At times at the close of 2010, some solid margin opportunities for 2011 surfaced within the pork production sector. There had been a slight reduction in input costs and lean-hog futures had returned to near contract-high levels.
But the interesting detail worth noting is that this margin opportunity has appeared at that time of the year in each of the past few years. If recognized, it could have saved many producers a lot of heartache.
Remember the Novel H1N1 influenza outbreak? What did you learn from that episode? Do you watch for these types of market movements and take advantage of margin opportunities when they present themselves? If you are bullish about the hog market, have you thought about using an options strategy?
As a livestock producer, it’s crucial that you identify an acceptable return either on a per-head basis or a return-on-equity basis. By determining an acceptable return, you will be able to set up and execute a plan to take advantage of opportunities when they present themselves. This certainly can be a challenge, but there are many analysts and brokerage firms available to supply the data and expertise needed to understand and determine an acceptable return for your operation.
One simple way to explain why we need to identify acceptable returns is to compare your operation returns to a 401K or stock portfolio. So, what is an acceptable return over the long term for your business?
Let’s assume a farrow-to-finish producer is able to produce a hog for $145, on average, for all of 2011. Let’s also assume the average futures position for hogs equals $80 per hundredweight. That puts average revenue at $160 and the average return per head at $15, using a 200-pound carcass and no basis.
Now, I’m not an economist but that’s a return on investment equal to 10 percent (15÷145=10 percent) for one six-month turn. In this scenario a producer could lock in that return twice in 2011, equaling a 20 percent return on his or her investment over a year time frame. The average investor would love to make a 20 percent return on his or her 401K or stock portfolio.
So, is 20 percent good enough for your operation, or what is a benchmark return that you could be satisfied with and commit to? There’s still a portion of the industry using the term “crush margin” as sort of a trendy statement versus a true understanding of what it takes to lock in an acceptable return.
The first and most critical step is to truly understand your production cost and the various risks. Do you control your pig source either through direct ownership, sow shares or contract? This is often a significant hurdle to risk management, as some producers don’t truly know their production cost because they don’t know their pig cost until animals are placed. This is exhibited by the current cash price of weaned pigs, which has varied from $50 to $60 because open-market weaned pigs are hard to find and expensive. In the long term, you will be able to do a much more effective risk-management job if you can control your pig source.
Beyond the pig price, it’s crucial to understand the opportunities to manage input costs. Direct production of feed ingredients, such as growing your own corn or a percentage of your corn, is an effective way to protect your operation against volatility. However, it’s certainly not the only way. If you haven’t investigated it, you may be surprised to learn of the various options local feed suppliers can offer to secure ingredients. You don’t necessarily need size and volume to get many of your inputs booked. There also are the CME’s tools to address corn, soybean meal and lean hogs through futures or options. Indeed, there are many sources available to help manage input costs if you’re willing to ask questions and learn.
Across the industry, the strength of grain markets continues to temper hog expansion through new construction. There are a few quality sow units that had been ramped down (due to health status and the financial issues), which are now being repopulated with air filters in place to increase biosecurity and productivity.
Pork-cutout values and exports have been strong, with 2010 pork exports up 2 percent versus 2009. USDA projects stronger exports this year, depending on the U.S. dollar’s strength and the global economic recovery.
All in all, 2010 began the process of healing producer balance sheets. With a solid risk-management program, 2011 and beyond will provide the returns that successful producers and the industry deserve. However, the key will be determining an acceptable return, and developing and executing your plan to achieve it.