“I'm bullish on the outlook for the industry, but that doesn't mean there will be less risk or everyone will make money,” says Bill Helming, of Helming Consulting Services, a leading agricultural economic analyst and consultant.
That summarizes both edges of current financial risk in the beef industry. One edge carves out new profit opportunities, while the other slices away mismanaged equity, sealing the fate of long-standing players.
Fact is, Helming says, there's more risk — financial risk, uncertainty and price volatility — today than he's seen in 40 years of owning cattle and trying to help others make sense of the industry's economic landscape. Keep in mind he was the first chief economist for the old National Cattlemen's Association and Cattle-Fax's first general manger.
Everything's up — good and bad
In terms of inherent financial risk, Helming explains, “You're having to put more capital at risk, both equity and borrowed capital, for profit prospects that are not a lot different than they have been historically.”
To be sure, all industry segments have enjoyed unprecedented profitability the past two years as prices established a higher level. But that means the stake has increased in existing assets, let alone expanded ones.
Barry Dunn, King Ranch Institute for Ranch Management executive director, says, “If you're increasing investment, you're increasing risk.” Dunn says that increased investment broadens the exposure to risk.
For investment perspective, if you were going to retain ownership in or feed a set of feeder cattle a couple of years ago, you needed $100-$135/head equity (20% of the value). Today's prices mean that requirement has increased 75% to $175-$200/head.
The same trend applies to replacement heifers and breeding cows, too. But, the flipside is that profit expectations continue to be at or slightly above breakeven over the longterm.
Helming cautions producers to remember why cattle prices reached their historic zenith. Increased consumer demand fueled a rare alignment of fundamentals in which the lowest cattle supply level since the 1950s coincided with increased demand. But competition for the tight supplies was driven in large part by a force that could prove net-negative in the long-term — excess cattle feeding and packing capacity.
Historically, Helming estimates utilization of feeding capacity has run 75-85%. Today, he pegs it at 60-75%. With every percentage point of decreased utilization, costs increase exponentially. Though the specific numbers would be different on the packing side, he says the magnitude of decreased utilization is similar.
“The trend of the past 10-15 years is we significantly increased cattle feeding capacity and liquidated cattle inventory. That won't change much in the next 4-5 years,” he adds.
Plus, more cattle feeders must own more of the cattle they feed because the large and once-deep pool of investor customers has all but dried up, he says.
“By definition, they're taking on more financial exposure. I think the number of cattle feeding customers will be even fewer over the next 5-10 years, so feeders will have even more risk than today,” he says.
All this adds up to the fact that despite extraordinary profits in each production segment the past two years, it's unrealistic to expect it to continue. So, profit prospects are not proportional to additional investment required and risk involved, he says.
In fact, pricing patterns are returning to normal, says Jim Robb, Livestock Market Information Center (LMIC) director. Fed cattle prices reached a cycle peak in fourth quarter 2003. Feeder prices (700-800 lbs.) reached their cycle high in August 2004. Calf prices were peaking this spring, all shattering previous price records.
With this return to seasonal normalcy, Robb expects the lowest calf prices of this year in the fourth quarter. He suggests to cow-calf producers, “Look at pricing cattle for fall delivery sooner this year than later.”
Clouds of uncertainty
Now, toss in the reworking of North American beef production taking place as Canada expands packing capacity, while a ban on exports of Canadian live cattle continues to threaten existing U.S. packing capacity. Consider the portion of former U.S. export market share Canada may be able to capture, and the prospects are even spookier just a couple years up the road.
In other words, uncertainty, which adds to risk, continues to grow. BSE and its many unknowns serve as a daunting example. When will the Canada border open and how fast will cattle move? When will U.S. beef exports resume to the Pacific Rim? How much lost market share can the U.S. regain and how fast? Will export limits on competing proteins throw beef prices into another spin?
For that matter, Helming explains the speed and degree cow-calf producers build the herd during the recently begun cattle cycle will drive their risk higher during the next 3-5 years.
Though the cow-calf segment has arguably been the primary benefactor of supply and demand fundamentals the past few years, Helming adds, “The cost of running a cow-calf operation is high and continues to increase. Even if they're faring well today, they may not be faring as well as some think due to the rising cost structure.”
Every time a market shock zaps the industry — or even threatens to, in some instances — LMIC's Robb says it takes the market 3-4 months to normalize.
With heightened capital investment requirements in mind, Robb says producers should exploit their recent profitability to build a pool of cash. This allows them the position to borrow if they need to hold calves longer to avoid market adjustments.
The need to position for management and marketing flexibility is underscored by the cliff's-edge price volatility that's entered the market the past 24 months.
“Any given week, it's not unusual to see prices of live cattle change $2-$5/cwt., or boxed beef cutout values to change $4-$7/cwt. in a week,” Helming says.
Old and new strategies
Bottom line, Helming believes supply and demand fundamentals will keep commodity cattle business margins tight and modest, just as in the past. So producers wishing to continue the commodity game must rely on the risk strategies they always have, from hedging to cost reduction.
“As time goes on, I'm less convinced there's a straightforward approach to risk management. It's more of a toolbox approach, year-to-year pulling out the tool you need,” Robb says.
For instance, though many would argue the futures markets for live and fed cattle hasn't offered the opportunity to adequately offset risk as prices entered a new frontier, Dunn says using the board to protect the input side is fairly predictable. Away from the futures, inputs such as feed, interest rates, fertilizer and fuel are all candidates for locking in prices.
Likewise, while many producers don't view it in this light, Dunn says, “Drought management is a risk management strategy in the two-thirds of the nation where there are cyclical droughts.”
Helming adds the ability to stay in the game long-term, “is doing a lot of things that will be a little different that gives each segment an edge or series of edges.”
He's talking about things each segment can do in concert, via coordination, to exploit value-added opportunities, be it increasing capacity utilization or the final value of the product, or slicing costs.
“The future is value-added. That doesn't mean we'll be completely integrated. It means the industry will be much more closely coordinated to make it possible for each segment to be a value-added participant,” Helming believes.
“To me, one major risk management tool few producers view as such — but which offers lots of opportunity — is figuring how to add value. A cow-calf producer can do that only through retained ownership. It offers the largest opportunity for cow-calf producers over the next 5-10 years,” he says.
That's an edge. And, Helming believes, “If you don't know specifically what your edge is, you don't have one.”