In charity golf tournaments, sponsors buy insurance to protect themselves from the happenstance, prize-winning hole-in-one. Yet, when playing the cattle feeding game, some customers choose to go unprotected from price swings, sickness, weather and all other risks.
Those who don't employ risk management strategies cite horror stories, lack of understanding, lack of control and other reasons for not taking steps to ensure a locked-in price. Those who choose to control risk say that guaranteed prices, a known delivery date and the ability to meet loan requirements make risk management worth the extra work.
With unlimited variables in the business and varying definitions of risk, it seems that more producers would take every step possible to eliminate risk. Yet, Paul Colman, director of customer service at Cactus Feeders in Amarillo, TX, says that only 25-30% of the industry "cattle on feed" numbers will be fully hedged.
A mixture of tradition, experience and comfort levels with futures markets often determines the level of risk management. Leonard Wulf, a partner in Leonard Wulf and Sons, Inc., Morris, MN, says a mix works best for his operation.
"We have 8,000 to 13,000 head on feed each month, depending on the time of year," he says. "We always have some on the cash market, but we also have some contracted. Right now, all of our cattle going into branded programs are forward priced. It gives us some security.
"However, we've been buying and selling cattle for 49 years. I don't mind having 25-30% contracted. At the same time, we're continually buying and selling cattle and if we keep a similar amount on hand, it's almost like an automatic hedge of sorts. Using the cash market lets us take advantage of the situation if the market goes up," he says.
Wulf admits the hit of a sudden market downturn can take a whack at profits. But, over the long term, his experience has made feeding and selling on the cash market profitable.
It Starts With A Plan If customers haven't used risk management before, getting started begins with the basics.
Neal Odom, manager of McLean Feedyard Ltd., McLean, TX, says managing price risk is more than simply being hedged.
"Developing a plan or strategy ahead of executing a hedge trade is risk management in itself," he says. "To develop a good risk management plan, an individual has to know production costs, be able to identify variables that may change the plan, the current price trend, seasonal price tendencies and understand basis."
He suggests sticking with a basic strategy until a customer is comfortable working with the futures market.
Personnel with some feedyards will work with customers to help determine variables and make a plan. In addition, several feeding fact sheets and calculators are available from Oklahoma State University at http://agweb.okstate.edu/pearl/agecon. Basic risk management terminology for customers is also presented in "Risky Business" on page BF-4.
Bruce Voyles, a customer service representative at Cactus Feeders, says planning and implementing strategies gets easier for customers as time goes by.
"To learn risk management well, you've got to be doing it every day," Voyles says. "That's what we have to do here and we'll work with the customer to help him determine what's best. Every set of cattle is different so there's no one way to use risk management. We're not brokers, so we can't advise customers as to which method is best. It comes down to making sure he understands all the options to aid him in his final decision."
Look At Your Options There are several ways to implement strategies. Voyles explains that when Cactus Feeders banks customer activity, they finance cattle and feed, less $125 equity per head. Next, they share with customers three alternatives that offer:
* A straight hedge with futures.
* Buying a put or floor, which basically insures the cattle.
* A put/call strategy when a customer knows his breakeven costs.
Customers at McLean Feedyard follow a similar mix. Odom says a lot of customers like to use options because it's like house insurance - it's nice to have if the house burns down. Others may use straight futures whether hedging a trend or locking in a price. And some incorporate a combination of futures and options.
"Complex combinations of options and futures provide greater flexibility and protection," Odom says. "However, they require extensive study before placing the positions and great attention to the liquidation process."
Retained ownership is another gadget in the risk management toolbox. Bob Sims, manager of Tri-State Cattle Feeders in Hereford, TX, says his yard has more cattle under retained ownership than in the 26 years he's been there.
"We've worked hard at retained ownership, especially in the last 10-12 years," Sims says. "It's a good way for customers to get top value for their cattle."
Feeders and industry analysts expect retained ownership to increase as more cow/calf producers understand its upside potential.
"Ranchers have gained a lot of experience the past few years and they're no longer afraid to keep their cattle, use a risk management plan and benefit from the genetic improvements they've produced," Odom adds.
Conquer With Cash Whatever approach customers take, experts advise caution. While minimizing loss and getting a fair profit are the primary goals, getting too aggressive may have disastrous results.
Colman says a judicious use of futures and options has created positive results for Cactus Feeders and its customers. He also doesn't rule out the cash market when times are right. Others agree.
"Nothing takes the place of buying low and selling high," Sims says. "Right now, most cattle are making $100-$150 a head. Had they been laid off against the Board, they'd be making very little money."
He adds that passing risk to a third party is fine when the market isn't so rosy, but it's important to take advantage of profitable conditions. Showing customers where profit opportunities exist can go far in developing long-term feeding relationships as well.
"For the past five years, we've learned to operate risk management strategies in a period of herd liquidation, an oversupply of cattle and soft demand," Odom says. "We're headed into a period of tighter supplies and are experiencing an increase in beef demand."
These factors, Odom says, suggest that being hedged less of the time and holding out for a little more money should provide the best risk management plan for now. But, he adds, "there will still be a need to hedge change in price trends, which are seasonal and supply-related."
Put simply, a risk management plan requires helping customers understand existing market conditions, ongoing trends and prudent employment of tools that fit the customer, his financial backers and the feedyard.
It also involves a realistic look at profit goals and not getting too aggressive. As Voyles' father used to say, "You'll never go broke making a little profit."