As the dairy industry is finishing its second year of low milk prices and the third sign-up for the new Margin Protection Program for Dairy (MPP-Dairy) is underway, there are many producers saying that the MPP-Dairy is not working to adequately protect in periods of significant downturns. In my Hoard’s Dairyman Intel column, I will look at several potential fixes to the program over the next few months.
There are three broad areas of potential problems that will be considered:
- Is the margin calculation a good measure of farm financial stress?
- Are the margin coverage levels calibrated well enough to provide meaningful risk protection?
- Are the premiums too costly for the levels of protection available to producers?
In this article I’ll look at whether the MPP-Dairy margin is a good measure of farm financial stress.
About a year ago, I looked at this question with colleagues from Michigan State and Cornell Universities. We combined annual dairy farm financial data from these three states over a 10-year time period. With more than 10,000 records, we found several interesting results.
The MPP-Dairy margin calculation was highly correlated with return on assets as a measure of profitability — almost 80 percent. We also looked at the debt-to-asset ratio as a measure of solvency and the current ratio as a measure of liquidity. Both solvency and liquidity were less well-correlated, but the MPP-Dairy margin was a better indicator of changes in all three measures than the other two indicators that we considered as possible replacements.
You can argue that the first signs of financial stress are measured in problems of cash flow, which is more related to liquidity. But the study also found that profitability was quite strongly correlated with liquidity. For example, holding more cash to alleviate liquidity risk comes at the opportunity cost of using that cash to be invested in productive assets on the farm.
Although the farm financial data considered embodied farms in the Northeast and Midwest and not other regions of the country, there were a wide range of farm sizes and business models represented in the dataset.
I would contend that the MPP-Dairy margin is a good indicator of financials stress on dairy farms. The next time, I’ll consider possible changes to the MPP-Dairy to provide more meaningful risk protection.
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(c) Hoard's Dairyman Intel 2016
November 21, 2016