6.0 ECONOMIC RETURNS TO OWNERS AND SHAREMILKERS
6.1 50/50 AGREEMENTS
One of the primary reasons the sharemilking industry is experiencing such upheaval at present, is that return on capital to the owner has fallen due to increasing land prices, while return on capital to the sharemilker has remained relatively static. The purpose of this section is to compare the return on capital of each party, for both the Waikato and Canterbury regions.
The figures used to estimate the farm budgets are based on model farm data for the Matamata - Morrinsville area in the Waikato, and for the wider Canterbury region. The figures are designed to reflect what is actually happening between sharemilkers and farm owners with respect to sharing of income and expenditure, rather than just the standard 50/50 agreement.
The model Waikato farm is 91 ha, wintering 256 cows. Production is 73,068 kilograms of milksolids (KgMS). In Canterbury the model farm is 150 ha, wintering 390 head with production of 122,100 KgMS. The Waikato farm is based on the standard 50% agreement and incorporates common changes to today's agreements. This includes the sharemilker receiving all the bobby calf cheque, in return for them paying all animal health and grazing costs. The Canterbury farm is strongly influenced in its agreement by the corporate farmers and investors, who are endeavouring to generate a return on their capital. As a result, a lot more cost is borne by the sharemilker than is the case in the Waikato. However, it must be remembered that this is against the background of a local industry, where the average size of a sharemilking job is in excess of 350 cows, compared to around 250 cows in the Waikato.
Table 7 examines the returns to sharemilkers and farm owners in both the Waikato and Canterbury regions for the 1995/96 season. The operations have been compared on a per hectare basis, so that it is easier to draw a comparison between the two regions.
TABLE 7: Return on Capital for Waikato and Canterbury Farm Owners and Sharemilkers
| INCOME | WAIKATO ($/Ha) | CANTERBURY ($/Ha) |
| SHAREMILKER | FARM OWNER | SHAREMILKER | FARM OWNER |
| Milksolids income | 1630 | 1630 | 1465 | 1465 |
| Cattle income | 174 | 158 |
| Gross farm revenue | 1804 | 1630 | 1623 | 1465 |
| Farm working expenses | 872 | 556 | 1089 | 663 |
| Economic farm surplus | 933 | 1074 | 534 | 802 |
| Wages to management | 495 | 55 | 300 | 34 |
| Earnings before tax and debt servicing | 438 | 1019 | 234 | 768 |
| Estimated capital | 3229 | 19330 | 2814 | 10703 |
| Return on capital (ROC)% | 13.6 | 5.3 | 8.3 | 7.2 |
If the figures in the above table are examined a little more closely, a number of points emerge.
- Despite higher per hectare and per cow production in Canterbury, the Waikato farmers grossed more per hectare. This is due to the higher payout in the Waikato for 1995/96 of $4.06/kgMS, compared with $3.60/kgMS in Canterbury.
- Total farm working expenses in Canterbury are $324/ha higher than for the Waikato. Feed costs are the main reason for this discrepancy. The need to employ labour on most Canterbury farms also contributed to increased costs over the Waikato farm which can be run by the sharemilkers with support from their family.
- The share of farm expenses for the sharemilker compared with the farm owner is 61/39 (1.56:1) in the Waikato and 73/27 (2.7:1) in Canterbury. However, due to the slightly higher income of the sharemilker (as they keep all proceeds from stock sales), the balance at EFS level, before wages to management are deducted, is 46/54 (0.85:1) in favour of the farm owner in the Waikato. In Canterbury, the ratio is 41/59 (0.69:1) in favour of the farm owner. In both cases the sharemilker is receiving less than the 50% of economic farm surplus which is the intent of the standard 50/50 agreement.
- Wages to management are $45,000 for sharemilkers and $5,000 for farm owners. This allows a true estimate of the value of labour provided by each party to be deducted from EFS to give profit before tax and debt servicing. These figures have been estimated to provide an indication of the value of the sharemilkers' and farm owners, labour on the farm. They bear no relation to drawings as a sharemilker will typically draw less, foregoing present income for lifestyle in return for achieving the goal of farm ownership at an earlier age. The farm owner will draw more to meet their living and lifestyle needs.
- The earnings before tax and debt servicing are $186/ha (87%) higher for Waikato sharemilkers and $251/ha (33%) higher for Waikato farm owners compared with Canterbury.
- Both Waikato sharemilkers and farm owners have considerably more capital tied up in the operation on a per hectare basis than their counterparts in Canterbury. For the sharemilker, this is due to a slightly higher stocking rate in the Waikato than for the Canterbury region. The farm owners' asset of land is worth $19,000/ha in Waikato, compared to $10,500/ha in Canterbury.
- Return on capital is estimated as earnings before tax and debt servicing, divided by capital investment. In the Waikato, the sharemilkers' return is 8.3% above the farm owner. The farm owner in the Waikato would have to earn a further $1,500/ha in order to have a ROC equivalent to their sharemilkers. In Canterbury, the sharemilker also receives a higher return than the farm owner. In this region, the difference is only 1.1%. For the Canterbury farm owner to gain parity with their sharemilkers in ROC, they would have to earn an additional $118/ha.
- Return on capital for farm owners in the Waikato is boosted by a higher payout and penalised by a higher capital value of their assets compared to Canterbury farmers who have lower returns per hectare but a lower capital value on their assets.
- Farm owners in the Waikato are receiving a poorer return than those in Canterbury. This is due to the difference in their effective contract ratios, with farm owners in Canterbury receiving a greater share of the profit, and the lower value of land in Canterbury. The opposite is true for sharemilkers in the Waikato who are receiving a higher return compared with those in Canterbury due to their higher share of profit and higher payout.
The variation in effective contract values between regions, and higher payout in the Waikato, means the sharemilker is better off in the Waikato; while a farm owner is better off in the Canterbury area due to lower land prices.
Hall and Martyn (1993) conducted a similar exercise for the 1972/73 and 1991/92 seasons. To gain some insight into how things have changed over this period their results have been compared to 1995/96 data in Tables 8 and 9.
TABLE 8: Return on Capital of Waikato Sharemilkers for 1972/73, 1991/92 and 1995/96 in Nominal Dollars
| SEASON | 1992/73 ($/Ha) | 1991/92 ($/Ha) | 1995/96 ($/Ha) |
| INCOME Milksolids income Cattle income |
146 50 |
1162 246 |
1630 174 |
| Gross farm revenue Farm working expenses |
196 78 |
1408 560 |
1804 872 |
| Economic farm surplus Wages to management |
118 32 |
848 317 |
933 498 |
| Earnings before tax & debt servicing | 86 | 531 | 438 |
| Estimated capital | 429 | 2325 | 3229 |
| Estimated return on capital (%) | 20.0 | 22.8 | 13.6 |
TABLE 9: Return on Capital of Waikato Farm Owners for the 1972/73, 1991/92 and 1995/96 Seasons in Nominal Dollars
| SEASON | 1972/73 ($/Ha) | 1991/92 ($/Ha) | 1995/96 ($/Ha) |
| INCOME Milksolids income Cattle income |
146 8 |
1162 48 |
1630 0 |
| Gross farm revenue Farm working expenses |
154 67 |
1210 535 |
1630 556 |
| Economic farm surplus Wages to management |
87 0 |
675 32 |
1074 55 |
| Earnings before tax & debt servicing | 87 | 643 | 1019 |
| Estimated capital | 960 | 9302 | 19330 |
| Estimated return on capital (%) | 9.1 | 6.9 | 5.3 |
Return on capital has behaved differently for sharemilkers and farm owners. Up until recently, ROC has been around the 20% mark for sharemilkers. This was true in 1972/73 and in 1991/92. However, in 1995/96 the ROC has dropped markedly to 13.6%. This can be explained by the following:
- A change in the share of income between farm owner and sharemilker, after expenses and wages to management have been deducted, has occurred over time. For example, one common area of change has been in the treatment of bobby calf income, grazing expenses and bloat and facial eczema control.
- Historically, bobby calf income was shared half and half by owner and sharemilker, as were feed costs, including grazing, and bloat and facial eczema control. Over the past five years it has become common practice for the sharemilker to take all the bobby calf income and in return, pay for all their young stock grazing and bloat and eczema control. This alteration in the agreement was instigated as a way to simplify and tidy up administration of the contract, but with falling bobby calf and cull cow prices and more people grazing their stock off the property, it has resulted in sharemilkers getting a lesser share of farm profit than they traditionally have been. Today it is also seen as a mechanism for increasing the owners' return, at the expense of the sharemilker.
- Sharemilkers have also revalued themselves as a labour force over the last 20 years. Wages to management, which reflect the value of the labour inputs of the sharemilker and farm owner to the business, have risen from 16% to 28% of income for sharemilkers. This has had the effect of further lowering the earnings before tax and debt servicing, resulting in a lower ROC. This has had a greater effect on the ROC of sharemilkers than it has had on farm owners. However, a progressive sharemilker is unlikely to devote all their wages of management to living and instead will devote some to investment in debt servicing in order to purchase a farm at an earlier stage.
Table 10 demonstrates how these changes have affected the effective contract share of the sharemilker and farm owner since 1972/73.
TABLE 10: Effective Contract Share of 50/50 Agreements
| SEASON | 1972/73 | 1991/92 | 1995/96 |
| Sharemilker % | 58 | 56 | 46 |
| Owner % | 42 | 44 | 54 |
Return on capital for the farm owner has steadily decreased over time. This is the result of land prices increasing while payout has decreased in real terms. The turn around in contract terms, outlined in Table 10, has cushioned the effect of the rapid rise in farm values over the past two to three years. If this had not happened, the return on capital would have been significantly lower.
The ROC shown in Table 9 is only generated from the farming practice. If capital gain were regarded as income by the farm owner, this picture may look slightly different. The value of farm land in the Waikato, excluding chattels, rose by $1619/ha (8.3%) between the 1994/95 season and 1995/96 season. If this is added into the return to the farm owners, their earnings, before tax and debt servicing, would be $2638/ha. This would give a return on capital of 13.6%, which is identical to that of the sharemilker for the 1995/96 season. If the same process is carried out for the 1991/92 season, the ROC would change to 22.6%, once again similar to the sharemilkers return before tax. However, this relationship does not hold true for all years, as the rate of increase in farm values between years is highly variable. Over the last 23 years since 1972 the average increase in land value has been 13.8% in the Waikato, from $960/ha in 1972/73, to $19,000/ha in 1995/96.
It must also be remembered that the capital gain component of the farm owners' income is not taxed, whereas the ROC shown in Tables 8 and 9 result from the farming operation, and as such are subject to tax. Using a crude calculation to estimate ROC after tax, the farm owner in 1995/96 has a total return of 8.3% from capital gain plus 4% from farm income, giving a total of approximately 12.3%. The sharemilker on the other hand, earned a post tax return of 10.3%. For the 1991/92 season, post tax returns for the farm owner are approximately 21%, while the sharemilkers return is closer to 17%. (Capital gain on cows has been ignored as it is unlikely that a herd owner will retain cows for this length of time. The average length of time sharemilkers have spent in the industry is six years (refer Table 22), over which time cow prices have shown virtually no net capital growth. In addition, any rise and fall in stock numbers is taxed.)
Although this represents a reasonably good return over time to the farm owner, land is a relatively awkward investment in that any capital gain, which is equivalent to interest in other investments, is not realised until such time as the property is sold. As a result, farm owners often feel that they are not getting a very good return on their investment. This is because they only take into account the return derived from the farming operation, which may only provide a small income depending on the size of the farm. From an investment point of view, this has implications for a retired farmer looking to increase their annual income. If they are unable to increase income through the farming enterprise, eg. through expansion, then perhaps they should look at selling their farm and investing in an area where they will receive regular interest for their immediate living needs.
6.2 LOWER ORDER AGREEMENTS
There has been some speculation throughout the industry that as land becomes more expensive with payout levels remaining relatively static, more farm owners will put lower order sharemilkers on their properties in an effort to improve their return on investment. This has been borne out to some extent with an increase in the number of agreements other than 29, 39 or 50% over recent years. Trends in these types of agreements are shown below in Table 11.
TABLE 11: Trends in Numbers of Agreement other than 29%, 39%, and 50%
| SEASON | AGREEMENT |
| < 29% | 30-38% | 40-49% | CONTRACT | TOTAL |
| 1988/89 | 52 | 48 | 63 | 290 | 453 |
| 1989/90 | 93 | 67 | 60 | 444 | 664 |
| 1990/91 | 174 | 156 | 137 | 130 | 597 |
| 1991/92 | NA | NA | NA | NA | NA |
| 1992/93 | 313 | 157 | 102 | NA | 572 |
| 1993/942 | 337 | 171 | 75 | 97 | 680 |
| 1994/95 | 643 | 245 | 106 | 84 | 1078 |
[ Data for 1991/92 season is unavailable .]
[ Data is unavailable for number of contract milkers in 1992/93 .]
[ Data in 1992/93 and 1993/94 is estimated only as there is a high proportion of unknown
agreements for both seasons.]
Source: Dairy Statistics: 1988/89-1994/95
Since the 1988/89 season, the total number of other types of agreements has more than doubled from 453 to 1078 in 1994/95. The main reason for this rise is the number of agreements which are less than 29%. These have risen twelve fold from 52 seven years ago, to 643 in 1994/95. Agreements between 30 and 38% have also risen but only by 200, and 40-49% positions have remained relatively static. Those agreements above 30% tend to provide higher returns and are therefore reserved for family members, which may explain the relatively small increase in these types of agreements.
Contract milking agreements over the same period have decreased from a high of 444 in 1989/90 to 84 in 1994/95. This is most likely due to the ambiguous taxation status of the contract agreement and as a result, owners are preferring lower order percentage agreements.
In order to compare the benefits of employing a lower order sharemilker the model farm, as used to compare 50/50 agreements, was used to create a set of accounts for a farm owner and sharemilker in a 25% agreement as per The Sharemilking Agreements Order 1990 Part II. Production figures have not been changed, despite the common perception that a lower order sharemilker will produce less than a 50/50 sharemilker. This is because LIC data for the 1994/95 season indicates that lower order sharemilkers (below 29%) produced as much, if not more than the 50/50 sharemilkers. The results for the Waikato region are shown below in Table 12.
TABLE 12: Return on Capital for Waikato 25% Sharemilkers and Farm Owners
| WAIKATO ($/ha) |
| FARM OWNER | SHAREMILKER |
| INCOME Milksolids income Cattle income Rearing allowance |
2445 163 |
815 11 17 |
| Gross farm revenue | 2608 | 843 |
| Farm working expenses | 1070 | 368 |
| Economic farm surplus | 1538 | 475 |
| Wages to management | 110 | 385 |
| Earnings before tax and debt servicing | 1428 | 90 |
| Estimated capital | 22207 | 352 |
| Estimated return on capital (%) | 6.4 | 25.6 |
Return on capital invested rose by 1.1% for a farm owner with a 25% sharemilker on their property, compared to a farm owner with a 50/50 sharemilker. This represents a difference in $213/ha of net income to the farm owner. Even if an allowance was made for a 5% drop in production, the farm owners' ROC would still be 5.9%, which is 0.6% higher than that of a farm owner with a 50/50 sharemilker.
The 25% sharemilker had a ROC of 25.6%. However, this is very sensitive to small changes in their total capital involved.
This relationship was also examined for the Canterbury region. However, due to the very high feed costs, a simple 25% agreement left the sharemilker with a net deficit. For such an agreement to work, the owner must take a larger part of the farm expenses. It must, however, be pointed out that there are many lower order agreements operating very successfully in the Canterbury region, with conditions and shares of expenses negotiated to suit the individual properties and parties to the agreement.
6.3 SUMMARY
Depending on the type of agreement used and other "environmental" pressures, such as land price, cow value or type of management structure, the return on capital derived from a farming operation can vary markedly. Table 13 demonstrates the returns generated from a farm owners' and sharemilkers' point of view in both Canterbury and the Waikato.
TABLE 13: Summary of Return on Capital to Farm Owners and Sharemilkers in Waikato and Canterbury
| ROC WAIKATO (%) | ROC CANTERBURY (%) |
| 50/50 Sharemilker | 13.6 | 10.2 |
| 50/50 Farm owner | 5.3 | 7.7 |
| 25% Sharemilker | 25.6 | - |
| 25% Farm owner | 6.4 | - |
The return on capital to sharemilkers is higher in the Waikato than in Canterbury, where significant feed costs and a lower payout combine to give lower farm returns. Lower order sharemilkers in the Waikato had a 25.6% return on capital for 1995/96, however, this is very sensitive to the amount of capital they have tied up in the operation.
Farm owners in Canterbury have a higher return on capital than those in the Waikato, due to alterations in the agreement which have resulted in an effective 41/59 (0.69:1) share of profit at an EFS level to the farm owner. This compares with a 46/54 (0.85:1) return to the farm owner in the Waikato.
Over the last 24 years, returns to sharemilkers remained relatively steady at 20% until recently, when owners have changed the effective ratio of the agreement and sharemilkers have revalued themselves as a labour force to better reflect their inputs into the farm. This has resulted in ROC falling to 13.6%.
Over the same time frame, farm owners have faced a steady decline in returns from on-farm income due to steadily increasing land price and decreasing payouts in real terms. The turn around in contact terms to favour the owner has partially slowed the decrease.
If the farm owner were to regard capital gain as income and revalue their property each year on their balance sheets, they would find that their return is superior to that of their sharemilkers'.
Contact for Enquiries
Rural Affairs Coordinator
Sector Performance Policy
MAF Policy
Ministry of Agriculture and Forestry
PO Box 2526
Wellington
NEW ZEALAND
Phone: +64 4 894 0675
Fax: +64 4 4 894 0745
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