What does a new high in farm debt mean for the ag sector?

There’s no question the credit landscape is changing: there have been four interest rate hikes from the Bank of Canada since our 2017 assessment of farm assets and debt. Agricultural markets are also going through significant turbulence because of weather and trade tensions. Commodity prices have generally declined in 2018 and volatility has picked up. Within that uncertain economic and financial environment, Canadian total farm debt increased 6.6% from 2016 to reach over CA$100B in 2017.

This might be cause for concern, but Statistics Canada’s Balance Sheet of Agriculture suggests not. It paints a picture of a sector that has had the resilience to get through a patch that has been bumpier than usual.

Statistics Canada’s latest balance sheet shows resilience in ag, even when going through a patch that’s been bumpier than usual.

I’ll look at how some financial measures from the Balance Sheet can be used to assess Canadian agriculture’s financial health, and why I believe the sector will be in good shape to end 2018 and head into 2019.

Leverage remained at safe levels

Of the four indicators of agriculture’s overall strength I’ll look at, the industry’s overall debt-to-asset ratio (DAR) improved slightly in 2017 – from a level that was already robust. It’s one of agriculture’s most-watched measures as its strength bodes well for the future health of the industry.

Debt-to-Assets Ratio

$
$

Results

Debt-to-Assets Ratio 0.00

A lower debt-to-asset ratio brings flexibility to an operation if it has to withstand unexpected challenges, or to seize opportunities that arise in the marketplace (such as expansion, diversification, etc.).


Interpreting ratio numbers

The DAR indicates the extent to which assets are funded by debt (and not equity). A low DAR brings flexibility such as borrowing more if opportunities arise.

Operations funding future asset purchases with more debt than equity run a greater risk of pay-back problems. Because agricultural prices are prone to cyclical behaviour and cash flows are subject to seasonal pressures, a healthy year-round DAR is critical.


The decrease in the DAR to .15 means the ag sector funded CA$1.0 of assets with CA$0.15 of debt and was right on par with its 10-year average (Figure 1). Provinces from Quebec to Alberta drove the decrease, with the DAR lower than the 10-year average in each.

Figure 1: B.C. and Atlantic provinces buck trend of lower debt-to-asset ratio in 2017 

Source: Statistics Canada’s Balance Sheet of Agriculture

The year-over-year story differs. While the DAR at the national level improved over the last 12 months, Ontario, Alberta, and B.C. each recorded an increase in the DAR from 2016 (not shown). In each of these provinces, farm debt increased at a faster year-over-year pace while asset values also increased, but at a slower year-over-year pace. 

Pressures on liquidity trends were building, but manageable

Current Ratio

$
$

Results

Current Ratio 0.00

A current ratio above 1 is ideal because it shows current assets are greater than current liabilities. But be mindful that a ratio which is too high can also suggest you aren't putting your money to work.


Interpreting ratio numbers

The CR indicates the extent to which an operation can cover current liabilities (debt to be paid within 12 months) using current assets (assets that can be converted to cash within 12 months).

A high ratio provides flexibility and shields a business from financial difficulties if market conditions worsen.  


Another key indicator of overall health is the current ratio, measuring liquidity. Even as debt has grown, Canadian agriculture could boast of good liquidity in 2017, with enough easily-convertible assets to cover all immediate debt. The sector’s strong current ratio (CR) of 2.27 in 2017 (Figure 2) means Canadian agriculture had CA$2.27 in current assets for every CA$1.0 in current debt. Although it also represented a 2.5% decline from 2016, and was lower than the 10-year average, it was still in a range we consider healthy. 

Figure 2: Current ratios weaken across most provinces, but remain strong

Source: Statistics Canada’s Balance Sheet of Agriculture

Only Quebec and Manitoba recorded year-over-year CR increases in 2017 and, along with British Columbia, had current ratios in 2017 that were higher than their 10-year average. Saskatchewan continues to have the highest CR of all provinces (3.4). That’s typical for the province because large grains and oilseeds operations dominate Saskatchewan agriculture. But even there, the 2017 CR fell below its 10-year average.

Because of price pressures on some crops, higher interest rates and farm input costs throughout 2017, current ratios for Ontario, Alberta, and the Atlantic also dipped in 2017 below their respective 10-year averages. Each, however, remains in a healthy range.

Asset value growth outpaces net income

Canadian farm assets were valued at CA$632.2 billion in 2017, having grown 6.9% year-over-year. At the same time, net income decreased slightly after commodity prices weakened, and energy and interest costs increased.  The simultaneous growth in asset values and weakened net income meant that Canadian ag’s return-on-assets (ROA) dropped below its 10-year average (Figure 3).

Return-on-Assets Ratio

$
$

Results

Return-on-Assets Ratio 0.00

A higher return-on-assets ratio means that a farm is more profitable, and is better able to leverage assets to turn a profit.


Interpreting ratio numbers

The ROA measures profitability (i.e., net income) relative to total assets.

As with the LR level, there’s no ideal ROA. A higher ROA is preferred when debt levels are increasing as it makes it easier to service debt.


Saskatchewan, with the highest ROA in the last ten years, recorded a 21% decline in ROA in 2017, the country’s largest drop. Alberta also recorded a declining year-over-year return-on-assets and Quebec saw no change in 2017. 

Figure 3: Even with the biggest drop from its 10-year average, Saskatchewan’s 2017 ROA still highest

Source: Statistics Canada’s Balance Sheet of Agriculture

Elsewhere, the sector’s ROA increased from 2016. And strengthening net income improved the 2017 ROA in the Atlantic provinces, Ontario, Manitoba, Alberta, and BC to levels higher than their 10-year average. 

Affordability of farmland continues to decline

Farmland values increased in 2017, totaling roughly 70% of all assets. Land prices, farm income and the relationship between the two vary across provinces but, in general, Canadian farmland, as measured by the land-to revenue ratio (LRR), has become less affordable. 

Farmland values in Canada total about 70% of all farm assets in 2017.

Land-to-Revenue = Value of Farmland/Farm Crop Receipts

Interpreting ratio numbers

The LRR measures the affordability of land using crop receipts (i.e., gross revenue from crops). Average land values and crop receipts are expressed on a per acre basis.

There’s no ideal LRR level. Crop mix and productivity influence the ratio, which therefore varies across provinces. Historical within-province comparisons assess current values more accurately.  


The pace of land value appreciation has exceeded appreciation in crop receipts since 2012. Given that more rapid increase, the LRR increased to be higher in 2017 than its respective 10-year average across all provinces (Figure 4). This suggests that land is expensive from a historical standpoint, but other factors must be considered. The downward trend in interest rates for most of the last ten years, wealth effects and expectations of future growth in agriculture can explain why the ratios are higher than their average. 

Figure 4: The LR ratio increased across all provinces in 2017

Source: Statistics Canada and FCC computations

Conclusion

A few headwinds emerged for Canadian agriculture in 2018 and we believe Canadian ag is in good shape to weather the storm. The industry’s financials are strong despite some recent softening. And we project 2018 and 2019 revenues to approximate 2017 levels given the strength of global demand.

Understanding the industry’s exposure to possible fluctuations in the environment, whether from farm income trends levelling out or further interest rate increases, can help to avert financial hardship. By providing guidance to individual operations, that understanding will go a long way to maintain the overall health of Canadian agriculture.

Next week, find out how the currently rising interest rates will impact Canadian agriculture.


Amy Carduner
Agricultural Economist

Amy joined the FCC Ag Economics team in 2017 to monitor agricultural trends and identify opportunities and challenges in the sector. Amy grew up on a mixed farm in Saskatchewan and continues to support the family operation. She holds a Master in Applied Economics and Management from Cornell University and a Bachelor in Agricultural Economics from the University of Saskatchewan.

@ACarduner