Debt - excess to be avoided

Let's hope that the drama being played out in Europe doesn't find the shores of New Zealand.  Although the issues seem remote from us, NZ is a heavily indebted economy and we are vulnerable to rising interest rates affecting solvency and economic growth.

At first glance, the problems in Greece, Italy and others don't seem to affect us here in NZ.  Asia rather than Europe now dominates our dairy trade.  But trade is inter-related and USA and Europe are China's key export markets.  So although the on-going issues will have an indirect effect there will be (and already is) an effect.  Fortunately China is evolving into a more balanced economy with more of its growth coming from domestic demand.  When China starts buying dairy commodities again in the New Year prices will probably respond by lifting.

But back to the issue of debt, The NZ Dairy Industry has too much debt; average equity levels in 2010 were 54% according to the Economic Survey published by Dairy NZ.  And 23% of farms had equity of 30% or less.

MyFarm properties have come through the GFC well - one of the principal reasons has been a conservative approach to debt.  In our view, businesses that are being established with the objective of paying regular cash dividends should have 30% or less debt.  And if markets take note of NZ's debt position, it is possible that interest rates could rise steeply with very difficult outcomes for those concerned.

So if buying a farm or joining a syndicate, make sure that debt levels are moderate.  Your investment's security may depend on it.