Usually, pork producers excel at production. Seldom do they take the same amount of time or resources to track and manage their operation's overall profitability.
They often find themselves at the mercy of suppliers or packers with little room to negotiate their financial position.
Financial Planning Help
Perry Iverson and Gordon Malarkey are the managing directors of Commodity & Ingredient Hedging (CIH), LLC, an agricultural consulting and training company. Its aim is to help commercial agricultural companies better manage the costs and values of their operations.
The pair and their team of advisors customize price management programs for over 100 domestic and international agricultural enterprises from crop producers and feed mills to livestock producers and food companies.
The Chicago firm added a new focus after the fourth quarter of '98, due to the incredible erosion in hog values and the distortion in relationships between producers and packers, explains Malarkey.
He recalls one pork producer client who called to complain he was losing money. Granted, hog revenues were very depressed in the late '90s. But when Malarkey calculated all of the producer's revenue streams, overall, he had still maintained a net profit margin on the operation — he just didn't know it!
That kind of experience made the company realize the need for producers to be able to easily see the true net revenue profile of their hog operations, says Malarkey. CIH developed the Profit Margin Management Service to help pork producers deal with uncertain market conditions. The unique service allows producers to identify their own profit margin using actual or expected input costs and hog revenues.
The four-pronged service features:
An easy-to-use spreadsheet calculator to identify and project your profit margin several months ahead and compare results with past performance. CIH typically compares results with performance from up to a decade ago, says Iverson.
An evaluation of various contract choices to best manage profit margins.
One-on-one consultation in a weekly conference call to review production figures, to ensure their accuracy and increase confidence in making contracting choices, and
A worksheet e-mailed once a week that allows the producer to assess and manage his/her net profit margin based on actual and projected corn and soybean meal needs, other feed and non-feed costs, production levels and expected hog basis or minimum return, explains Iverson. The net margin is simply the difference between the revenue generated from hog sales, including all premiums, and total costs for feed and other expenses, says Iverson.
Projected costs and potential revenues are developed using the futures market to set prices for feed inputs and hog sales.
“To develop a producer's unrealized profit margin four quarters out, we use a projected hog basis that could be based on a historical average for the last few years,” he says.
DeKalb, IL, pork producer Bob Johnson has used the services of CIH for 18 months, since they started the Profit Margin Management Service for pork producers.
The service uses a software spreadsheet to take the cost structure data supplied by Johnson Farms and provides weekly e-mailed worksheet reports. “Those reports show (project) how much we can make each quarter, during the current and subsequent three quarters, and how it compares with the past 10 years,” notes Johnson.
“Since its inception, we have used the service's worksheets as a decision-making tool to help us decide to establish hedge and option protection for a portion of our production,” says Johnson, co-owner of Johnson Farms, a 1,200-sow, farrow-to-finish operation.
For example, he says, the hog operation protected just under 50% of its first and second quarter 2002 margin last November and December using an options strategy.
“This strategy did provide $6 per carcass cwt. of downside protection in our margins, which helped this spring (when cash hog prices plummeted),” observes Johnson.
Johnson Farms sells hogs to Hormel on a spot market formula, not on a long-term contract.
Johnson points out that the worksheets are only a tool to use at decision time. “A producer still needs to evaluate his/her own situation and risk-taking capabilities when making marketing decisions.”
However, Johnson adds, the worksheets do help make “the bottom line impact of potential marketing decisions much easier to understand.”
He observes, “It's a way to look at the big picture and what ways are available to lock in profit margins.”
CIH's Malarkey emphasizes that each weekly report (worksheet) provides updated information on current and projected margin or worth of an operation. That kind of information can be helpful in identifying the best time to book corn and/or soybean meal orders and when to pull the trigger on hog sales and arranging contracts with suppliers or packers.
Iverson says CIH analysts spend a lot of time with clients going over buying and selling alternatives that provide floors or partial protection for producers hesitant to fully commit to their buying or selling decisions.
For more information on how to obtain a customized commodity price management program for your operation, call CIH at (312) 347-5103 or toll-free 800-241-5498. E-mail cihedging.com or log on to their Web site, www.cihedging.com.
Insurance for Low Markets
Pork producers in Iowa have two new revenue insurance plans available to provide protection against market price risks.
Both new products, introduced July 8, are pilot project spin-offs of the Federal Crop Insurance Program. They include the Livestock Gross Margin (LGM) and the Livestock Risk Protection (LRP) programs, according to the Iowa Pork Producers Association (IPPA).
Two Different Plans
The revenue insured under LGM is actually the return over feed costs. The guarantee is based on projections for three variables — prices for market hogs, corn and soybeans — the most important determinants of gross margin that are beyond the producer's control, says an IPPA report.
Producers will be paid when the actual gross margin is less than the guaranteed value.
IPPA reports that producers who purchase all or most of their feed will achieve the most risk reduction with LGM.
LRP protects against unexpected declines in hog prices. Coverage levels are based on the expected cash lean hog price using the Chicago Mercantile Exchange lean hog contracts. Five guarantee levels are offered in $2 increments. Coverage levels can be fixed for 90, 120, 150 or 180 days into the future.
Producers who depend on the cash hog market, or a formula based on it to sell their hogs, can use LRP insurance.
Unlike some marketing contracts, neither LGM nor LRP ties the producer to a specific packer.
Livestock revenue insurance policies don't create profit, since coverage levels are tied to current futures contract prices. However, they do protect against unexpected drops in the cash hog market.
For more information on LGM, call (712) 325-5721 or Iowa Farm Bureau Mutual Insurance (515) 225-5543. LRP information is at (515) 254-0400 or (877) 585-6285 or by contacting American Agri-Business Insurance Company at www.aa-bic.com or www.livestockcoverage.com.
Also call Iowa State University extension economist William Edwards at (515) 294-6161 or e-mail him at firstname.lastname@example.org.