About This Episode
Machinery is the second largest line item in most crop budgets, behind land, and in parts of North Dakota it is the largest. Most operators still handle it by reflex: you need it, so you buy it. Gloy calls that the too-hard drawer, a Warren Buffett idea, and says it is time to take equipment out of it. Return on assets has two levers, operating margin and asset turnover. Farmers work the margin constantly and almost never touch the turnover, which is where the opportunity sits.
Southwest Airlines is the comparison: a plane parked on the ground earns nothing, and the CEO's line was that if he wanted to make money sitting still he would have started a bus company. Applied to a farm, that means fewer machines run harder rather than more machines run occasionally. The tracking Gloy wants is specific. Log hours of utilization. Log repair bills, and log them by operator. Then compare the depreciation curve against the repair curve to find the right moment to trade.
Leasing raises asset turnover and flatters return on investment, but the payments usually run higher than ownership and they come due whether the crop pays or not. Lease everything through several years of low prices and the operating losses eat working capital until there is no equity to fall back on. When margins are good, put some of it back into owned land or owned machines. Gloy also pushes past price and yield risk to landowner relationships: know the family, not just the person whose name is on the check.
“It's time to pull that out of the too hard drawer.”
— Brent Gloy
Key Takeaways
Return on assets is operating margin times asset turnover. Most farms optimize the first and ignore the second, and equipment is where the second gets decided.
Machinery is usually the second largest line item after land, and the largest in some areas like parts of North Dakota where land is cheaper.
Track equipment hours and repair bills, and break repair bills out by operator. Set trade timing by comparing the depreciation curve to the repair curve.
Leasing lifts asset turnover but the payments are typically higher than ownership and they are fixed. Several low-price years on an all-leased base can burn through working capital and leave no equity.
Reinvest good years into owned land or owned equipment rather than expanding the rented and leased base further.
Risk is not only price and yield. Landowner relationships count: know the rest of the family, not just the person you write the check to, or the rental agreement can walk.
Full Transcript
Narrator: And it all comes down to this. Two on, two out, bottom of the ninth. The Farmers lead by one. Full count, here comes the play at the plate, and it's the Ag View Pitch!
Chris
Barron: Welcome everybody to another episode of the Ag View Pitch, and today we have a little conversation on equipment utilization and efficiency and a few other little things here. But before we get going, I want to introduce Brett Gloy, and he's with Ag Economic Insights. And Brett, go ahead and introduce yourself and tell us a little bit about what you're up to right now.
Brent
Gloy: Yeah, Chris, it's great to be here. I work in Ag Economic Insights with a partner, David Widmar, a company we founded as I left Purdue. I was a professor at Purdue for about 5 years. Before that, I was 10 years at Cornell as an ag economist. Moved back to the family farm, operate that as well. If you wanna check out what we're doing, go to AEI.ag.
Chris
Barron: Awesome, well, that sounds great. So today we're here at TPAP and you and Dr. Bolji were having a really interesting conversation and I went up to you and said, hey, I gotta corner you because you're talking my language here, you know, on equipment utilization. And that's one of the resources that we have and we look at that with our client base as it's typically the second largest line item expense in specifically in crop production. And so I guess what I'd like to do is, is have you give us a little insight on kind of what you were talking about today and, and really what the important key points are with machinery and equipment and, and, and how as producers a lot of time we underutilize that resource and, and maybe over-invest in it.
Brent
Gloy: Yeah, I think that's a, that's a really great point. And equipment is one of those things I always say, you know, you've got the— it's the old Warren Buffett idea that, you know, you've got a too-hard list, and you put it in your drawer. And a lot of times, I think most of us put equipment in that. You know, you've got to have it, so you just buy it. And you kind of get into a routine, and that's what it is. But it's a huge cost. It's a huge investment. It's a huge category of most of our costs. And if we want to be successful, I think we've really got to get the pencil out and figure out, evaluate our machinery investment and utilization strategy because we've got all these dollars tied up in it. We have to make sure, one, we're utilizing it right and that we're making the proper investments in it.
Chris
Barron: Yeah, exactly. And you guys were talking about that today and using some of the terminology. Explain some of the terminology that we're using and kind of help the listeners kind of visualize what they should be thinking about when it comes to investing in their equipment and what they should be expecting in terms of, of, you know, value back on that, on that equipment line.
Brent
Gloy: Right. So Mike Bolge's big thing has always been kind of the idea of earns and turns. And earns is really your operating profit margin, right? And then The turns is your asset turnover. And you multiply those two numbers, you get your rate of return on assets. And so he's always trying to encourage people to think about, if you want to drive your rate of return on assets, you've got to modify those— you've got those two levers to pull. And most of us think about our profit margins a lot, but we don't necessarily think about our asset utilization or asset turnover. As much. And that's where there's probably a lot of opportunity to do some things differently and use your equipment, you know, a smaller set of equipment, maybe a fleet of equipment. I don't mean smaller size, but like fewer machines or use them more intensively while you're using them.
Do things to get as much out of that equipment as you can rather than have it just sitting around on your balance sheet. And, ultimately depreciating as well. So, you know, it's trying to size your operation efficiently and make sure that you've got, you've got everything kind of oriented to be efficient on your farm.
Chris
Barron: Yeah, one of the examples I like that you guys used, and ask you to tell us a little bit about that, but you used like Southwest Airlines as an example, you know, your turn and burn, you know, the, you know, not, not having things sit any longer than they have to and figuring out ways to keep things moving, right?
Brent
Gloy: Right. One of the things they've figured out is, you know, we've got to have these airplanes are a huge cost. Right. And having them sit on the ground is, you know, nobody. And I think Mike used the quote, you know, the CEO had said, you know, if I wanted to want to make money, if I'm sitting on the ground, I would start a bus company, not an airplane company. Right. Right. So, you know, you got to keep that stuff moving, keep it serviced, take care of it. But really start trying to manage it and start tracking utilization of your equipment. Start tracking the repair bills, track repair bills by operator. I mean, start really thinking about, you know, even when's the best time to trade equipment. What's that trade-off look like? What's the depreciation curve look like versus the repair curve? And really starting to get into that because it's big money, right?
I mean, it's a huge portion of your costs. And it's time to pull that out of the too hard drawer.
Chris
Barron: Right, yeah. So talk a little bit about some of the other things you guys were talking about today too, just on risk management and some of those things. Is there any, anything good advice that you would want to throw out there to some of the listeners and some of the things that we're getting out of TPAP, some of the things you guys brought today to the discussion in the class?
Brent
Gloy: Right, so what we were really talking with the group about is just strategic positioning and thinking about setting the strategy in your organization, figuring out, you know, the things you're really going to focus on, what you might outsource, other things like that. But also from a risk management standpoint, starting to think about things beyond just— you know, when I say the word risk management, most of us just think of price risk or yield risk, right? But there's a whole bunch of other risks that we're exposed to and trying to think of What those risks are and what are we doing to manage them? And so we were just pushing the group to kind of get outside their comfort zone a little bit and think about things like relationship risk with your landowners, maybe.
You know, how well are you connected to, you know, not just the person you write the check to, but to the rest of their family? Because that can be a time when, you know, you can lose rental agreements or whatever.
Chris
Barron: Yeah. One of the other things, um, kind of back to the equipment for a minute, you guys talked about that I thought was interesting in terms of risk financially on leasing versus owning. And that's a question we get a lot of times on machinery and equipment. You know, um, a client will call and say, hey, I got an option to, to rent this machine or, or, you know, or lease it or to purchase it. And, and part of, I think what you guys were saying today is if you've got a heavy amount of your equipment is being leased, there's, there's a potentially a risk scenario to be, to consider. And then the same thing with owning everything, you know, there's, there's a couple of different ways to look at that. Can you kind of talk to that a little bit?
Brent
Gloy: Right, so if we go back to that kind of earns and turns deal, the way to get your asset turnover up is to have fewer assets you own, lease more of them, lease more farmland, lease more equipment, all that kind of stuff. They'll drive up your ROI, but But there's risk to that because a lot of times your lease payments will be higher than they would be had you owned it. So you've got to trade that off. And then also, you know, the risk of those fixed payments coming due all the time can create some financial risk. And what we try to encourage people, especially guys that are starting, you know, when you're starting, you're really trying to turn that earnings on, you know, and create some earnings. But what you really have to push yourself to do is take those earnings and reinvest them back into the farm and build financial resiliency into your farm.
So get some land, you use that earnings to build a little bit of a land base or, or buy some of that equipment so it's not all leased. Build some, some, put some of that equity back into the business and build your financial resiliency. Resiliency.
Chris
Barron: Yeah, I think one of the things you guys pointed out that I thought was, was really good is that if you would continue to lease and you lease at too heavy of a rate, you run the potential of, you know, having almost negative equity, right? I mean, you start going completely backwards. Can you talk about that for a second and the risk with that?
Brent
Gloy: Yeah, and you know, the risk is kind of just what you said, you know, if you get into a situation where you're leasing everything, a lot of times your costs will creep up on you and get in a situation like we're in now, where we've got multiple years of lower commodity prices than a lot of us, you know, thought we were going to be facing 5 years ago. You're burning through, you know, you're generating operating losses and your working capital is going out the door. And all of a sudden you have no equity left to fall back on. And that's what I think You know, we're trying to encourage people, you know, when you are making the earnings, make sure you build some resiliency and not just double down on a high, high, high proportion of rented everything or leased everything.
Chris
Barron: Yeah, that's a pretty risky scenario if we choose to put ourselves in that position, for sure.
Brent
Gloy: It is. And sometimes it can be a great tool, though. Let's say you have a nice base and you get a chance to expand some more. Maybe leasing instead of buying the equipment to go with it can be a reasonable thing if you don't know what the time, you know, if you can get the time scenarios to match up.
Chris
Barron: Or if you can get the cash flow. If you've got a base of revenue stream on a, say, on a custom operating system and you can have some sort of a guaranteed revenue stream that would change the scenario a little bit too, wouldn't it?
Brent
Gloy: Yeah, absolutely. I mean, and that's what, you know, it's all about finding the right place for everything. And because somebody asked, well, you're, are you saying leasing is better than owning? And we're like, no, that's not, I'm not saying that at all. I'm saying you, you have to use the right tools at the right time.
Chris
Barron: Right. It's, it's kind of the balance, right? Between, between those things. So, um, I appreciate your time. Is there anything else, you know, I mean, you guys talked about a ton of stuff today and as you well know, Brent, I mean, TPAP is an amazing place to come and learn and appreciate your guys' education today. It was a phenomenal thing to sit in and listen to. Any other comments or anything I didn't bring up on the equipment utilization or any other final comments you would have?
Brent
Gloy: No, I just think, you know, it's time to pull it out of the too-hard drawer and really start asking yourself, what is it costing me to operate this equipment? And really get yourself in a good space with knowing what that equipment really costs you as opposed to just kind of guesstimating. And spend some time on it because I think it's worth it. And these times of tight margins, we gotta find all the cost savings we can.
Chris
Barron: Great, well said. And, you know, like we were just talking, you know, machinery and equipment, second largest line item expense next to land. And there's certain states where, you know, you go up to North Dakota and some of those areas, equipment can be the number one line item expense, you know, depending on the price of the land and the location, the country where growers farm. So again, if people want to get a hold of you or want to look you up, how do they do that?
Brent
Gloy: Just go to AEI.ag. AEI.ag.
Chris
Barron: Awesome. So thanks a lot. This is a great conversation today. I really appreciate it, and we'll hit you up again for another topic. You're a great resource for information. We appreciate it. Thanks a lot.
Brent
Gloy: Great, great to be here, and we'll talk to you again sometime.
Chris
Barron: Sounds good. Will do. And thanks everybody for listening this time on the Ag View Pitch, and we will catch you next Next time.