By Sherry Bunting, Farmshine, December 23, 2022
NEW HOLLAND, Pa. – “Too much money chasing too few assets,” that’s the definition of inflation, said Gary Sipiorski, ag lender and financial consultant from Wisconsin.
He didn’t have to tell the over 250 dairy farmers attending Homestead Nutrition’s dairy seminar at Yoder’s Restaurant in New Holland on December 7 that inflation is real, because they are feeling it.
His bottom line is to measure every decision by its impact on cow comfort and manage the net income the cows generate.
As president and CEO of Citizens State Bank of Loyal, Wisconsin, Sipiorski is also an advisor to the Federal Reserve Board of Chicago. He expected the Fed would raise interest rates another half a percent, and several days later, that’s what they did.
Raising interest rates is meant to slow things down enough to curb that inflation, and as farmers, “you’re feeling the effects of both,” he said.
Sipiorski described the effects of both the disease and the cure as something that creeps up gradually to squeeze the margin.
“You can be taking good care of things and don’t see this happening, as the temperature gradually increases. It sneaks in slowly,” he said. “The war on inflation will continue for at least the next 12 months, and we are likely to see interest rates continue higher before stabilizing around the middle of next year.”
The good news for dairy, he said, is that even though consumers are drinking a little over half as much milk per capita as they did 50 years ago (18 gallons vs. 30 per person per year), they are eating more than double the gallons of milk in the form of all dairy products, combined.
In 2021, Americans consumed 667 pounds (77 gallons) of dairy products per capita. That’s 12 more pounds per capita than in 2020.
“We didn’t drink the 77 gallons, we ate it,” said Sipiorski, adding that dairy exports have also become crucial.
“By the end of this year, 20% of your milk production will be going elsewhere,” he said. “That shows the faith the rest of the world has in the superior product you make.”
Inflation, rising interest rates and supply disruptions are slowing the rate of dairy expansion, as the industry focus turns inward to manage margins even more tightly as feed costs have doubled, cropping costs have quadrupled, lines of credit cost more and are harder to get, machinery and parts cost more and are harder to find, and some farms must deal with a milk base program from their milk co-op or buyer — putting penalties on overbase milk in the output side of that margin equation.
Sipiorski shared his insights on the most important things the top 30% of dairy producers do in a talk he titled ‘Chasing inflation with a cow.’
The top third of dairy producers double-down on managing these primary areas: feed, debt, labor, cow comfort, and knowing their numbers.
Minimize feed shrink
With feed and cropping costs so much higher, Sipiorski told dairy farmers the 10 to 20% they can be losing in feed shrinkage is a significant area to manage.
“Losing 10 to 20% of the feed from field to rumen is a big cost to the dairy,” he said. “We are seeing more investment in feed storage sheds, bringing the mixing indoors and thinking about how you mix the feed, in what order.”
Pay down lines of credit, not term debt
Choosing carefully what debt to pay down at this time of rising rates is also critical. Paying down lines of credit that have adjustable interest rates and keeping some of that cash liquidity may make more sense than paying additional principal on longer-term fixed rate loans.
“Your thought process may be to pay down that term debt, but if the rate is locked-in, and you pay it down, that money is gone, and you may need that money later, and then pay a higher interest rate for it,” Sipiorski explained, advising farmers to talk with their lenders about their debt structure.
Push pencil on machinery
“Do the math on whether to lease or buy machinery,” Sipiorski urged. “If it is something you use three months of the year, can you afford it? Can you afford the cost to have and maintain that piece of equipment?”
He noted that the top dairy farms push the pencil to compare costs of owning new equipment, leasing it, or hiring custom operators for segments of their field work.
Time is money, spend it wisely
In addition to dealing with hired labor cost and availability, Sipiorski advised farmers to “count your steps and measure your time.”
In other words, know what your time is worth and find ways to streamline chores for yourself and your employees. One example he gave was to put tools around where they will be used to minimize time spent going back and forth for tools needed.
Keep improving cow comfort
“Cow comfort is a place to keep improving to fight that inflation with that dairy cow,” Sipiorski declared.
It’s the accumulation of a lot of simple little things the top third of producers do, such as providing enough space at the feedbunk, waterer and in the dry cow area.
“The dry cows are working just as hard for you, so don’t cheat them” he said, adding that top producers are absolutely passionate about cow comfort.
The cows require a lot of investment, and the top producers benchmark the investment per cow at $8,000 to $20,000, while benchmarking gross income per cow at $5,000.
“Cow comfort is an area of investment that brings you the most return. Every decision you make, ask yourself, are you making money with that decision?” he said. In other words, “are you making cows more comfortable with that decision?”
Keep improving milk components, quality
Producing milk with higher component levels and lower somatic cell counts (SCC) is what the top third of producers are doing, said Sipiorski.
“This is even more important if your co-op has a base program. If you can’t produce more milk, make the milk you are producing better,” he said, noting that components drive value.
Quality as measured in SCC will also increasingly drive value and market access. Sipiorski sees the industry getting to the place where milk will eventually have to be under 150,000 SCC.
While he didn’t specifically mention transformation in the processing sector, it’s becoming clear that ultrafiltration and microfiltration in some of the newer dairy plants is aimed at removing the lactose from the milk to be used in making cheese, other dairy products and lactose-free high protein milk beverages.
Those working with this technology have repeatedly said it requires farm-level SCC thresholds to be even lower because, as the water and lactose are removed through membranes and reverse osmosis, the remaining solids are condensed. This includes the SCC being concentrated with those valuable solids, so those processors expect a lower-SCC limit at the starting point.
Get educated on marketing
Sipiorski advised farmers to be “educating yourself on marketing and risk management.”
He noted that milk markets are volatile, and marketing through a broker or a cooperative program or other risk management can be good or bad.
“You won’t know if it’s a good deal or not, if you don’t know your cost of production, your margin,” he said.
Know the numbers, focus on high quality forage production, and look at areas where changes and investments can help fight inflation, he advised.
One thing he has seen more farms moving toward – to reduce marketing costs – is to increase milk storage to go from once a day to every-other-day pickup to reduce fuel costs, transportation and ‘stop’ charges.
This is something that has been occurring at the retail end for years, with less frequent deliveries from processors to retailers becoming the norm today.
Benchmark against industry or self
Benchmarking the dairy to itself year over year or to industry averages is important financial management, according to Sipiorski.
The numbers that are needed to do this are found on the balance sheet, income statement, and accrual accounting of yearend income – not the IRS tax return.
He said that doing a business plan with projected cash flows helps make better financial decisions.
Sipiorski gave farmers some financial benchmarks to keep in mind, noting again that the numbers need to be based on accrual accounting, not the year end IRS tax return.
“In that tax return, you have prepayments and depreciation,” he said. This skews the cost of production calculation, for example, because the cost of inputs are not directly aligned with the output revenue.
Sipiorski ticked through some industry benchmarks to be aware of: Equity position (50%), liquidity (2:1), net profit margin (10%), cost of production ($17-22.00/cwt), operating expense as a percentage of gross income (65-80%), and debt to revenue ratio (1:1).
The bottom line, he said, is “you need to produce 100 pounds of milk for less than you sell it for.”
On that point, he noted the most recent USDA forecasts at the end of November are for Class III milk to average $19.80 in 2023 with the All-Milk price next year forecast to average $22.70, while the cost of production in 2022 is averaging $20 to $22.00 across the industry, but the range is wide.
“Pennies (per hundredweight) are a big deal,” he said, showing that the 47-pennies per hundredweight difference in a Q2 2022 comparison of the net margin per hundredweight of $6.64 for all herds vs. $7.11 for the ‘top 30% of herds’ amounts to just shy of $113 per cow annually.
“That’s $2800 on 25 cows, $11,280 for a 100-cow dairy. That’s how we fight inflation with a cow,” he said. “Who in this room wouldn’t want another $11,000 in the pocket to fight inflation?”
Sipiorski described dairy as a dynamic business full of chaos and volatility, but with that comes lots of opportunities.
He sees a ‘barbell-shaped’ future for dairy, where there will be opportunities for small and mid-sized family dairies even if a large portion of the milk supply comes from much larger dairies.
Gary Sipiorski, a lender from Wisconsin, talked about dairy financial management in these inflationary and volatile times. Despite the chaos and consolidation, he sees opportunities for small and mid-sized family dairies in the future, even if a large portion of the milk supply comes from much larger dairies. Photo by Sherry Bunting