Managing Through Volatile Times

"You can handle a bad year. You can handle a short cash flow year but when they start stacking on top of each other, your working capital and your equity position play a really outsized part in your credit availability in the future" - Sam Miller, BMO Harris Bank
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The swine production business has always been an industry marked by price cycles of significant losses and profits. While it was more predictable in the past, profit cycles remain volatile and painful when you get caught in them after events that cause reductions in working capital and hence, increased leverage occurs.  

Those events might include expansion or an acquisition, or they could be related to animal health issues. Some events make it difficult to hedge pigs as you normally would, and you stay open to the market. Basis changes might eliminate what you thought you had locked up for margins.

Whatever the case, getting caught with higher leverage and less working capital than you are comfortable with makes you vulnerable. You might make decisions you normally wouldn’t to conserve capital through the down-cycle.

Below is the October 2018 futures chart through mid-September. Production for this period would have been farrowed in late February to early April, and at that time, futures would have been trading in a range from $64 to $70.  

October 2018 Futures

Assuming $66 cost and historical basis of 99¢, your profitability range would have been $6.16 to $6.20 per head. From weaning through mid-September, futures ranged from $50 to $66 and the profitability range expected with the same cost of production and normal basis would have been $35.00 to $2.04 per head.  

Another issue has been basis. Hedges on pigs marketed in late August and early September have been lifted with extremely wide basis relative to history and have created $10 to $12 per head in unexpected losses on hedged pigs. Open-market pigs during that time are likely marketed with losses between $45 and $50 per head.

Futures prices improving

Futures prices in deferred months have rallied on the news of African Swine Fever (ASF) spreading in China. With roughly half of the world’s pig production, controlling the disease in China has been and will continue to be difficult.  

The result might be an opportunity to grow pork exports around the world if ASF is not brought under control in China. That opportunity and the price it would drive for U.S. pork are factors to consider as you adjust risk management strategies going into 2019. Our markets have responded to some degree already. 

Following are some points I think you should consider as those market plans are developed or implemented.

ASF seems to be spreading in foreign countries. Will we be successful in keeping the disease out of North America?

Does an option strategy make more sense than straight hedges? If the market runs, as it did in 2014, taking advantage of that opportunity by leaving some top side open is one factor; margin calls under that scenario with hedges can take a lot of capital.

Working capital and equity should play into your risk management decisions. Can you afford not to lay off some of the risk? Looking at a forward crush, the 12-month outlook improved by more than $20 per head from mid-August to mid-September. Do you have the working capital and equity to be wrong by $20 per head over 12 months?

This strategy will be a difference-maker for your farm and our industry. Your risk-bearing ability is an essential step in developing a plan and executing it.