Depressed ag sector puts squeeze on largest co-ops

David S. Chesnick,
Agricultural Economist
USDA Rural Development

Editor's note: This is the final article in a three-part series providing an overview of the cumulative fiscal performance of the nation's 100 largest agricultural cooperatives in 1998. Part I appeared in the November-December issue; Part 11 begins on page 28 of this issue.

griculture continues to suffer through a period of depressed commodity prices, impacting not only farmers but the businesses that deal with them. Cooperatives are no exception. While some cooperatives are weathering this crisis well, most are not as fortunate. The average performance measures for all 100 cooperatives show some deterioration during 1998. Tools developed to analyze cooperatives' financial performance include four types of performance measurements. These measurements are standard ratios found in most financial textbooks. A list of these ratios and averages for all Top 100 cooperatives are presented in Table 1.
These major areas of measurement include: Liquidity
The most common liquidity ratios used today are the current and quick ratios. Both evaluate a cooperative's short-term liquidity by measuring the degree to which it can meet its short-term obligations. Liquidity implies the ability to convert assets into cash in the current period. Liquid assets include cash, marketable securities, accounts receivable, inventories and other debt that is to be paid to the cooperative within the current fiscal year. Figure I illustrates the average liquidity ratios for all Top 100 cooperatives. The current ratio is calculated by dividing total current assets by total current liabilities. The higher the ratio, the more liquid the cooperative is. However, a note of caution is warranted. Interpreting these ratios -beyond the conclusion that they represent current resources over current obligations at a given point in time -requires a more in-depth look at the trends of the individual parts that make up the ratio. For example, during a period of business contraction, current liabilities may be paid off while there may be a concurrent, involuntary accumulation of inventories and uncollected receivables causing the ratio to rise. The average current ratio for all the largest 100 agricultural cooperatives declined from 1.38 to 1.35 in 1998 -the lowest value in the past five years. Even though combined current assets for the combined Top 100 cooperatives increased more than the combined current liabilities, as reported in an earlier article, most of these cooperatives found the opposite true. This illustrates the influence of some of the largest cooperatives on the combined balance sheets.

Fruit/vegetable, grain, and rice cooperatives, on average, had increasing current ratios. The other commodity groups had either no change or a lower average value for their current ratio. The fruit/vegetable cooperative group had a higher current ratio, due mostly to a build-up of inventory. For grain cooperatives, the ratio was generally higher, due mostly to lower current debt. It was also higher for rice cooperatives because of higher accounts receivable, which - along with lower debt - slowed the decline in current assets. Lower cash balances and accounts receivable - combined with higher debt, accounts payable and pool liabilities - pushed down the current ratio for cotton cooperatives. The dairy cooperative sector's decline was attributed to higher accounts payable and liabilities due members in relation to current assets. Diversified co-ops had lower inventory levels, higher short term debt and accounts payable while farm supply co-ops had lower amounts of receivables, which pulled down their current ratio. For poultry/livestock cooperatives, a combination of several factors caused the decline in the current ratio. Sugar remained unchanged from the prior year. The quick ratio is calculated the same way as the current ratio, but inventories are excluded from current assets. The theory behind this suggests that inventories cannot be converted to cash as quickly as other current assets during liquidation. Also, if the inventory needs liquidation, the cash value would likely be much less than the book value. Therefore, it can be argued that the quick ratio is a better measure of liquidity. The average quick ratio for all cooperatives followed that of the current ratio and fell from 0.79 to 0.77 in 1998. However, the decline in the quick ratio was not as large as the drop in the current ratio. This would indicate that, on average, inventory levels are either not increasing as fast as other current assets, or that they are falling faster than other current assets. Cotton, fruit/vegetable and farm supply co-ops had larger declines in their quick ratios than in their current ratios. These cooperatives had a relative buildup of inventory over the past year. However, cotton co-ops maintained a strong liquid position, with an average quick ratio above 1.0. All other commodity groups averaged fewer inventories compared to other current assets.

Leverage
Leverage relates to the capital structure or sources of financing for a cooperative. There are several important perspectives on analyzing capital structure, including an examination of the difference between debt and equity. Equity is the basic risk capital put up by co-op members. The risk inherent in member equity is the uncertainty or unspecified return. Sometimes there is no defined repayment schedule. There must be some equity within the capital structure to bear the risk associated with the cooperative's business. Debt, on the other hand, is the use of external funds and must be repaid at specified times regardless of the cooperative's financial condition. Failure to pay the principal or interest typically results in members losing control of their cooperative. Financial leverage is the use of debt to increase returns on member investments. Thus, if the fixed cost of the debt is lower than the returns those funds generate, the excess returns will accrue to members. However, if the revenues were less than the fixed cost of the debt, member equity would make up the difference. This is the concept of leverage. The first leverage ratio, debt-to-asset, is calculated by dividing total liabilities by total assets (figure 2). This represents the claims of outside interests on the cooperative's assets. The average debt-to-asset ratio for all cooperatives remained steady at 0 .60. With the exception of poultry/livestock cooperatives, most commodity groups didn't remain constant.
Cotton, dairy, diversified, and fruit/vegetable co-ops increased their relative use of debt. Cotton and fruit/vegetable cooperatives used higher amounts of working loans to finance an increase in their inventories and receivables. Both dairy and diversified co-ops increased overall assets. However, dairy relied on short-term debt and member payables to finance the expansion while the diversified co-op sector relied heavily on long-term debt. The other co-op commodity groups showed a strengthening of their equity base. Farm supply cooperatives used members' equity to pay off a substantial portion of their working loans. Grain cooperatives transferred current debt for long-term debt and paid off the rest with retained patronage refunds. Rice cooperatives apparently sold off inventory and used the proceeds to pay off working loans. Sugar cooperatives increased fixed assets through retained patronage refunds. The second leverage ratio is long term debt-to-equity (figure 3). Since both equity and long-term debt take a long-run view of financing, it should be a natural comparison between the two. Unlike the relatively unchanged debt-to-asset ratio discussed earlier, the long-term debt-to-equity ratio increased steadily over the past five years to end 1998 at 0. 5 1. This would indicate that, on average, either cooperatives are transferring their debt from short-term to long-term or they are decreasing the amount of member equity in relation to long-term debt. Diversified, fruit/vegetable, grain, poultry/livestock and rice cooperatives were leading the trend of shifting their capital structure to more long-term debt in relation to equity. Diversified and fruit/vegetable cooperatives accumulated more debt than equity, with a larger percentage of that debt being long-term. Meanwhile, most of the grain, poultry/livestock and rice cooperatives had a higher amount of equity financing, but are also moving their debt from short-term to long-term obligations. Cotton and dairy are using more overall debt in their operations but are also using more equity for long-term financing. Sugar cooperatives are generally moving from debt to equity financing while farm supply cooperatives have maintained similar balance in their capital structure. The last leverage ratio is the times interest earned (TIE). This mainly looks at how many times net revenue will cover interest expense. It is calculated by dividing earnings before interest and taxes by interest payments. A note of caution: this ratio looks at the minimum expenditures needed to cover debt payments. It does not include fixed payments such as principal and lease payments.

The average TIE ratio for the largest cooperatives dropped from 5.8 to 5.4 in 1998 (figure 4). This marks the first decline since 1995. Both higher interest expenses and lower net margins before interest and taxes pushed the average ratio lower for all. Some cooperatives were able to improve their TIE ratio. Cotton coops had a larger increase in their income than interest expense. Thus, they had a higher interest cover ratio. Grain, rice and sugar cooperatives lowered interest rates while increasing their bottom line. Fruit/vegetable coops improved their average ratio, primarily as a result of one cooperative. Without that co-op to pull up the average, fruit/vegetable cooperatives would be at the same level as in 1997. The situation was very similar for the dairy sector, where one cooperative pulled down the average. This cooperative, which typically carries a small amount of debt, had a substantial increase in debt while income fell. Diversified and poultry/livestock coops had higher debts and interest expenses while net margins before interest and taxes fell. Farm supply cooperatives generally had lower net margins pulling down their TIE. Even though the average cooperative had five times the earnings to cover interest expense, diversified, poultry/livestock and sugar cooperatives had average TIE ratios between I and 2. This does not necessarily mean further stress in these sectors would be a cause for grave concern for these cooperatives. Many of these cooperatives operate on a pooling basis and, after all expenses, the final payment to members leaves little margin for distribution. Thus, these cooperatives generally have low TIE ratios. However, the diversified co-ops have been carrying a large amount of debt and the decline in their net margins is a concern.

Activity
Where the first two types of ratio examined the liquidity and capital structure, the next two look at the operating performances. Activity ratios reveal how much revenue is generated by each dollar invested in the cooperative's assets. Higher ratios here generally mean higher efficiency within the cooperative. The first activity ratio, local asset turnover, is calculated by taking the total revenues divided by local assets. Local assets are total assets less investments in other cooperatives. Investment in other cooperatives is generally not considered a revenue-producing asset. Therefore, it makes sense to leave it out of the calculation when looking at the local asset turnover ratio. The average local asset turnover ratio took a dramatic turn, falling to the second lowest point in the past five years (figure 5). The average ratio fell from 3.8 to 3.5, primarily due to slower sales growth compared to the growth in local assets. All commodity groups experienced a decline in their local asset turnover ratio. More than two-thirds of the Top 100 co-ops had a declining ratio. The commodity groups with the largest changes were dairy and poultry/livestock. The dairy cooperatives increased their average local assets at a higher rate than the increase in sales, causing the turnover ratio to fall. Poultry/livestock co-ops' ratio was pushed down by lower sales. Cotton cooperatives would be in the same situation as poultry/livestock cooperatives, with the exception of one cooperative that cushioned the fall for all cotton cooperatives. Diversified, farm supply, grain and rice cooperatives also saw their ratio fall due to lower sales. Meanwhile, sugar co-op ratios fell because of a relatively higher increase in local assets compared to their sales. The local asset turnover ratio for fruit/vegetable cooperatives fell because of both higher local assets and lower sales. The second activity ratio, fixed asset turnover, looks at how efficiently the cooperative uses its fixed assets to generate sales. This ratio is calculated by dividing total operating revenues by net fixed assets. While a ratio value out of line with what would be considered "normal" may be a cause for alarm, further examination of the details will be needed to ascertain whether a problem exists. For example, a cooperative with fully depreciated assets could have a high ratio due to the low value of its fixed assets. On the other hand, a cooperative that is expanding its operations could have a temporarily depressed ratio because the new capacity is not fully used at this time. Therefore, other information - such as the average age left on the fixed assets and how much new equipment is purchased - will be needed to help interpret the fixed asset turnover ratio. The average Top 100 agricultural cooperative purchased $17 million in fixed assets in 1998, down from $17.8 million in 1997. Total net fixed assets for all the Top 100 co-ops hit a record amount of $8.5 billion. The average age of fixed assets (estimated by dividing net fixed assets by depreciation expense) was down from 9.3 years in 1997 to 9.1 years in 1998. These figures would suggest that while cooperatives are expanding their fixed asset base, the industry as a whole didn't build excess capacity. At the same time, though, a few cooperatives had substantial investments and appeared to have built excess capacity for future growth. The average fixed asset turnover ratio fell from 18.6 to 15.1 in 1998 -the lowest in the five-year period. Most commodity groups had a lower average fixed asset turnover ratio caused by lower sales. However, dairy cooperatives actually had higher sales without a corresponding increase in assets. Yet, a few dairy cooperatives had substantial declines in their ratio that pulled down the average ratio for the group. While a couple of cotton cooperatives increased their capacity, most of the decline in their fixed asset turnover was caused by lower sales. Similarly, fruit/vegetable cooperatives increased their average capacity along with lower sales.

Profitability
Profitability ratios measure the power of the cooperative's earnings. With poor earnings, the co-op may find it cannot meet its obligations and will be forced out of business. However, cooperatives can have other objectives than to accumulate high returns. The nature of a co-op is to fill a market need of its members. Therefore, co-ops' profitability ratios can be, and usually are, lower than those of investor-owned firms. However, comparisons of the same cooperative or group over time are very informative. The four profitability ratios used in this report include gross margin percent, net operating margins, return on total assets and return on member equity. Gross margins are the excess of revenues above the cost of goods sold. All operating and non-operating expenses plus payment of patronage refunds, dividends and income taxes must be covered by the gross margins. Gross margins also indicate the pricing policy of the cooperative. In other words, is the cooperative charging enough for the products sold or paying too much for member products to cover its expenses? Figure 6 depicts the five-year trend for the average gross margin percentage and net operating margins for the Top 100 agricultural cooperatives. Following a gradual decline since 1994, gross profit margins increased to 14 percent of total sales in 1998, up from 13 percent in 1997. More than 70 of the Top 100 cooperatives registered an increase in their gross margins. Dairy cooperatives were the only commodity group averaging a lower gross margin percentage. The situation facing most dairy co-ops was that the costs associated with their sales increased more than their revenues. Thus, gross margins were suppressed. No other commodity group averaged a lower gross margin percentage. Net operating margin percentage looks at the amount of margins that is generated by operations expressed as a percent of total revenue. It is calculated by taking the gross margin less operating expenses and dividing that by total revenue. Indirect income/expense items (patronage refunds, interest income/expense, gains/losses on the sale of assets, and any other extraordinary revenues or expenses not directly related to operations) are not included in the calculation. Net operating margins as a percent of total revenues continued a downward trend, reaching its lowest level at 1.9 percent. Only two commodity groups had an increase in net operating margins percentage: fruit/vegetable and grain co-ops. The fruit/vegetable cooperatives had both declining revenues and operating expenses. However, the decline in revenues was relatively greater than the decline in expenses. Grain cooperatives also showed declining revenues. Yet, they were able to control their operating expenses and actually increase their operating margins. All other commodity groups experienced lower net margin percentages. Diversified, cotton, farm supply, poultry/livestock rice and sugar all averaged higher gross margins but lower net margins. This would indicate these cooperatives lost some efficiency within their operations. Return on total assets (ROTA) is calculated by taking net margins before taxes and interest divided by total assets. This ratio looks at the return on the total investment by all parties associated with the cooperative. After reaching a five-year high of 7.39 percent in 1997, return on total assets took a dip in 1998, ending the year at 7.25 percent (figure 7). Only fruit/vegetable and grain cooperatives averaged a higher ratio in 1998. Grain cooperatives saw improvement in their net margins, enabling them to post a higher average return on assets. Fruit/vegetable cooperatives, while averaging higher net margins, relied on slower growth of their asset base compared to their net margins to boost their return on assets. Lower net margins were the cause for most declining ROTA values. However, some industries - such as the dairy and sugar commodity groups - showed a higher increase in their asset base compared to their net margins. A few cotton cooperatives also experienced a larger increase in their asset base. This will put downward pressure on their ROTA ratios. Some of these cooperatives appear to be building for the future. The other cooperatives generally had lower margins pulling down the ratio. The last ratio compared in this report is the return on member equity (ROE). It is calculated by dividing the net margins after interest and taxes by total member equity. The reason interest and taxes are excluded is because interest is a return to creditors and taxes are a return to government. Excluding these will provide a true return on member equity. What is interesting about this ratio is the fact that despite the wide fluctuations between the different years for each cooperative, the average return on member equity for all Top 100 cooperatives has remained steady between 11 percent and 12 percent. Diversified, farm supply and poultry/livestock cooperatives had substantial declines in their average ROE ratios, pulling down the overall average. Much of this decline is attributed to declining margins. Sugar cooperatives again ended the year with a net loss, yet the loss was not as large as the prior year and their return on equity improved. Fruit/vegetable cooperatives boosted their ROE with the help of two cooperatives. Dairy, cotton, grain and rice cooperatives all had a larger percentage increase in their net margins compared to their increase in equity. In summary, the downturn in the agriculture sector hurt farmers and their businesses. Liquidity indicators point toward a less liquid position for many larger cooperatives at the same time they accumulate more debt. At present, there doesn't seem to be too much of a concern. However, if the lower activity and profitability of these cooperatives doesn't improve, agriculture could see more consolidation and change in the cooperative community.