Risk management is a daily priority and it plays a key role in preserving your profitability. While volatility and uncertainty have always been a part of your business, today the swings seem to be even more sudden and extreme.
With corn and soybean meal costs likely to remain volatile for the second half of the year, your operating margin also may get tossed around. There is some uncertainty about whether the hog market will see further weakness in the next six months and beyond.
Robust exports of U.S. pork have been listed in the “plus” column for the past several years, but that’s always an uncertain market. Last year sales reached record-high values of over $6 billion and accounted for more than one of every four hogs produced. However, everyone remembers the sudden downturn that the 2009 H1N1 influenza virus prompted.
Increased international travel and trade have raised your margin risk. Minor disruptions of exports would hurt; major disruptions such as a disease outbreak could cause pork supplies to pile up in U.S. warehouses. “Exports could become the Achilles’ heel,” says Daniel Bluntzer, Frontier Risk Management, Robstown, Texas.
Domestic pork demand is still a key ingredient to hog prices. After all, more than 70 percent of your product remains at home. “Our model suggests a loss in domestic pork demand versus the same period last year, resulting in a loss of roughly $15 per hundredweight on a carcass basis,” Bluntzer says.
Are your Risk-management Strategies Sufficient?
While new risk-management options come along periodically, be sure that you’re taking full advantage of the conventional ones.
“Existing tools with futures and options offer many opportunities to lay off risk and help manage basis,” says Kent Bang, vice president, AgStar Financial Services, Mankato, Minn.
The emphasis, according to Bang, must be on strategy and execution. That’s a better use of your time and energy than exploring new tools. But for those who need more, a new lean-hog calendar spread option is available. A futures calendar spread consists of a combination of a purchase in one futures contract month and a sale in another futures contract month. For more, see http://bit.ly/KQl2a2.
Depending on your situation, increasing on-site grain storage can offer another risk-management route. “With additional grain storage, managing new-crop corn purchases and physical inventory becomes another tool to manage a larger share of your inputs,” Bang says.
Even when grain prices are trending in your favor, managing volatility is a priority. “As we see it unfolding this spring, grain prices should move lower, which will help, but prices will likely remain quite volatile,” Bluntzer says.
March and April futures markets caught some producers off guard and took significant profit opportunities off the table. “Margin destruction from the rising soybean meal futures emphasizes the need for a ‘crush’ mentality,” according to Bang. “While some producers took advantage early this year and crushed strong margins, a few with 100 percent coverage, many missed the opportunity presented.”
Currently, the revenue side of the risk-management equation is where you face the most adverse market exposure. “Much like the opportunity presented in January and February, there will be more opportunities in the future to use risk management to lock in a profit on hogs,” points out Shane Ellis, Iowa State University livestock economist. “However, those opportunities do not last forever.”
Certainly, raising hogs is a margin-driven business and should be treated as one. “Don’t miss an opportunity to capture profits,” Bluntzer says. For a wide range of commodity derivatives with trading available on corn, soybeans and soybean meal as well as hogs and other commodities, go to http://bit.ly/JXvcGi.
A resurgence in domestic meat demand will help support hog prices, but Ellis says that may take some time. Until consumers have more confidence in their own financial security, he believes the meat complex will have a hard time establishing a bullish market trend. “Economic conditions and consumer confidence are still shaky, and that will tend to hold down hog prices.”
While risk management is a high priority, don’t take your eyes off production essentials. Bang believes there is still room for continuous improvement and revenue enhancement in many systems. “Keep your production team focused on improving survival in both the pre-wean and wean-to-finish stages,” he says. “Marketing a higher percentage of full-value pigs is an area where revenue can be enhanced.”
Thinking about Expansion?
If you’re thinking about growing your pork production business, a prudent first step would be to calculate your post-expansion capital position and determine how you will stack up against industry peers. You’ll likely face the question from your lender, so making that calculation would be time well spent.
“Any expansion plan should be based on an honest assessment of your system’s ability to out-produce and out-market a large portion of the industry,” Bang says. “How you compare to your peers is critical. Have your plan ready to address how you can reduce costs and maintain a strong financial position through the next cycle.”
If it’s new construction or expansion of farrow-to-wean facilities, expect to bring a lot of capital to the project. In general, new construction costs have outpaced market values or appraised values of real estate.
Be ready to communicate your strategy clearly to your lender. This includes your capital requirements as well as results of your risk-management strategies. “You will increase your lender’s knowledge and comfort level in the process,” Bang says.
Expansion should be done slowly with as little leverage as possible, according to Bluntzer. He recommends finding a lender who is savvy about hedging and understands why and how it’s used. “Do your homework with several pricing scenarios and understand margin-call risk,” he adds.
While protecting your margins in today’s environment is a challenge, don’t look to set new profit records with every hog sale. Ellis says the decision of when to price feed and hogs should be mechanical rather than emotional. “Those who make some profit every time will have more profit longevity than those who cash in on large profits only occasionally.”
In Their Own Words
Feed prices are always top-of-mind and rank No. 1 on most producers’ list of concerns. However, depending on your production system, a few other topics are not far behind.
“It may sound familiar, but risk management is currently the most important issue in the pork industry,” says Gary Asay, Asay Farms. “With the good profitability outlook early in 2012, some producers may have gotten complacent and neglected to lock in profits.” The Osco, Ill., producer operates a wean-to-finish system and markets 9,400 hogs annually.
Asay quickly adds other top industry concerns. “Sow housing options and environmental issues also are having a bigger impact and affecting more operations,” he says. “We all know that it’s getting more expensive to raise hogs on a number of fronts.”
Bankers have money to lend for expansion, but it may involve a longer process. “With the oversight on bankers, loans may not move quickly and more documentation will likely be required,” Asay adds. Make sure all the details are in place first and double check everything. “There may not be room for errors.”
Looking ahead, another concern is that the U.S. hog herd may grow beyond packing plant capacity. “Long term, there likely will be global demand for our pork;
the trouble may be funneling it through the packers,” Asay points out.
Both pig flow and health status are crucial factors in protecting operating margins, according to Leon Sheets, Ionia Pigs, Inc., Ionia, Iowa. “If you’re on the sow-herd side producing weaners or if you’re buying feeder pigs, throughput becomes key,” he says. “In either case, health challenges can take a bite from your marketing plan.”
Sheets sells 20,000 weaned pigs at 50 pounds to 60 pounds and also finishes around 5,000 hogs annually from his farrowing operation.
Maintaining herd health and biosecurity are high priorities. “You may have your inputs calculated right but if the throughput isn’t there, the cash flow just won’t add up,” he says.
If you’re thinking about new facilities, whether for finishing space or sows, pay attention to the location to minimize neighbors’ objections, Sheets says. Other factors to figure into the growth equation are the need to hire more workers as well as any revenue from manure produced for use as fertilizer, he adds.