As we look at our portfolio, it remains very strong in terms of working capital and owner equity, in general, but I know it’s just a snapshot and does not represent one individual producer. I also know the variation in financial performance is wide between farms due to many business factors. Let’s discuss that variation looking at two main drivers of profitability: cost of production and revenue.
Too much variation
Cost of production variation in the U.S. pork production sector remains wide. Corn (and other feed ingredients) is one major factor. Grain-based systems have an economic situation that generally would have a negative impact on cost. In other words, with cost of production on corn higher than market prices would indicate, grain-based systems will have higher costs in hog production. Another factor is location. Farms located in grain-deficit areas (such as many parts of the Southeast), will have higher costs than Upper Midwest producers.
Disease outbreaks also have a marked impact on production costs. I have used the Iowa State University profit model for years, and it indicates costs of production over the past 12 months (ending July 29) at $62.40 per carcass cwt.
This cost of production likely represents the top 25% of producers, and a range of $60 to $68 would be reasonable to expect during that time for Upper Midwest producers. The Southeast might have costs of $64 to $72 per cwt in the same period. The variability range is more than $16 per head in total costs, but that is the reality.
Revenue is a driver, too
Revenue per head during the same period (August 2016 to July 2017) was $62.50 per cwt based on the Western Corn Belt (WCB). First, consider that the cost of production during that time was about breakeven for the top 25%, based on the ISU model and on the premise WCB was the market price received.
Market price is discovered in different ways and other formulas are becoming more common. One method is a percentage of the wholesale cutout value. Cutout during the past year has averaged $81.91. Marketing at 93% of the cutout, for example, would have yielded $76.18 over the past year, or $28.34 per head more than the WCB. This differential has and will continue to vary over time and selling on the cutout will not yield the same results. It might, in fact, be a detriment at some time in the future.
Back to the beginning
There is variation between farms in terms of profitability, so it’s important to understand your position relative to the industry. Consider business strategies based on individual position and how it relates to working capital in these areas:
1. Capital spending and growth must take into account working capital after the project is completed.
That brings in current and future profitability, which is why we need to consider the seasonality of the industry, along with the commodity cycle.
2. Understand the financial structure of your business.
Changes in term debt versus operating debt might help absorb losses on capital spending and maintain working capital.
3. Asset use and rationalization are a routine part of the business cycle,
but need to be revisited from time to time to get the best return on the business and maintain strong capital position.
4. Risk-bearing ability and risk management strategies are critical to the success of a business.
Some producers have very strong balance sheets and can afford to take the risk on all their production, while others need to take some of the financial risk off the table. Hedging and option tools can and should help reduce the financial risk to the farm.