The serious financial downturn in U.S. ag has caused farm producers to aggressively search for ways to lower costs and improve cash flow. In the short-term, one of the most obvious ways that farmers can improve cash flow is to delay capital expenditures. That is exactly what they have done. Since 2014, U.S. farm capital expenditures have been in free-fall. This week we take a look at USDA’s recent forecast of capital expenditures to see if they have continued to fall and whether further declines are likely.
The Rapid Rise and Fall of Capital Expenditures
The USDA’s Economic Research Service estimates that in 2017 U.S. farmers will make roughly $30 billion of capital expenditures (not including operator dwellings). In today’s dollars, this amount is 63% of the level hit in 2014 and roughly equivalent to the levels seen in 2010. This is hardly the first time that capital expenditures have taken a roller coaster ride.
Although today’s declines have been sharp, the past has seen even bigger declines. Figure 1 shows how capital expenditures have evolved over time. The very large expansion in capital expenditures of the late 1970’s is very apparent in the figure. At its peak in 1979, capital expenditures were the equivalent of $55 billion in today’s dollars. As the farm crisis unfolded, they dropped precipitously, bottoming in 1986. At that point they had fallen 70%. From that point capital expenditures started to trend slowly higher reaching $30 billion by 2004.
Slight Changes in Types of Capital Expenditures
That capital expenditures had been on a steady uptrend prior to their rapid increase from 2010-2014 is not entirely surprising. This is in part due to agricultural production’s continuing substitution of capital for labor. Over this time period it is also true that the composition of capital expenditures has shifted.
Figure 2 shows the percent of total capital expenditures made for four different categories of capital expenditure; tractors, trucks, autos, and machinery. This chart clearly shows that autos share of capital expenditures has fallen dramatically over time. Likewise, the share of capital spending on machinery has fallen somewhat over time, but still accounts for the largest share of expenditures. Spending on tractors has seen the strongest upward trend in share of capital expenditures.
Capital Expenditures Relative to Income – More Declines to Come or Bottoming Out?
As farm cash flows have tightened it is apparent that many farmers have delayed some of their capital investment. In figure 3 we show the ratio of capital expenditures (excluding operator dwellings) to the value of farm production. This ratio currently stands at 7%. This means that farmers are spending about 7% of the value of farm production (a proxy of gross receipts adjusted for inventory changes) on capital expenditures.
As a percent of value of production, capital expenditures are clearly down from recent levels. The ratio has also been lower in previous time periods, for instance the late 1980’s to the late 1990’s. The ratio was also much higher prior to the 1980s. However, we feel that is unlikely to be wise to compare current levels to the 1960-1970’s time period because agriculture was going through a substantial period of mechanization.
So where does that leave us today? If one looks at the values of this ratio from the late 1980’s to today, it is difficult to conclude that capital expenditures are either really high or really low relative to the value of farm production. At times it has been quite a bit higher, for example in 2014 it reached 9%. It has also been this low as recently as 2010.
Our take is that further meaningful reductions (say another decline of 1 to 2 percentage points) in capital expenditures relative to the value of farm production are not likely. In other words, based on the history in this chart, the ratio rarely falls much below 7%. The most recent example of this is the period coming out of the farm crisis and on the heels of a period of intensive capital investment. However, keep in mind that we are not saying capital expenditures won’t fall, just that it seems likely that they won’t fall much further in relation to the value of production.
Wrapping it Up
Capital expenditures on U.S. farms have fallen rapidly as the farm economy contracted. In recent years, capital expenditures have declined more rapidly than the value of farm production. This contraction is reaching a level at which it will likely slow down. In other words, it will probably be difficult for farmers to hold capital expenditures at levels much below 6-7% of the value of farm production. This may be welcome news for providers of capital equipment.
However, this does not mean that capital expenditures will necessarily increase in the near future. If the value of farm production continues to decline, look for capital expenditures to also decline. How that unfolds will depend largely upon how harvest and commodity markets evolve in the coming months.