Considerations and Trends in Farm Supply: An Informative Discussion for ABLs

Steve Katz

Hi  everybody and thanks for taking time out of your busy schedule to listen in on our Hilco global smarter perspective podcasts. As return listeners know by now I’m your host, Steve Katz. And if this is your first time with us, well, then welcome. We’re glad you could tune in. Today we’re joined by Stephen D’Aquila, and Dustin Miller of Hilco Valuation Services for a discussion geared at helping lenders most effectively evaluate prospective borrowers and existing portfolio accounts that specialize in the farm supply industry. So Stephen, Dustin, welcome to the podcast.

Stephen D’Aquila

Hello Steve. Thanks for having me back on.

Dustin Miller

Great to join you, Steve. Thanks,

Steve Katz

Well we’re Glad to have you guys on. I know, there’s a lot to talk about today. So we’ll try to get through as best we can. And then if we run out of time, or we want to dig in further, we’ll get you back on,  alright? Okay, so Steven, I know there’s quite a wide range of products and services that those in the farm supply industry can and do offer. Can you kick us off today with a quick top line of what those look like. And then also maybe talk a bit about the type of industrial equipment assets that businesses that are materially involved in Farm Supply tend to own lease and operate to deliver those products and services.

Stephen D’Aquila

Absolutely Steve. So if you think about farm supply, in general, it’s a fairly broad industry and the types of companies that operate in it, as well as the products that are being offered. And the customers that they’re catering to, is fairly diverse. So if you start with the companies themselves, we range from nationally known retailers down to smaller regional players that might include cooperatives, for example. And these companies are then selling predominantly into rural markets. And that’s a similarity that you’ll see among many of these desperate retail companies. So they’re selling to retailers in to a lesser extent to the suburban market. And the primary customers are also varied. You’ll go from business to business, wholesale sales to commercial farmers to hobby farmers to individual homeowners and do it yourselfers so the needs of these different customers will vary in the products that they purchase will also vary from customer type to customer type. So with that, you think of the different types of products that are being carried at these farm supply locations. And it could start with agronomy, agronomy, being fertilizer and seed and crop protection and the related services for those types of types of products. From there, you have other farm related goods that might be purchased and could include goods related to livestock such as feed and feed bins and related equipment, animal health, veterinary type products, fencing, light farm equipment, pools and work wear type apparel. But beyond that pocket of goods, you also have a secondary bucket of goods, which starts to bleed over into with a sporting goods and big box home improvement center type of assortment. So in that case, you have goods such as apparel, and sporting goods, indoor and outdoor type products, pet products, and other type items that aren’t necessarily related to farming, but would potentially be purchased by residential customers in the communities that these companies service. So in thinking of all of this, you have a wide assortment of products. And then beyond those products, you have services related to some of these products. And those services can include the delivery of bolts type products, such as the fertilizer, or large equipment to commercial or, or customer sites. And then beyond that, you also have potential for application type services, the actual spreading of feed and prop protectant, or other types of services as well, that would include testing of the soil that the farmers are planting their crops in. So you know, overall, what we’re doing here is when we’re looking at a company for the first time, we want to get a good sense as to how this company is set up, where their locations are, who their customers are, and the type of inventory that they’re selling. Because all of these factors collectively will then influence our overall valuation modeling approach and our general disposition strategy.

Steve Katz

Very interesting and more diverse than I might have thought and I’m thinking some of our listeners might have thought as well with a, you know, a range of products and services, and delivery models and customers. Mmm, there’s, it’s more, it’s definitely, definitely a little more complex than one might imagine. Alright, Dustin, could you talk a bit about the relationship of commodity products such as fertilizer and seed, some of what Steven just talked about, to farm suppliers businesses, and give us a feel for perhaps some trends that you and the team had been observing or are expecting in regard to those products and their pricing?

Dustin Miller

Absolutely, yeah. So once we’ve identified that there is a significant amount of commodity inventory within a farm supply company  such as fertilizer seed livestock feed, we want to really understand how the business is managing the risk associated with that, to make sure that they aren’t getting caught with inventory purchased at a cost above a current market price. Some farm supply companies will engage in hedging of a more traditional type with financial contracts or commodity futures. But many as well will manage their risk by engaging in forward looking Pricing Agreements with both their vendors and customers. Many vendors and customers will will be involved in programs to either prepay or lock in Pricing Agreements, generally starting in the fall or the spring planting season, frequently, those are offered with certain discounts for the prepayment, as well. And so it’s important to understand, you know, how a company is managing that risk and what they’re doing to make sure that the pricing is consistent on both the customer side and the vendor side. So that they’re, they’re able to maintain a gross margin. As far as what we’re seeing in commodity prices. You know, it’s no surprise that since 2020 through early 2022, I would say we saw commodity prices rise pretty consistently, with supply chain disruptions, as well as the Ukraine conflict, which is, you know, impacted Russia and Ukraine, which are major sources of fertilizer. What we’ve seen since then, is that some more volatility than just a true rise in prices. And all we can say looking forward is we’re still in a unprecedented volatile environment. So, you know, I would just say it’s most important to understand how companies are, you know, hedging their risk rather than trying to understand, you know, where prices are going in the future.

Steve Katz

Okay, thanks for that. Dustin, you know, your thoughts. There are really a perfect segue into where I wanted to take our discussion next. And that’s a question for you, Steven. Hilco is well known for its evaluations, bench strength, and has advised a great number of lenders across a wide range of industries. Farming supply, as we’re learning here today, is very specialized, and in your experience, how well versed and informed overall or lenders on the industry and other some key areas of diligence, specifically, diligence best practices that you might be able to point out here and discuss with us on the podcast today.

Stephen D’Aquila

Absolutely, Steve, I think when it comes down to doing the due diligence on a particular company, there’s a variety of different monitoring areas that we as appraisers are looking at when we’re conducting our due diligence and through throughout the overall appraisal process. To start the nature of the business. I touched on it earlier, when I’m speaking. And when it comes to the overall type of business that we’re looking at from a farm supply standpoint, who are their customers? What type of inventory are they selling? Is it that high volume, distributor of agronomy type product business to business to that commercial farmer? Or is it ancillary type products or retail adjacent type products that would be more similar to that sporting goods or big box home improvement location, these different customers inventory levels, and overall sales trends will influence our overall setup and our modeling. And it’s key for us to get a good understanding of that business model up front from the company. And that will then help guide us through our overall valuation process. Beyond the setup of the business, one of the next things we look at is general seasonality within the company itself. So when you look at it from a demand perspective, when we’re looking in talking about products that are catered toward crop production, the first thing we want to do is get an understanding of where is this company operating, where regionally are these customers located? What types of crops are they growing? Because the different types of crops and where the physically they are located will influence the growing season. General seasonality within sales will also influence the types of products that are needed. for these particular crops, in addition to that there are weather related factors that will influence the overall growing season, it might extend out the growing season, or reduce our delay the start of a growing season. So what we want to do is understand one time weather events and how they may impact near term sales trends. So what we do is go back in time historically to look to see what is a more normalized overall sales velocity for different product categories that aren’t being impacted by one time weather events. In addition to crop related seasonality, we also look at seasonality of other product types. So when we look at the sales of product that’s related to livestock farmers, those type of farmers have a different seasonality in comparison to the crop farmer. So livestock would have needs such as livestock feed and the housing for the animals, the fencing, etc, which won’t align necessarily with overall crop seasonality. So from an appraisal perspective, what we’re doing is looking at seasonality, not just an aggregate, but at a category by category basis to understand how depending upon the time of the year the impact on overall demand and subsequently recovery value. In addition to the sales seasonality, we also take a look at inventory, seasonality. And when it comes to inventory seasonality, what we have found is that agronomy products in particular, are bought generally in bulk fashion. And the inventory levels are held at elevated levels toward the start of the overall growing season, and then theoretically are bled through throughout the growing season to arrive at a low balance at the end of the season. So what we want to do is understand how the inventory fluctuates throughout the year based upon the different agronomy products held. And should the company be holding a higher than normal balance of product at the end of the growing season? What is the overall strategy by the company going forward? If they’re going to sell off the goods? Or do they have the ability to carry the products into the next year? Beyond seasonality, we look at ancillary services that are provided by the company. It might be delivery of bulk product, whether it’s agronomy product, or the commercial type equipment being delivered direct to customer sites, there might be a fee charged for that. So there’s a revenue stream associated with this or it might be an expense for the company. We take a look at what products are delivery dependent and in the absence of delivery, what would the expected impact would be on the overall demand for a particular product. In addition to that, we also take a look at other services that company might be offering, such as services related to application of agronomy products, or the assembly and installation of various equipment such as grain bins or tanks and fences. We take a look at the ability for a liquidator to maintain these type of services in a liquidation which is generally fairly challenging. And with the absence of the use of the services, we look category by category, what would be the potential follow up in demand without the services being offered and a liquidation scenario. The final piece I’ll talk about is the commodity nature of several the inventory categories, no fertilizer comes to mind immediately and then you also have livestock feed and crop protectant and seed for example, you know all of these are tied into various commodity markets which are influenced by general supply and demand. But in addition to that macro factors such as changes in fuel pricing, or trade regulations, and government policies, all can impact overall market pricing for these different commodities. So what we do from an appraisal perspective is take a look at how the company holds these products on their balance sheet at what cost basis from a gallons or tonnage perspective and how that compares to the current spot market. And then deviations from that will help us determine the overall discount we would need to employ to sell this product. The good news is that even if the inventory that’s commodity like nature exceeds historical demand in a liquidation environment, you have alternate channels to sell into. The commoditization of the product leads you to opportunities to sell it to other customers, competitors for example, their cooperatives to sell into and generally moderate discounts to historical market value.

Steve Katz

Okay, well, I think I’m safe in saying this is great information for lenders. I’m guessing there’s more on the must hit diligence list for Farm Supply. Dustin Do you want to walk through the balance of any additional areas of diligence that you and the team consider critical.

Dustin Miller

Absolutely Steve, happy to. The first one I’ll touch on is something I mentioned earlier, which is customer pre payments. farm supply companies generally offer a variety of pre payment programs. For customers. These may include pre payments for specific products or just general prepay accounts that the customers can hold with the Farm Supply Company. From an appraisal perspective, it’s important to understand the extent of these customer deposits and to think about whether they would be honored in a liquidation. If they’re going to be honored in a liquidation, then we would recommend that lenders reserve appropriately against that balance in order to avoid over advancing and you know, in a liquidation, if the lender is going to be senior to depositors, then we’re going to think about how that’s going to impact an appraisal if those customers effectively lose their deposits. You know, would that affect their ability to participate in a liquidation or their willingness to and so that’s a major factor to consider. Another is EPA regulation. This generally, mostly applies to crop protecting more than anything, these would be insecticides, herbicides, fungicides, you know, from time to time, it’s determined that these are, you know, damaging to wildlife, the environment, groundwater, and so they are banned. Generally, there’s a kind of a grace period and existing product is grandfathered in for a certain time period when they’re banned. But it’s important to understand if any inventory falls under EPA regulation and to consider the fact that it might not be saleable in the future. Federal crop insurance and agricultural subsidies are government programs that support farmers. They put a floor under the risk of crop failure and also commodity prices for crops, which allows farmers to fully participate in farm supply market with knowledge that they are protected from the most severe downside scenarios. So any changes to those could impact behavior among farmers as consumers of these products. The next category I touched on here would be dropship sales. When farms are taking large deliveries of fertilizer or seed, this could be several truckloads of product. It’s not uncommon for that product to actually ship directly from the the supplier to the customer without actually going into the farm supply company’s inventory, just to save on freight costs, and for logistical reasons, those sales are going to be included in the farm supply company’s financials and sales record. So it’s important to understand what portion of the sales are composed of that and how those numbers may be distorting the the interpretation of sales figures from the farm supply company from an appraisal perspective and understanding the salability of the on hand inventory. The next point would be agri finance. This these are finance products that are geared toward farms, credit products that are offered by financial institutions. One difference is that it’s more common for agri finance credit products to include some recourse to the seller, this, in this case, the Farm Supply Company. And so we would recommend understanding the extent of any recourse lenders have to the Farm Supply Company and whether those credit products would be honored in a liquidation scenario, you know, farmers lose that access to credit to participate in a sale, that could be a negative impact on, you know, their ability to fully participate. Another point we’ve been monitoring that’s more of a current event here would be rail strikes or disruptions. You know, there was a real potential for a rail strike it seemed and you know, late 2020 to early 2023. It seems that was negotiated and averted for the time being but Farm Supply is heavily dependent on rail transport to move fertilizer and other commodities around. Any interruption of rail service could have a significant impact on these companies and their ability to operate in the last point, which is a point for really any appraisal, but in particular to farm supply cost accounting, the costing of inventory just needs to be understood, particularly for commodities to understand the way that from an accounting perspective, changes in market prices will impact gross margins and you know, the recovery on inventory at cost. Those are the additional topics that I would suggest covering.

Steve Katz

Fantastic that I mean, there’s a lot to consider there. Obviously. Really great detail the info I’ve been taking copious notes. I’m gonna put my pen down now. But before we wrap up, is there anything else that we haven’t touched on that either of you would like to add?

Stephen D’Aquila

You know Steve, I think we’ve covered quite a bit on this call. And you know, the listeners would like to visit our website, we have the written article available on the site as well that they can then reference. I mean, I think the main goal of these podcasts these articles is really just to present key areas that we would recommend that the lender speak to, you know, their prospective borrower or their portfolio account borrower on an ongoing basis in the city. How does the company operate? And all these different monitoring points? Are there any areas of risks that the lender is identifying, and then take that information even at a high level and bring it back to the appraiser? I would say even before the onset of an engagement, just to have a general discussion to understand how that will impact value? What would be the best approach for modeling in inventory appraisal. And so being proactive in that process, I think would be, you know, the best way to lower risk and really get the work product that you would like to see.

Steve Katz

Perfect, very well said. Really appreciate it. Thanks for joining us. Clearly, you guys have developed a lot of expertise that could benefit lenders with exposure and farm supply. And I’m sure there gonna be some follow up questions. So you’ve already pointed people to the website, which is great. But maybe you could each provide your preferred contact info so listeners can reach out.

Stephen D’Aquila

Sure My cell phone is area code 857-204-2841. And I can be reached via email at s daquila. At Hilco global.com. That’s SDAQUILA@hilcoglobal.com.

Dustin Miller

And I can be reached at my direct phone number which is 216-329-0442. Or by email at D Miller at Hilco global.com. That’s dmiller@hilcoglobal.com.

Steve Katz

Alright, perfect. Steven D’Aquila, Dustin Miller. Thanks again for joining us. And listeners. As always, we hope that this smarter perspective podcast provided you with at least one key takeaway that you can put to good use in your business or share with a colleague or client to help make them that much more successful moving forward. And if you found today’s discussion insightful, be sure to check out our library of other podcasts you can find them at Hilco global.com forward slash smarter dash perspectives or on your favorite podcast platform. Till next time for Hilco global. I’m Steve Katz.