The sudden increase in combine sales in the months of April and May of this year has created a great deal of head scratching around our office. Commodity prices are down, tariffs are in place on some grain exports and the prospects of other agricultural tariffs do not suggest an increase in combine sales in the U.S., yet they did occur. The question that looms large is “What happened?”
Our database stretches back to 1969 and it has served as the basis for the development of various forecasting models used in our annual Tractor & Combine Forecast. There are many advantages to utilizing these historic models, but there are also a few drawbacks associated with their use. When there is a substantial shift in market activities, it renders these models less effective, but what are the changes that led to variation?
We began our search by looking at history and found that combine sales began a slow, steady climb in 2004 and had increased by more than 50% in annual sales by 2010. The influence of the Section 179 bonus depreciation program spurred some growth in 2011, and we decided that would become our base year in this study.
The period of 2011-14 was marked by rising commodity prices, lower U.S. dollar value compared to other world currencies and an extremely active export market. This was also the period when the Internal Revenue codes added the “bonus deprecation” clause as described in Section 179. This particular code resulted in increased purchases of combines and more frequent replacement of combines in the U.S. agricultural markets.
As commodity prices began to falter in 2014 and the dollar began to gain strength in the international marketplace, farmers and ranchers in the U.S. experienced a decline in net farm income that would continue through 2017 and would impact agricultural equipment purchases.
This impending decline in equipment purchases brought about an interest in equipment leasing programs offered by the major tractor manufacturers and other financial companies. Leases were considered to be “off balance sheet” transactions and could produce a positive impact on the individual’s debt/asset ratio. This was very attractive to young farmers and ranchers since it would allow entry into farming with a smaller cash outlay and a reduced impact on their ability to borrow for their farming operations.
During the period being examined (2011-17), there were 52,102 combines purchased in the U.S. and sales of combines in 2011-14 accounted for 74% of the total units sold during the study period. During the 2011-14 timeframe, farmers’ net farm income increased to record levels and most farmers were profitable and could take advantage of the tax benefits afforded by the Section 179 bonus depreciation. That also indicated that substantial future sales were pulled into those years.
We have produced models that predict the “normal replacement rate” of combines in terms of units and found that 3,908 combines were purchased annually. Based on this assumption, 2016 combine sales (3,979) represented essentially only the basic replacement units were purchased.
It became apparent that combine sales were exceeding the rate of growth of comparable tractors and we developed a comparison to 100-plus horsepower tractors to find if a correlation existed since the purchasers of these tractors are most likely purchasers of combines, as well. We found that the relationship in 2011 was 30% and the figure declined each year until 2016 when it reached 21.5%.
Based on the information produced by the major tractor manufacturers and provided as public information, sales that were financed by lease contracts began to increase in 2014 and grew as a percent of the total sales of tractors and combines in the U.S. each year. These contracts typically cover time periods from 24-48 months, which had the effect of shortening the length of time that a user would have possession of the unit.
What is not clear is the percent of combines acquired each year through a leasing agreement. As the financial strength of farmers and ranchers declined, it is apparent that leasing of equipment had become much more prevalent, especially in the higher valued equipment.
The impact of shorter lease contracts and the normal base replacement numbers indicate that these higher sales as reported for April and May might be the “new norm” for future forecasts. Lease contracts typically cover a 2-4 year period, which would suggest a much shorter replacement cycle by producers than what history might suggest.
Our research indicated that producers’ length of ownership of combines varied widely. Custom combine operators placed many more hours per year on their combines and therefore required a more frequent replacement of their equipment while there is a small group of farmers who may buy only one combine in their lifetime.
When combines sales are viewed from a calendar year perspective, the majority of units are sold during the September to December timeframe. The total 2018 first quarter sales were slightly under (–1.3%) our November 2017 forecast, but the April and May results were significantly higher than forecast. Our 2018 total forecast for combines was 3,879 units, which is below the indicated replacement unit number so we most likely will have a year-end total higher than our forecast.
From a dealer’s perspective, this could indicate a much larger value of used equipment on their lots and the need to formulate a program to deal with returning leased equipment of all types. Both the dealer and the manufacturer must have retail sales no matter what the economic conditions. The use of lease contracts to achieve those results is certainly a two-edged sword; it will bring needed sales in slow times but it will also will bring inflated used inventories filled with relatively higher priced, late model equipment that might be difficult to move profitably in slower economic times.
For us, this problem brings an inconvenience and potential embarrassment, but for dealers and manufacturers there are significant financial consequences.