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How much will farmers spend on equipment?

How much will farmers spend on equipment?
As crop values go, so go equipment sales

That’s the nervous question farm equipment dealers have been asking for some time and will likely continue in 2016. But an easy answer might be to look at crop values – as those values go, so go equipment sales (see chart). It’s pretty clear those two figures track together over time. But what does that mean for future equipment sales?

How much you have to spend on machinery goes back to land costs, equipment and family living costs. If your land cost is cheap you can spend more on the other two categories. If your equipment spend was high during the good times and you're still paying that debt, it’s unlikely you’ll be buying more new equipment.

Equipment sales tend to track closely with crop values over time. Source: Wells Fargo

In high farm income years farmers had extra dollars to update their fleet and buildings, plus a tax incentive. As income has come down they're looking at what they need to update – and not much more. They did a tremendous amount of updating both used and new during the good times, so now it becomes more of a judgment. Return on investment must be much more concrete now.

Even as margins tighten equipment dealers know farmers must utilize equipment no matter what the price of corn is. “So eventually things must get replaced,” says Gary Dyshaw, heavy equipment dealer group head with Wells Fargo.

“Right now there are a lot of efficiency buys going on, and tax reasons are not the driving issue,” he adds. “In the last 18 to 24 months, everyone is more cautious about making upgrades, and zero financing deals are not really making a difference. It really depends on whether the equipment works in their operation.”

Over the past 45 years, on average, about 16% of crop value ends up as equipment investment. In 1985, one of the lowest levels ever, the number fell to 10%. The last couple years have been well above long term average.

Dealer worries

Big ticket items like combines aren’t selling well right now, and the once robust overseas market for used equipment has been stifled by the rising dollar. Coming off a high cycle, dealers are worried about inventory. To keep balance sheets in shape they must adjust quickly when equipment values sitting on their lots are too high. They are facing headwinds now on used equipment inventories on big dollar items. It's an industry still looking for a bottom.

They’re also worried about losing some of their best customers. According to FINBIN data, when grain prices were high and gross income rose above $1,000 an acre, spending 15%, or $150 per acre on machinery made sense; those values must drop with corn below $4 per bu. So, high cost farmers – a combination of rent and machinery – may wash out in these circumstances.

For farmers to stay in business they must adjust their cost structure says Mike Swanson, Wells Fargo economist. One third of gross farm cost, on average, is land, followed by 15% for equipment for a total of 50%. “When those numbers get out of whack, farmers start eating into working capital and profitability,” he says. “Farmers must whittle these figures down to where they should be for long term sustainability.”

A simple, but well executed plan outweighs a fancy poorly executed plan. No matter if you're an equipment dealer or producer, you have to become more efficient over time, says Swanson. “The one thing we have going for us this time that we didn't have in past soft cycles is lower interest rates."

But for how long is the topic of another blog.

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