Cooperatives: What we expect to see in 2020 – Dennis Gardiner, CPA, Managing Partner
I believe the general consensus is that everyone is glad to have 2019 behind us! What does 2020 hold for the industry and our clients? As always, our perspective comes from being involved in your audits, board and annual meetings, planning sessions, visiting with management and being immersed in agriculture. Here are our thoughts:
- Capital Expenditures – We do not expect to see a big spending boom in 2020. Many clients are still adjusting to their capital expenditures from the past few years We are seeing some big projects being considered, but the price tag has become pretty hefty with many of your needs and wish list projects. Recent profitability required many of these projects to be set on the back burner. While we still expect to see you spending close to your depreciation expense, you will continue to focus on the divisions that continue to perform well.
- Local (Operating) Earnings – Bottom-line contributions from your grain divisions depends on what region your ag-business is located in the Midwest. Many areas around South Dakota and Minnesota were severely affected by weather last spring and fall, which means the bushels being will be impacted again in 2020. The outlook for soybeans appears to be improving as China and US relations improve and trade tariffs are waived. The competition for the seed and chemical business shows no signs of letting up, further stressing margins and reducing volume sales. Milk prices in 2020 are likely to improve over 2019, with a small increase in production and gains in some product prices (except butter). Precision agronomy income continues to increase.
- Struggling Divisions – We expect to see continued focus on how to address struggling divisions. As desirable as it is to have all divisions contributing to the bottom-line, that is more of a rarity than reality. Interest from regional cooperatives and private companies has ramped up over the last year, especially in agronomy. Joint ventures will be explored with these parties or neighboring cooperatives. We saw one client sell two divisions to another cooperative this past year, which will allow them to focus on their company’s strengths and future. I don’t predict that we will see a lot of that, but we do expect to see more clients exploring options to address struggling divisions. It has become too expensive to have to have divisions being subsidized, which may lead to somewhat of a “specialization” by the cooperatives.
- Expenses – Expense control will be a greater focus as bottom lines have suffered in the past. Struggles to right-size continue as volumes of grain and fertilizer have been significantly affected by the weather. Fixed expenses are not likely to decrease, although depreciation may stabilize. Personnel costs will continue to increase as cooperatives struggle with a new work force, competition for talent, and ever-increasing benefit costs.
- Credit Risks – Most of you have been very good at managing this risk, and we encourage you to stay the course. The importance of having and adhering to strict credit policies is very clear. Be diligent and adhere to your policy in this risk area of your operation.
- Cybersecurity – What can I say, this is one of your organization’s biggest risks. Your organizations are not exempt from hackers taking over your computer systems and demanding ransom. Like all risks, diligence and adherence are the best way to protect your organization from cyber risks. Continuously educating your staff, working with your vendors, and strengthening your controls are necessary to reduce your vulnerability to hacking and cyber fraud. We expect to see continued improvements in controls over information, access restrictions to your systems, applications, data, third party records, and sensitive data. Additional layers of security will become necessary to address all of the mobile devices that may affect your systems. Ongoing testing of vulnerabilities is necessary to stay vigilant against phishing schemes and other means of accessing your systems.
- Fraud – Performing a fraud risk assessment of your organization, its divisions, and accounting functions should become a routine and ongoing process. Use of third party “whistle-blower” hotlines to provide for anonymous reporting will increase. Many of your organizations have continued to grow, hiring new employees, or replacing employees through attrition. This will increase the number of new unfamiliar employees to your organization. A strong “tone-at-the-top,” creating an ethical work environment, and having a zero-tolerance to fraud can help to mitigate your fraud risks.
- Mergers – A slowdown in mergers is not likely. Managers retiring or smaller companies struggling will driving most merger studies. “Peer on peer” mergers will continue, but with the size of some of your organizations already, they will slow down. Attempting to right-size your cooperative from the last merger affects how you look at another one. The question “is bigger better?” continues to be discussed.
- Acquisitions – Cooperatives will continue to draw interest from smaller (even competing) businesses as they consider exiting, and perhaps working to retirement to have health insurance for the owners. Acquisitions will continue to be an outlet for growth in the coming years.
- Retained Earnings – The growth (past, current and future) of permanent capital is hard to avoid. We expect to have more conversations on how or whether to address the growing retained earnings. That said, we do not expect to see a lot of changes in emphasis as the cost and cash flow demands of capital expenditures and capital (both debt and equity) continue to increase. The common argument we hear is that the members are not concerned about it. Efforts to revolve older deferred patronage will continue.
- Non-Qualified Patronage Allocations – We have this discussion with almost every client, regardless of size. Increased use by the regional cooperatives will elevate the conversation. Use of non-qualified patronage will become more prevalent to address maximizing tax deductions, managing cash flow, and addressing retained earnings.
- People – Mother Nature may present many challenges to your company, but nothing like the ability to find and retain staff. Sadly, weather only makes it a greater problem as you wrestle with answers to solving staffing issues. Finding and retaining staff to work demanding hours in sometimes difficult work conditions is going to continue to be one of management’s challenges. Even if your budgets allow you to pay higher compensation, that doesn’t resolve the problem. The number of key individuals retiring in the next few years is going to cause plenty of struggles. Find good staff, invest in them, and help them find the work-life balance they desire (despite how difficult it is to overcome the “this is how we have always done it” mentality that may exist in your organization). Defining what your work force will look like and how they will work should be a priority and ongoing process. There are no easy answers and no end in sight to this challenge.
- Technology – Conversions to new data processing systems will continue as companies look to find and address the recent and ever-changing advancements along with demands of users and patrons. You just can’t seem to spend enough to keep up with technology advances. Mobility will allow users and members to access the system and their accounts from any mobile device is the trend. As mentioned earlier, this increases exposure to more cybersecurity worries. Precision agriculture technology continues to improve, and investments in providing this service will increase.
- Section 199A(g) Deduction (DPAD) – Despite the changes that came through from TCJA (Tax Cuts Jobs Act), the deduction is largely the same to the cooperative, and the way it has been used, and will continue to be used, is not likely to change. Maximizing the benefit to the cooperative and allocating the balance to the patrons is still the most common approach, which capture the most tax benefit to the cooperative. We are still functioning under proposed regulations from Section 199A, and there are issues yet to be addressed. We will keep you apprised of the resolution of these as they become final.
The good thing is that 2019 IS behind us and all of you are looking at a brighter future, not challenge-free, but with great upside potential. Cooperatives and agribusinesses have always faced their challenges, evolved, and adapted, and will be ready for what the future brings! We are very proud of our long history with so many of you and the industry, and we will strive to be a source for you to address and overcome your challenges. Happy New Year!