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Bear Market for Corn? Impact to Food and Beverage Industries
Extreme Volatility in the Agribusiness Markets
Corn had been one of the most price-stable commodities for over 50 years, until the 1970’s oil crisis and high inflation. Even so, the price of corn per bushel never reached $5 until 2008, hitting a peak of $7.63 in August 2012. The key price-drivers relate to U.S. exports to China and other developing countries, increased meat consumption, biofuel and ethanol market expansion, and the 2012 drought.
Today, most experts agree that we are in a multi-year bear market as corn prices continue to slide. The key drivers that created the peak in 2012 are now subsiding. The Grain Analyst sees 2013-2014’s old crop trading in the $3.75 – $4.50 per bushel range for much of 2014. They also see the new crop trading to as low as $3.50 by the 2014 harvest.* This poses a significant risk to the food and beverage industries.
Food/Beverage Ingredient Producer Impact
Many suppliers to the food and beverage industries rely on farm grown commodities for their product offerings, and many of these commodity-types experience similar pricing volatility as corn. Although corn volatility is more easily mitigated through purchasing future contracts, there are no established markets to hedge other commodity prices like there are for corn, soybeans, and wheat.
Those industry segments that “buy at harvest,” as is common with ingredient suppliers, are most susceptible. Since growers tend to agree on pricing with their customers before planting, there can be a long lag time between the grower purchase contract date, and when commodities are ultimately sold to the ingredient supplier’s end customers. Absent an effective hedge in these highly volatile markets, generally accepted accounting will require the industry to mark their inventories from purchase cost to potentially a much lower market amount.
Also, many companies operating in these industries use loans secured by inventory as collateral. The “mark-to-market” accounting, will, in the best case, squeeze seasonal cash liquidity needs, and in the worst cases, could result in insufficient collateral valuations resulting in loan default(s).
Strategies to Avoid a Financial Crisis
Analyzing your business from a cash perspective is imperative. This requires forecasting and “stress testing” the projected business collections and disbursements for up to one-year prospectively so that liquidity shortages are identified. Proactive companies will hire an experienced consultant well in advance of a crisis to assist them in the planning and analysis, evaluating risks, and communicating their liquidity challenges with their lenders and growers. Companies that wait will undoubtedly surprise their lenders and/or growers, resulting in weaker negotiation leverage and fewer options available to provide liquidity.
Advances above prescribed collateral formula levels are sometimes a possibility with a lender (i.e., over-advances), but not without a clear and reliable operational and financial plan demonstrating the ability to re-pay the over-advance within a relatively short time period. Lenders will need to understand how and when the business’ liquidity needs will stabilize including addressing the impact from the growers’ lien rights (i.e., PACA or similar statutory claims that rank ahead of the lenders in order of priority). There is also an opportunity, if addressed early, to defer payments to growers in order to improve short-term liquidity. However, many growers are cash strapped and may even rely on their own lenders for liquidity. Therefore, providing adequate lead times to address challenges is important.
Once short-term liquidity needs are met, it is imperative that appropriate hedging strategies are formulated and implemented so that recurring pricing risks are mitigated in the future. In the absence of established, cost effective hedging markets, areas to consider include completion of customer contracts at the same time the grower contracts are placed. This way, the profit margin between purchase cost and sales price are secured. Another form of risk mitigation is joining, or when unavailable, forming industry cooperatives to pool and spread supply and pricing risk. Another model recommended by O’Keefe with other client companies are pricing models that involve “risk sharing” between suppliers on one side, and customers on the other. While this doesn’t completely eliminate risk, it is a means for mitigating market price volatility.
*Grain Analyst 2014 Corn Outlook, page 2