Proceed With Caution
Deciding how (and if) to expand requires
knowing if you’re already profitable.
People get sick of hearing this, but don’t buy a bigger truck unless you’re already making money,” says Kevin Dhuyvetter, Kansas State University (KSU) agricultural economist. “Know you’re doing a better job than the average; if you’re not, don’t expand.”
Profitable or not, few producers are rushing to grow their herds. According to USDA, the July 1 inventories of beef cows and beef replacements heifers were 2% less last year.
There are plenty of reasons why (see “Expanding in Today’s Market – Part I” in August BEEF). Mostly, it boils down to profit. Though calf and feeder prices are higher, and input costs are lower than a year earlier, profit margins continue to be narrower than a horned frog’s eyelash.
Some tempted to expand
“If we keep seeing pressure on the cost side, we’ll have to see considerably higher cattle prices (for expansion). We’re not seeing a lot of heifer retention, and I think that has to do with the cost side,” says Larry Falconer, an agricultural economist with AgriLife Extension Service. Instead, he’s seen more expansion via retained ownership.
“It appears stocker margins will be good for the next several years, and stocker producers will have the opportunity to sell into higher markets,” Falconer explains.
Likewise, Darrell Mark, Univer-sity of Nebraska agricultural economist, says, “In the last few years, we’ve definitely seen more ranchers with available grass putting more stockers on grass in the summer as opposed to more pairs.
“It offers the advantage of being able to move in and out of the market on a yearly basis, which is beneficial when you’re uncertain of grass availability. Plus, there have been good margins for doing this in the last couple of years. This trend has been a result of higher corn prices in recent years – we’ve seen the trend toward placing heavier feeder calves in feedyards.”
However, Mark also says high prices for bred cows and heifers in Nebraska and surrounding states last spring could signal the beginnings of herd expansion there.
Mark explained that in July, “While average prices for replacement heifers have been in the $900-$1,200 range, it wasn’t uncommon to see prices of $1,500/head, especially for reputation stock. At that upper price range, I think you need to look closely at the costs of raising your own replacement heifers.”
Speaking of which, KSU’s Dhuyvetter points out there is no clear-cut heifer replacement strategy that’s profitable for everyone.
Consider an analysis of four, heifer-retention strategies conducted by John Lawrence, Iowa State University agricultural economist, in 2002. The strategies were:
• Retaining the same number of heifers each fall in order to maintain a steady herd size;
• Selling enough heifers each year – in addition to steers calves, cull cows and bulls – in order to maintain a steady cash flow year-to-year;
• Retaining heifers worth the same total value each year – more heifers are retained when prices are lower and fewer heifers are retained when prices are higher (dollar cost averaging);
• Retaining heifers worth the previous 10-year average of the number of heifers that would be retained to maintain a steady herd size (rolling average).
“The dollar cost averaging and rolling average strategies produced higher average annual revenue, returns over economic and cash costs and larger accumulated cash and herd net worth than the other strategies,” wrote Lawrence at the time. “These results hold for producers who have a fixed land base if a stocker enterprise can be used as a shock absorber for excess forages as the size of the cowherd fluctuates based on investment decisions.”
“However, producers who retain and develop more heifers when calf prices are low and produce more calves and retain fewer heifers when calf prices are high, also have greater variation in returns,” he adds. “Thus, producers who implement these strategies must be prepared financially to weather wider swings in cash flow.”
In sum, Mark explains heifer-development costs are highly variable. “My average heifer-development budgets, based on a 17-month development period and including breeding costs, opportunity cost of the heifer calf, etc., put the total costs between $1,100 and $1,200/head,” he says. “So, the optimal decision of whether to retain or buy heifers will depend on local market conditions for breeding stock and local feed costs and availability. It also depends on how quickly a producer wants to get a calf on the ground; buying bred stock can result in a sellable calf more quickly.”
Be nimble and smart
“You have to play the opportunities that come to you; we do things when the opportunities arise,” Dhuyvetter emphasizes. That means the most profitable strategy changes across operations and time. It also assumes knowing true costs of the current operation.
As an example, current industry demographics may represent more opportunity for non-traditional expansion strategies.
“If I’m young, I probably need to be more open to strategies other than sole ownership because of capital requirements,” Dhuyvetter says. “I think we’ll see more cow leasing because of that, and because the age of some producers who want or need to cut back on their personal labor investment but aren’t ready to sell their cows.”
There are several tools from universities and other sources to help sift through the opportunities (see below). But they require having a firm handle on true total costs.
“When creating budgets, you must be realistic about prices and other assumptions,” Mark says. “It’s also important to include all the non-cash costs in the budget. It’s easy to estimate cash costs like feed, but it’s also important to estimate things like the opportunity cost of labor and management, which require estimating hours worked per animal and the true value of your time.”
Before that, Mark says, “A good first place to start is seriously considering whether you want to expand your investment, given your personal, family and professional goals. Are you nearing retirement and don’t relish more work? Are you bringing a new generation into the operation and would like to expand?
What are the opportunity costs for your investment dollars? Could you make more by expanding into backgrounding cattle, crop agriculture or off-farm investments?”
Dhuyvetter says that if you know you rank among the top third of producers, you should be looking for opportunities to expand. He suggests focusing on production that allows compliance with more value-added programs.
If you’re among the bottom third, though, increased volume will only deepen the hole.
Editor’s note: A variety of tools to help assess current expansion opportunities can be found at: