As I was preparing to write this article, I was looking back at comments I made in the July Financial Preview. Oh how things can change is a short period of time. In July, margins for the next 12 months averaged $12 - $15 per head. Porcine epidemic diarrhea (PED) virus was just starting to make its presence felt and there was still a tremendous amount of uncertainty in the U.S. corn crop.
Fast forward to today and PED virus is on everyone’s mind on how to avoid being the next casualty, the U.S. corn crop is at a record 13.9-million bushels, which helped improve crush margins going forward.
Hog Margins & Margin Opportunity
Current hog margin crush is projected at $30 per head for the next 12 months. This is a tremendous opportunity for producers who have struggled through high feed prices in 2013. Current margins will allow producers to not only rebuild liquidity in their business but may spur future growth.
Typically in the past, producers I work with would be willing to take full advantage of this opportunity. However, I am having continuous conversations with producers about the proper level of coverage. With the onset of PED virus in the United States and with no suitable vaccine today that is the magic bullet, producers are starting to questions long-range plans for risk management.
To be sure, we still have more hogs hedged than at anytime during my career at AgStar, but producers are questioning what is the proper amount of risk management, especially for the deferred contracts.
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For those who work with packers using either delivery contracts or hedge with a packer, I would urge you to have an open dialog with your packer in the event your operation is impacted by PED virus. I know everyone understands the risk to deliver, however, if you do not have the pigs to deliver and cannot deliver, then you need a clear understanding of your obligations with the packer.
If you are a producer who has one source of weaned pigs, then your risk will be higher than a producer with several sources. For the pigs on the ground, there has been very little hesitation to take advantage of the incredible margins of over $40 per head for next summer. I would expect producers will continue to increase their exposure as hogs are placed into inventories. The question remains on the proper level of coverage for those deferred contracts. This depends on each individual’s liquidity and ability to source weaned pigs in the event of contracting PED virus in your pig source.
I have heard of current wean pig sales approaching $80 per head. If PED virus continues to spread, watch for weaned pigs to move even higher. The challenge to procure wean pigs will be compounded by the new COOL requirements that went into effect this past Saturday. The new requirements do not allow U.S. product and Canadian product to be packaged together and will need to be segregated for labeling.
Financial Position of Your Operation
The other anomaly we are seeing in operations is some added stress to operations in liquidity and owners’ equity ratio. This is purely a function of tremendously high inventory costs directly attributed to high feed costs in 2013 and aggressive hedge strategies implemented by producers.
With $4 to $5 corn now being fed, we fully expect inventory costs to fall by $25-$30 per head in 2014. As these costs fall and inventory is liquidated with profits, the liquidity position for your operation will improve. At the same time, hedge positions will be liquidated and your hedge line balance should be reduced providing additional relief. The one caveat would be the impact of PED virus.
Malakowsky has more than 16 years of experience with AgStar Financial Services. For more insights from Steve and the AgStar swine team, including their weekly video Hog Blog, visit www.AgStar.com.
If you’d like more information on AgStar’s Margin Manager Tool, check it out at www.AgStar.com/MarginManager.
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