Cattle feeding losses reflect changing times for industry

News
Feb 13, 2009
by WLJ
Cattle feeding losses reflect changing times for industry

—Feeders must reassess risk management.

For feedlot operators, the final determination on whether 2008 will be classified as “the worst year” or simply “one of the worst years” could depend on whether they are still feeding cattle in 2009. The financial losses during the past year are welldocumented for feeders.

February 2009 fed cattle futures fell from $116 per cwt. last July to about $81 now. That’s an average decline of about $450 per head. CattleFax, an industry market-analyst group, projects feedlot operators lost an average of $150 per head in 2008. Tom Brink, vice president of risk management and cattle ownership for Five Rivers Feeding, calculated that even at a more conservative $100-per-head loss, that would amount to about $2.6 billion in losses in the feeding industry last year. “That’s one of the worst years in the cattle-feeding business on the books,” Brink said. Brink talked about riskmanagement strategies for cattle feeders at a Cattlemen’s College panel for the Cattle Industry Convention recently in Phoenix.

Times are changing, Brink said, and while the average cattleman may love the image of John Wayne as a cowboy, the modern image of a cattle feeder may be of someone wearing a suit, sitting at a desk with a laptop and spreadsheets, and looking at his Blackberry.

Red ink continues to flow

Using a university-extension calculator and some average projections based on buying feeder steers at last week’s prices, those feeders will likely sell as fed cattle next summer at a $30-per-head loss. Buying cattle at a loss every day is a poor strategy, and industry is shooting itself in the foot, Brink said. “We’re going to see a fair number of operators carried out of the feedlot business,” Brink said. At Five Rivers, Brink is in a unique position to assess risk management. Now owned by packer JBS, Five Rivers has 10 feedlots in five states with a capacity for 811,000 head, making it the largest cattle feeder in the industry. Five Rivers also sells practically all their cattle on a grid marketing scheme.

Francis Fluharty, an associate professor at Ohio State University, said in a phone interview with DTN that even small farmer-feeders who might only be feed-ing 500 head to 5,000 head need to take advantage of the risk management that larger-scale feedlots do; if they’re not going to do anything else, they need to buy puts to lock in the loss they might incur if the market goes down. “In a market like this, to not lock in a loss, to not use puts, to not be forward contracting grain, to not know your costs, is just asking to lose money,” Fluharty said. “And from that standpoint, from that point on, you try to manage things as best you can in terms of animal health and bunk management—efficiency of gain— that comes down to feedlot management, your bunk management.”

Raising cattle is a business—and like any other business, to improve efficiency, cattlemen need to look at spending money where it makes sense.

Risk management is difficult because no one likes to hedge at a loss. So feeders are looking for a $2 to $3 upswing in the market before they consider hedging their cattle. Instead, the futures went down last week, making it even more difficult to find a breakeven hedge, Brink said. At times of low fed prices, high corn and energy costs, in addition to labor costs, Brink said feedlot operators have to balance feedlot occupancy versus a reasonable breakeven. Operators need to better know their operating costs at different levels of occupancy.

“This is one area where all of us need to spend some time understanding those trade-offs,” Brink said. Since 2003, Five Rivers has maintained a more disciplined buying strategy to draw a hard line on breakevens when buying feeder cattle.

Five Rivers feeds about 1.5 million bushels of corn per week. While corn prices have come down from their summer 2008 highs, the reality is that corn prices are going to stay at a higher level than historic prices.

That’s a constant struggle for a cattle-feeding industry that built itself based on cheap corn. “We’re vulnerable to these higher grain prices in the cattle-feeding business. There’s no question about that,” Brink said. “We need to start thinking about ways to defend ourselves against these high corn costs.”

Nevil Speer, a business analyst at Western Kentucky University, said purchasing grain has been the most challenging thing for a lot of feedlots—there doesn’t seem to be a right time to buy corn. A 25,000-head feedlot uses 7,000 bushels to 8,000 bushels of corn per day. If corn moves 30 cents in a week, that’s $200,000 for a three-month supply of corn if people made the wrong decision.

Challenging business environment

Everything that’s coming at these guys is all brand new—no historical basis for guidance—it’s all new,” Speer said. “Unfortunately, it’s going to take some people out along the way. When they start making risk management/marketing decisions, what producers forget to consider is cash flow situation, management options, needs for their particular operation.”

As for do they have the resources to feed calves for a few more months, Speer said feedlots are “all over

the place” when it comes to buying feed. Some are hand-to-mouth and have ridden this market down; some have used strict risk management, such as options and traditional hedging strategies. There’s not one strict solution.

“That’s the other challenging thing—so much variation in terms of feed costs because of that,” Speer said. “Who got caught, who didn’t—no way really to know that in aggregate.

Those guys who’ve been hand-to-mouth have gambled correctly.” When placing cattle, feeders need to cover at least a portion of their corn needs— potentially 50 percent or more. Feeders may risk losing out on a potential price decline with the higher amount of feed they lock in up front, but cattle feeders can no longer consider “hand-to-mouth” feed as a viable strategy, Brink said. “There is too much risk, too much exposure,” Brink said. Placing cattle at heavier weights also reduces overall feeding costs. At 600 to 700 pounds, cattle are on feed an average of 191 days, compared to an average 138 days for cattle placed on feed at 800 to 900 pounds. That’s an average 10 bushels less per head. Feeders should also look at alternatives to cattle, but they need to consider the various factors involved there. Not only should producers consider nutritional issues, but they should also consider how that new feed additive affects operations and logistics. Are the feeds easily set up to handle or procure?

Energy markets play a role

As far as the energy markets, Brink said producers will need to better understand energy futures and how to use those markets to their advantage.

“It’s kind of been tough for us to look at it and how we approach it,” Brink said. “We know about the corn market. We’ve been paying attention to it for a lot of years. And we know about the cattle market ... We obviously haven’t historically paid much attention to our energy costs. So this is learning ground for all of us in the cattle industry.” — DTN

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