The business of drought

Extraordinary circumstances justify support for farmers

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Recently Agri SA published the results of a drought survey which highlighted projected job losses of 31 000 and an estimated R7 billion in damages, among other serious concerns. The South African agricultural industry is yet again struggling with a drought which is placing enormous strain on agriculture’s financial systems.

The question, however, is whether the everyday business person understands the implication of a drought. To illustrate, a small comparison between agriculture and a normal business has been drawn. Let’s start at the beginning.

Return on investment

Large capital investment is needed to start an agricultural business. Stock and machinery is expensive: a combine costs more than an Austin Martin Vantage. However, the challenge lies within the risk component. If a businessman starts a new business, a financial statement is reviewed, potential and target markets are analysed, and sales projection is developed, just to name a few. With all this information, a reasonable return on investment (ROI) can be calculated. In agriculture, one can use long-term average yields, develop cash flows and enterprise budgets to calculate ROI , but the chances of realising those fixtures are slim, due to climate dependence. The truth is, over and above the start-up funds, an average grain farmer needs to finance R14 million in order to produce his commodity – every season – without knowing what the outcome is going to be. Thus, everything can be planned and prepared with pinpoint accuracy and according to the book, but if it does not rain, there will limited or absolutely no sales.

In the business environment, following a month of below-normal or bad sales, the business can regroup and implement new plans, generally in the form of increased marketing spending, cost-cutting measures, stock reduction or launching specials to increase sales and move towards break-even. In industries such as grain production, the businessman only has one opportunity in a production year! If that opportunity is not realised, they are left with very little room for new plans. Thus, there is only one opportunity within a year to obtain an income. Yes, grain producers do diversify, but if the enterprise comprises a combination of livestock and grain, drought will affect both divisions. In fact, the cost of feeding livestock skyrockets when natural grazing has been depleted due to the drought.

Grain producers can experience two types of drought. In the first case, sufficient rain falls for the producer to plant, but later in the season there is no follow-up rain. This will result in producers obtaining a yield – albeit below average – and a partial income. Then there is a drought similar to this season where, due to a lack of rain, producers struggled to plant and in several areas, could not plant at all. There will be no crop and no income for the producer for the rest of the year. Compare this scenario to a business enterprise not having clients for a year, resulting in zero sales. In spite of this, costs still have to be covered. Fixed costs, repayment on equipment, labour costs, insurance costs, electricity, just to name a few – easily adding up to 30% of total costs.

Price and the economy

Commodity prices are mainly determined by an international market. The international market currently has high stock levels resulting in low prices. Current prices can be compared to similar levels dating back 10 years. Thus, output prices have not followed normal inflation, while input costs have increased occasionally by more than inflation. In order to survive, grain producers are required to operate in a constant state of super efficiency and optimisation. A drought does nothing to assist in this instance. In a business enterprise, prices can be increased to test market absorption of these increases, which can at times provide a solution. I, for one, cannot name a lot of products that have remained at the same price levels since 2009.

The last few years have been a real agricultural rollercoaster with three out five years being dry. As a result, all reserves and various credit methods are now depleted. Typically, one would say that a producer can produce himself out of trouble in the next few seasons, but this implies higher supplies and lower prices (10-year low prices). Given the low international prices, it is extremely difficult to recover from a drought!

Keep in mind that agriculture plays a critical role in the economy, more specifically within the inflation figures. If food inflation increases, it can influence overall inflation, up to the point where if severe enough, it can even affect the homeowner through increased interest rates. Over and above regular food prices and food security, agriculture can also have an effect on the economy. This is clearly seen in rural areas, where the multiplier effect is estimated at 4:1, whereby a decrease of R1 in agriculture causes a R4 decrease in the rural economy.

Bail out

In reviewing the South African economy, if there is a problem with an industry which affects the public, a bail-out guarantee is offered towards that entity. A few of these come to mind, most notably South African Airways and Eskom. These bail-outs have yielded very limited results. Agriculture now needs help, and I am confident that agriculture can recuperate. There is historical evidence to prove this. Agriculture is in high need of support to survive this bad season and stay in production.

In reviewing all of the above mentioned, it is evident that agriculture is a risky business – and not for the faint hearted. How do these producers survive? They survive because they are among the best in the world, have an undying passion for what they do, and above all, they have faith. These producers need a boost in order to assist the entire economy.

Dr Dirk Strydom

Courtesy of Grain SA

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