The Business of Dairy
The Business of Dairy podcast will look at aspects of management of dairy businesses from both within the farm gate and outside the farm gate, speaking to farmers and service providers with skills, information and knowledge of value to you and your business. We will bring to you monthly discussions on topics that will grow your knowledge and understanding of management areas that will drive strong farm business performance into the future. This series is brought to you by the NSW DPI Dairy Business Advisory Unit with funding and support from the Hunter Local Land Services.
The Business of Dairy
Features of the Most Profitable NSW Farms in 2023
What were some of the features of the Top 25% of NSW Dairy Farm Monitor farms in the 2023 financial year? This month’s podcast provides insights into some of the physical and financial metrics associated with their productivity and profitability compared to that of the remaining 75% of farms in the project.
Links to useful resources related to this podcast:
Link to January 2024 podcast: Highs and Lows of Dairy Farm Monitor 2023
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It is brought to you in partnership the Hunter Local Land Services
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Transcript here
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The information discussed in this podcast are for informative and educational purposes only and do not constitute advice.
Welcome to the Business of Dairy podcast. I'm your host, Sheena Carter, development officer with the New South Wales Department of Primary Industries dairy team. This month, I'm sharing some insights into features of the most profitable New South Wales dairy farms in the 2023 financial year, as measured by the New South Wales Dairy Farm Monitor project. Now a quick background into Dairy Farm Monitor. It's a national program that looks at the physical and financial performance of dairy farms in each dairying region of Australia. In New South Wales, it's delivered in partnership with the New South Wales DPI and Dairy Australia, and it's now run for 12 years. I've taken a look at our New South Wales data in a slightly different manner to how we report on the performance in our annual report, so you can access the 2023 Farm Monitor Annual Report via the show notes in this episode, and you can also listen to our January podcast, in which I discuss the results as described in the annual report. So, this looks at the average performance of all farms at a state and regional level. This discussion will explore some physical and financial metrics associated with the productivity and profitability of the top 25% farms in Farm Monitor, compared to the rest of the Farm Monitor farms, so the other 75% of farms. So, we're looking at them as two separate groups. Firstly, I need to clarify how we identify the top 25% farms in Farm Monitor. Farms are ranked based on their return on total assets managed– so that's leased and owned assets. Return on total assets is calculated dividing EBIT, so earnings before interest and tax, by the value of all the assets under management. Given we had 36 farms in Farm Monitor for the year, when that represents about 8% of the New South Wales industry, this translates to nine businesses in the top 25 and 27 in the remaining 75%, which I will refer to that group as the main cohort. Of the nine top 25% farms, two are in the north and seven of these were in the south of the state. Also, all farms that participate, they're very generous in sharing their records and information as part of Farm Monitor, and they do remain anonymous, so I'll not be discussing specifics of any individual businesses. Right, well clearly the first place to start this discussion is with profitability of the two groups, and for context, the 2023 financial year saw the strongest year for New South Wales in terms of profit in all the 12 years of Farm Monitor in New South Wales. It was also a year with the strongest milk price and the highest cost of production. When we look at the performance of the top 25%, they had an average earnings before interest and tax, or EBIT, of $4.27 per kilo milk solids, compared to $2.28 for the main cohort. So this translates to a return on total assets of 12.3% for the top 25 and 3.9% for the main cohort, on average. Now, with the top 25 having an EBIT that's about $2 per kilo milk solids higher, or nearly double that of the rest, you might wonder why there is such a large variation in return on total assets. What do I mean? Well, if the main cohort have an EBIT of $2.28 and a return on total assets of 3.9%, why isn't the top 25% return on total assets more like 9%? This is explained by asset value, which is heavily influenced by land values. And with our top 25%, more than half of these farms are inland, and the majority of the cohort farms are located in areas where land values are very high due to competition for land. So, we've got, you know, competition with lifestyle blocks, they're often in popular coastal locations or they're in areas where there are competing intensive – particularly horticulture – competing intensive or resource focused industries. So the higher asset value has precluded some farms which generate a very high EBIT from being included in the top 25%. So, there are farms with a higher EBIT than some of the top 25% farms, but their asset value means a lower return on total assets. Let's now take a look at some of the physical characteristics of the top 25% and main cohort groups. So, the top 25 tend to have larger herd sizes. They tend to have larger usable areas, so that's both milking area and support area, and as I've just said, larger milking area. So, that group tend to have a milking area that averages around 241 hectares, compared to 123 hectares for the main cohort group. Both groups contain total mixed ration herds, or zero grazing farms, where the milking herd doesn't actually graze any pasture – they're fully fed on a feed pad, in a housed system, whatever the case may be. So, looking at stocking rate on the usable area, which is used when comparing farms of different systems, we see that the main cohort had a slightly higher stocking rate of 1.4 cows per hectare, compared to 1.1 for the top 25 group. Milk production per cow, so litres and solids, was higher on the top 25 farms, but when we look at the productivity of the usable land in relation to the production of milk, both groups were reasonably similar, however, the main cohort generated around 3%, bit over 3%, more kilograms of milk solids per hectare than the top 25 group – so that was 667 versus 645 kilos of milk solids per hectare, respectively. Another commonly used measure in dairy production systems is cow efficiency. This is the amount of milk solids, so fat and protein, that is produced per kilo of cow live weight, and ideally we see an efficient cow producing around one kilo of milk solids per kilogram of live weight. Now, there are many things that will influence cow efficiency, so it's multi-factorial, as with so many things in a dairy system. Some of the key drivers include good pasture management skills, so grazing quality pastures at the right time with low wastage; cow reproductive efficiency and, you know, having cows that have got genetics that are suited to the farm system; animal husbandry practices and good owner operator management skills, including, you know, milking the right type of cow for the resources and system that they operate. In this year, the top 25% farms had cows that were 18% more efficient on average than the rest of the farms. So if we look at this in relation to profitability, these top 25% farms tend to have cows that are 90% and up to around 125% efficient. Now, it's worth noting that we see some farms in the main cohort which averaged similar cow efficiency, but they weren't as profitable. Okay, so now let's take a look at the financials. Here the obvious starting point is milk income, given it's the primary source of income in a dairy business. Now, many of you might think that in order to achieve the highest profit, you need the highest milk price, and this is absolutely not the case. We see a large variation in milk price throughout New South Wales, depending largely on farm location. So, farms in the north tend to receive higher milk prices than those in the south, and I've already mentioned that seven of the nine top 25% group are in the south. So, if we look at the two groups, the average milk price for the top 25% was$10.65 per kilo milk solids, and the main cohort averaged just over a dollar more than that at $11.69 per kilo milk solids. So, milk price doesn't appear to hamper the profitability of the top 25 group, however, we certainly need to recognise that variability in milk price is a big challenge that farmers need to manage, particularly in years of low milk prices, which will erode business profitability. So, now if we jump to cost of production, this clearly impacts profitability. To be clear with what I'm talking about here, this is true cost of production, not cash cost of production. We'll refer to cash cost of production as farm working expenses. So, true cost of production includes non-cash costs as well, you know, such as feed and water inventory change, livestock inventory change, depreciation, and imputed labour, so that is generally the family labour that takes drawings out of a business, rather than a wage or a salary. So, the average cost of production for the top 25 group was $7.74 per kilo milk solids, while for the rest it was 34% higher, at $10.39 per kilo milk solids. Now, there's obviously variation within, and between, the two groups in terms of cost of production. So, it should be noted that having a high cost of production doesn't necessarily exclude a farm from being a top performing farm. Some farms are able to manage other aspects of their system very well in order to be profitable. Conversely, a very low cost of production should be looked at with caution. While it's got the potential to result in a higher profitability, if the money is spent in the right areas of the business, it generally won't be sustainable over the longer term, and a very low cost of production is often driven by the operating conditions at the time. When we look at cost of production in relation to milk price, there's a trend seen where, as milk price increases, cost of production tends to increase. Now the two aren't definitively linked, however, there will be numerous factors that drive the trend, such as having the ability with stronger milk prices to play catch up on repairs and maintenance, and other things like fertiliser application. Also, with a stronger milk price, some businesses will position themselves to capitalise on this and produce marginal milk, which comes with additional costs relative to the normal production levels achieved within the existing farm system. However, as owner operators of a business, it's important to be wary of cost creep in the business. You know, it's human nature when times are good and there's a bit more cash available, we do tend to spend a bit more, and the good operators will spend in the right area of the business. So, we do need to just think, you know, is this spend actually driving performance or is it just a 'nice to have'. If we look at some of the specific costs in these businesses, our biggest operational costs in dairying is feed, obviously. Our feed costs are purchased and home grown feed, and we also capture the impact of feed inventory changes in a profit analysis, which I'll explain in a minute. So, I'm talking about feed costs in dollars per kilo milk solids, not dollars per tonne, dollars per kilo milk solids. So, the top 25% averaged $4.29 per kilo milk solids for total feed costs, compared to $5.28 for the main cohort. If we're looking at purchased feed costs, as a percentage of the total feed costs, the top 25 had a slightly lower proportion of purchased feed expenditure compared to the rest, and their proportion of home grown feed in the milker diet was much higher at 58%, compared to 49% for the main cohort. Now, we do need to be mindful of the conditions experienced on farms in that year, you'll probably recall if you were a farmer, or living in New South Wales, throughout that year we had severe flooding in many locations and prolonged wet weather, which was very widespread, and this limited the ability to graze and optimally manage pastures and crops. So, the severity of these conditions, it's likely to have impacted the main cohort of farms to a larger degree than the top 25% farms, just given their geographical locations. Now, I mentioned feed inventory change earlier, I'll just give you a quick explanation. In a profit analysis, we're looking at all the costs incurred during the year that are related to milk production within that year. So, sometimes a business will be in a position where they can conserve, or have on hand at the end of the year, more feed than they did at the beginning of the year. So, in this instance, the businesses incurred a cost to do this, but the feed that is still in the shed hasn't been used to produce milk in that year, so, the value of this feed on hand becomes a negative cost. Now that value of the feed is also captured in the balance sheet as an asset. In the following year, if the farm draws down on their stored feed over that 12 month period, then the value of the feed used will be incurred as a positive feed cost, as it's been used to produce the milk in that year, so, I hope that makes a bit of sense. In the 2023 financial year, we saw the top 25 had a much higher value of feed inventory on hand at the end of the year, at an average of... it's a negative, of -$0.36 per kilo milk solids compared to the main cohort group, which had a -$0.07 per kilo milk solids. So, while this doesn't tell us actual tonnages, it does suggest the top 25 were in a better position to build inventory over the course of the year. So, this is often a... it's a key risk management strategy used in businesses, so, it's making the most of conditions, when they allow, to build up hay and silage stores to have on hand when they don't have enough feed available in the paddock, and potentially limit their exposure to, you know, often higher priced fodder markets. So, if we move on to herd and shed costs, these make up a relatively small proportion of our cost of production, however, some farms have higher costs in each of these categories than others, depending on many things within their system. So, the average herd and shed costs were significantly lower on the top 25% farms, and for this year, it's important to remember these wet conditions that we had, they are likely to have impacted herd costs on the main cohort farms, relative to the top 25% group, partly due to higher herd health costs, but this will only be one factor impacting herd costs. For example, farms that, you know, they're passionate about genetics, or stud farms, they'll often have higher herd or breeding costs relative to other farms. And we're also seeing, with the increased uptake of sexed semen and genomics across the industry, we're seeing, you know, slightly higher herd costs. Well, with shed costs, it's likely that we shed costs, with larger and more efficient dairies, the top 25%, they're able to reduce shed costs on a dollars per kilo milk solids basis relative to the main cohort. Now we look at overhead costs, which include items such as labour, both paid and imputed labour, repairs and maintenance, depreciation, insurance and other general overheads. It's important that these costs are managed well because if these take up a large proportion of operating costs, then there are fewer funds to spend in areas of the business that can drive production and income, such as production of higher quality feed. Average overhead costs for the top 25 were $3.05 per kilo milk solids, and $4.36 for the main cohort. So, if we look at overhead costs in relation to total milk solids produced, there is a trend, it isn't a direct relationship, but there's a trend to lower overheads with higher total solid production. It also appears, that below about 170,000 kilos of milk solids, there tends to be insufficient milk production to dilute overhead costs unless they have a very efficient business with good overall cost control. So, we'll now take a look at some of the bigger overhead costs, starting with labour. I've mentioned that the top 25% have good overhead cost control, and their labour efficiency is one of the key drivers of this. We report labour efficiency as the quantity of milk solids produced per labour unit, with one labour unit representing 2400 hours worked across the year, so, I'll refer to this as a full time equivalent or FTE. So, the top 25% were 56% more efficient than the main cohort, producing 51,208kg of milk solids per FTE, compared to an average of 32,837 for the main cohort, and nearly half of the top 25% group were exceptionally efficient, producing well over that 50,000 kilos of milk solids. They're able to achieve this in numerous ways, as they're not necessarily the largest farms. In terms of total labour, so, paid and imputed, total labour cost, the top 25% averaged $1.81 per kilo milk solids, compared to $2.63 for the main cohort. You know, interestingly, for both groups, labour costs, total labour costs, averaged around 60% of total overhead costs. Some of the factors that contribute to lower labour efficiency and higher costs can include things that... You know, smaller operations with a greater proportion of family labour, typically have high imputed labour costs, and in businesses where there's been a lack of investment, or regular maintenance in on- farm infrastructure, there can be higher repairs and maintenance, and labour costs, you know, due to inefficiencies around the use of that labour. So, for example, the dairy might not have been upgraded in a long time, there might be cow flow issues with slightly larger herds, and all these things will impact your labour usage and the efficiency of that. The next one we'll look at is depreciation. Now, this is a non-cash cost of great importance. It's the cost of assets, mainly plant and equipment, that decrease in value over time and ultimately have to be replaced. In the 2023 financial year, we saw an increase in the value of plant and equipment on many of the farms in our Farm Monitored data set. There's a number of factors that will have driven this, including things like the instant asset tax write off, which was available at the time, stronger cash flows and also the higher value of both new and used machinery, which is primarily as a result of supply chain issues in recent years. So, with the Farm Monitor farms, this increase in plant and equipment and significant buildings was more evident in the north of the state, where the majority of the main cohort farms are located. So, we do see what we would class as over capitalisation in some businesses, which will impact depreciation and repairs and maintenance costs. In some instances with smaller farms, there's an issue of scale. So, the amount of equipment they have, it might be more than is required by the business, but it isn't possible to actually have less equipment to exactly meet their needs. So, it's not possible to have half a tractor. In other cases, it's a function of the type of system they have. So, they might have a feed pad that's used opportunistically throughout the year, but they still need the associated equipment, such as loaders and mixer wagons, which depreciate over time and also require repairs and maintenance. Also, with the challenges of accessing contractors in some areas, many businesses have elected to purchase their own equipment, you know, for sowing or fodder conservation. It enables them to get crops, pastures, sown in a timely manner, and probably harvested in a more timely manner, than waiting for a contractor, who can be difficult to get. But by having all this equipment that's used periodically throughout the year, it's often underutilised, but again, it still has all the associated costs. And some people just love machinery. So, the average depreciation cost was $0.35 per kilo milk solids for the top 25 group, and it was 69% higher at $0.59 per kilo milk solids for the main cohort. So, that wraps up some of the key points in my analysis of differences between the New South Wales top 25% farms and the rest of the Farm Monitor group in that 23/24 financial year. I guess some key points to take away. It's not the highest milk price that necessarily generates the highest profit. The productivity of that top 25% group is often key to their performance, particularly in areas such as cow and labour efficiency. This helps with management of their cost of production, as does management of their feed base, with good production from the milker diet and lower total feed costs on a dollars per kilo milk solids basis. I think also it's apparent that overhead cost control can be challenging in smaller businesses, with the lower production often not being enough to dilute their overhead costs. And it's important, I think, also to remember that every business is unique. They all have different goals, different resources, and productive capability, and ultimately their performance is influenced by how the manager uses their skills to manage all the complexities and variables in their business. And I'd just like to go back to goals, I mentioned the goals of the business, it's also important to remember that not every business is aiming to make the biggest profit. People are in the business of dairying for many reasons, such as lifestyle, a passion for cows, you know, and many other [reasons], so, the biggest profit isn't, or the highest and strongest profit, isn't the be all and end all. So, finally, a big thank you to all the 36 farms that participated in Farm Monitor for the 2023 financial year. Without them, we would not be able to have unbiased discussions and insight into the performance of the New South Wales dairy industry. So, I'd strongly encourage other farmers who are interested in understanding the performance of their business to use Dairy Australia's freely available online tool called DairyBase, or become a dairy Farm Monitor Farm in 2024. So, that wraps it up, thank you for listening and thanks again to the Hunter Local Land Services, who we produce this podcast with funding and support from them. Also, feel free to share the podcast with your friends and networks, and send any feedback or suggestions for future episodes to thebusinessofdairy@gmail.com