KAY'S korner

Nov 6, 2009
Packers manage margins

Fed cattle processors enjoyed their best August operating margins since 2003. The real story, though, is that they achieved this not at the expense of cattle feeders. In fact, the opposite occurred. Cattle feeders enjoyed a strong and much-needed rally in prices.

Cash prices advanced $4 per cwt. during the month, putting many feedlot closeouts in the black. So how did packers make more money yet pay more for cattle? The main reason is that packers are managing their spreads (the difference between what they pay for cattle and sell the beef for) better than I’ve seen them do in 25 years. The second reason is that wholesale beef prices held steady through August, and actually strengthened a bit the last two weeks, despite higher production than in July. Buying for the Labor Day holiday weekend was one factor, along with some sizeable out-front sales extending into October. The third reason was the continued rally in byproduct values, notably hide prices. The values averaged $8.61 per cwt. the first week of August.

They averaged $9.44 the last week of August. This difference gave packers an extra $11 per head. The values are still well below the inflated values of this time last year.

But they are now much closer to their 2007 levels.

Packers paid more for cattle in August because they needed them. Cattle feeders benefitted from a sharp increase in weekly slaughter levels during August versus July. Kills the four full weeks of July averaged 632,000 head per week, the lowest in many years. They averaged 644,000 head per week in August. The August market proved again that the supplydemand relationship is the dominant determinant of live cattle prices. Packers had a demand for more cattle and supplies remained relatively tight. So live cattle prices went from $81 per cwt. to $85. I’ve watched packers’ behavior every week for 23 years and I’ve never seen them acting the way they are now. They are managing their margins instead of fighting for market share.

It’s helping them make money in 2009 despite the worst economic crisis since the Great Depression. Beef processing has always been a spread business.

Packers years ago told me how they attempted to match the price spread between cattle and beef. Sometimes they would refer to this as “matching paper to paper.”

But at times, the battle for market share outweighed the discipline required to manage the spread. One packer or another would bid up the price of cattle to put pressure on the others, or sell beef at a lower price.

The battle was particularly intense in the late 1980s when IBP (now Tyson Fresh Meats) opened a new plant in Lexington, NE. It added 4,800 head of daily kill capacity and IBP did what it had to do to fill it. Every week was a battle for cattle. This was terrific for cattle feeders, who enjoyed a $3-4 per cwt. “competition premium” for two or three years. Legendary IBP Chairman Bob Peterson later talked of ramping IBP’s cattle kill up to 12 million head from 10.5 million. How ironic that Tyson Fresh Meats has been the major packer to close plants in the past two years. It removed 7,300 head of daily capacity in the U.S. and sold its Canadian operations in Brooks, Alberta. The plant there can process 4,800 head per day. U.S. kill capacity is now in much better balance with cattle numbers and beef demand. Packers have also sharply reduced their Saturday kills. Barring holiday weeks, these kills so far this year have averaged less than 20,000 head. The declines reveal how packers have adjusted their operational strategies and how they are managing their margins.

Tyson’s top red meat executive, Jim Lochner, referred to these trends when he spoke with financial analysts at the start of August. Tyson (still the largest U.S. packer in terms of sales and cattle pro cessed) is running a significantly different beef business compared to a few years ago, he said. Daily capacity utilization has improved dramatically over the past two years and Tyson has reduced its operating costs, he said. Capacity utilization at Tyson’s seven beef processing plants was 87 percent in the quarter, according to Lochner. This percentage was based on five days, implying that Tyson no longer predicates utilization over a longer week. Tyson and other packers have realized they can achieve similar production levels in five days that they previously spread over 5.5 or six days because of increased efficiencies.

Packers will have to continue to do this and reduce their costs per head even more. The industry still has over-capacity and this will grow, without more plant closures, because of shrinking cattle numbers. But the more efficiently that packers can operate their plants, the more likely it is they will make money. This makes it more likely they will pay more for cattle. Cattle producers should be aware of how important packing plant efficiency is to the prices they get for their animals. — Steve Kay

(Steve Kay is Editor/Publisher of Cattle Buyers Weekly, an industry newsletter published at P.O. Box 2533, Petaluma, CA, 94953; 707/765- 1725. Kay’s Korner appears exclusively in WLJ.)