Thanks to a profitable environment for the pork industry dating back to June 2010, producers have rebuilt their balance sheets to respectable levels. In many cases today, we work with producers who have very little or no borrowed operating funds. At the low point, our average producer had a Generally Accepted Accounting Principles owner’s equity of approximately 30 percent. Through earnings, equity levels have rebounded to over 50 percent GAAP or higher for many producers. This has prompted many interesting discussions with clients. The most common question they’ve been asking is “what options best fit my operation for growth?” Let’s take a look.
First you have to determine the most suitable direction for your business. Is your objective to grow your operation for future generations? Do you want to reduce operating costs long term by owning more of your fixed assets? Are you looking to reduce your input risks by growing more of your own corn and utilizing the manure from your operation? There isn’t a fits-all answer to these questions. Looking at some of the alternatives, you can acquire an existing operation, build a new facility, purchase land, lease facilities or own the production. All of these options will allow you to grow your business. What you need to assess is what option is best suited for your business.
Let’s weigh some of today’s options. First, with land prices increasing almost monthly, what is the high in today’s market? No one can predict when land prices will top out, but we can look at the cash flow implications. Assuming in central Minnesota or northern Iowa you can purchase land for $8,000 per acre, what returns will that generate compared to building a 2,400-head finish barn?
Assuming you finance 50 percent of the land cost over 20 years with a 5.5 percent fixed rate, your payment would equate to $330 per acre rent. However, you would expect a return on 50 percent of the down payment used to purchase the land. To generate a 12 percent return on your investment you would need to make $480 per acre. Assuming your all-in cost to raise an acre of corn is $500 per acre, less land costs, you would need to generate $1,310 per acre of gross revenue to achieve this goal and cover your cash-flow costs of operation. At $6 corn, this would require a yield of 218 bushels per acre. As you can see, this would be difficult to achieve unless corn yields continue to improve. If your normal yield is 190 bushels per acre, your return would fall to 7.75 percent in a $6-corn market.
Recently USDA came out with a projected corn price ranging between $4.50 and $5 for the next 20 years. Dropping the price to the upper end of the range at $5, your return would fall to 3 percent under the same cost and yield scenario.
Now let’s compare the returns of a finishing barn. Assuming it will cost $280 per space to purchase the site and build a 2,400-head finishing barn, you would have a total cost of $672,000. Using a typical finish-barn financing model, you would finance approximately $200 per space with a down payment of $80 per space.
Assuming the same interest rate of 5.5 percent and amortizing the barn over 138 months, the required payment would be $23.51 per head. All other operational costs will run approximately $12 per head. That would put your cash-flow need to operate the barn at just less than $36 per space. If you have a contract barn or if you are replacing a contract barn which has a payment of $36, it would appear that you are cash-flow neutral. However, in today’s environment, at least in southern Minnesota, it’s common to receive $8 per space in value for the manure. Based on this assumption, your return on investment over cash flow would be 10 percent.
Granted, the higher return is partly due to the leverage between the two scenarios. However, you need to recognize the cash flow implications as well. You also need to recognize that no residual value was assigned in either scenario. This can change the analysis dramatically and will be the main driver behind the decision-making process.
These are just two of many options to grow your operation. The point is to encourage you to complete a comprehensive analysis to identify the best solution for your business. With AgStar’s Margin Manager, you can analyze input costs against revenue streams and even compare what-if scenarios to explore changes and outcomes by adjusting various elements. You can access this free tool at agstar.com/marginmanager.
Editor’s note: Each week an AgStar swine expert posts a video blog addressing current topics in the pork industry. You can view this blog at agstar.com.