflation increase does not cause a rise in interest rates. Conversely, if the long-term interest rate increases, there will be greater downward pressure on farmland prices and the P/rent ratio. If neither of these occur (increase in inflation or long-term interest rate), the P/rent ratio may decline modestly, but is likely to stay above its long-run average for the foreseeable future.

Cyclically Adjusted Price to Rent RatioShiller (2005; 2014) uses a moving average for earnings in the P/E ratio, often labeled the cyclically adjusted P/E (CAPE), to remove the effect of the economic cycle on the stock market P/E ratio. When earnings collapse in recessions, stock prices often do not fall as much as earnings, and the P/E ratios based on the low current earnings sometimes become very large (e.g., in 2009). Similarly, in good economic times P/E ratios can fall

and stocks look cheap, simply because the very high current earnings are not expected to last, so stock prices do not increase as much as earnings. By using a moving average of earnings in the denominator of the P/E ratio, Shiller’s CAPE smooths out these business cycle effects.

The P/rent ratios reported thus far are the current year’s farmland price divided by current cash rent. Here we model our P/rent5 ratio after Shiller’s cyclically adjusted P/E ratio. The P/rent5 ratio is computed by dividing the current farmland price by the 5-year moving averagecash rent.

Figure 3 shows the P/rent5 ratio for Iowa, Illinois, and Indiana. The P/rent5 ratio for each state followed a similar pattern to that of the P/rent ratio in each state. The P/rent5 ratio has been above its average for the 1973 to 2015 period since 2006 in Iowa, since 2005 in Illinois, and since 2002 in Indiana. The peak years and ratios for each state were as follows: 42.2 in 2014 for Iowa, 40.5 in 2014 for Illinois, and 44.4 in 2013 for Indiana. The P/rent5 ratios declined sharply for each state in 2015. The discussion below will focus on the relationship between the two P/rent measures, and projected trends in the P/rent5 ratio.

First, we examine the relationship between the P/rent ratio and the P/rent5 ratio. For ease of illustration, we present the relationship for the two P/rent measures for just Indiana in Figure 4. A couple of observations pertaining to Figure 4 are particularly noteworthy. The P/rent5 ratio reached a higher peak and exhibited a deeper trough in the 1970s and 1980s than the P/rent ratio. The reason for this difference can be best understood by examining trends in cash rents during the period. Cash rent was rising from 1973 to 1981. This upward trend in cash rent resulted in a five-year moving average cash rent that was lower than the actual cash rent. Subsequently, the P/rent5 ratio was higher than the P/rent ratio. The opposite occurred from 1982 to 1988 - cash rent declined faster than the moving average of cash rent. This created a lower P/rent5 ratio in comparison to the P/rent ratio.

73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

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Figure 3. 5-Year Cyclically Adjusted P/rent Ratios forIowa, Illinois, and Indiana.

Iowa Illinois Indiana


In order to maintain the current high farmland values, cash rents would have to remain very high, or even move higher, and inflation and interest rates would also have to remain very low. Most agricultural economists expect crop returns to be modest, putting downward pressure on cash rents, and for inflation and interest rates to move upward in coming years. However, even if they increase moderately, inflation and interest rates are likely to remain below their long-run averages. This suggests that the P/rent and P/rent5 ratios may decline somewhat over the next few years but remain above their long-run averages.

It is also important to note that the P/rent5 ratio has been higher than the P/rent since 1989. In general, from 1989 to 2014 cash rents steadily increased. These increases were particularly large from 2006 to 2013. These phenomena created a situation in which the P/rent5 ratio was higher than the P/rent ratio, larger differences in the ratios between 2006 and 2013.

For reasons similar to that given for the P/rent ratio, the P/rent5 ratio is likely to stay above its long-run average for the foreseeable future if inflation and interest rates remain low. If the cash rent continues to decline, the P/rent5 ratio will move below the P/rent ratio.

Final commentsFarmland prices and cash rents have fallen in Iowa, Illinois, and Indiana in the last couple of years. However, our analysis indicates that the P/rent ratio (farmland price per acre divided by cash rent per acre) and cyclically adjusted P/rent ratio (farmland price per acre divided by average cash rent for the previous five years) continue to be substantially higher than historical values.

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073 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

Figure 4. P/rent and 5-Year Cyclically Adjusted P/rent Ratiosfor Indiana.

P/rent P/rent5


SAM HALCOMB

CCA ADVISORY COUNCIL

DAVID HARDIN

DAVID HOWELL

BRYANJOHNSON

LISAKOESTER

KYLELENNARD

MATT MARTIN

DANITA RODIBAUGH

MIKESHUTER

KIPTOM

DONVILLWOCK

BOBWADE

LEVIHUFFMAN

ROBMANN

JOHN NIDLINGER

CCA INDUSTRY COUNCIL

CCA FARMER COUNCIL


CENTER FACULTY AND STAFF

Tim BakerProfessor

Mike BoehljeDistingished Professor

Freddie BarnardProfessor

Liza BraunlichDistance Education Specialist

Joan FultonProfessor

Ken FosterDepartment Headand Professor

Michael FairchildGraphic Designer

Brent GloyFounding Director and Visiting Professor

Aissa Good Business DevelopmentManager

Chris HurtProfessor

Roman KeeneyAssociate Professor

Allan GrayProfessor and Land O’Lakes Chair in Food and Agribusiness

Mike GundersonAssociate Professor

Craig DobbinsProfessor

Jason HendersonProfessor and Associate Dean and Director of Purdue Extension


George PatrickProfessor

Jennifer Stewart-Burton Content Marketing and Social Media Manager

Katricia Sanchez Event Manager

Lisa SwainMarketing Director

Nicole WidmarAssociate Professor

David WidmarSenior Research Associate

Elizabeth YeagerAssistant ProfessorKansas State University

Janet PoolOffice Manager

Tammy KettlerDirector of Corporate Relations

Jim MintertDirector and Professor

Lindsey BalensieferCRM Analyst/ Marketing Coordinator

Michael LangemeierAssociate Directorand Professor

Craig DobbinsProfessor

Nathan ThompsonAssistant Professor

403 W. State Street West Lafayette, IN 47907-2056(765) 494-7004 | www.ag.purdue.edu/commercialag

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