The situation with pork packing margins has been somewhat of a mystery this year. There is always mystery regarding the actual level of packers’ profit margins since they are quite understandably reluctant to publicize those numbers beyond what is required of the publicly traded companies, such as Smithfield Foods, Tyson Foods and Hormel Foods.
I think it is safe to say that most pork producers feel the same way about their financial performance data. But we do have enough data to estimate pork packers’ gross margins (i.e. the margins that they achieve above the amount they pay for hogs) by comparing the pork cutout value to the cost of hogs and then adding in an estimate of by-product revenue. Figure 1 shows these estimates for 2008 and 2009, year-to-date, as well as the five-year average.
It is easy to see that 2009, as bad as it has been for pork producers, has not been a banner year for pork packers either. The first week of July was the lowest estimated gross margin in the history of my data, which goes back to January 1992. That $3.22/head estimate is even more shocking considering the fact that packer margins were at their highest level since 1999 just last summer when export demand added significant value to both pork and pork by-products.
Following that abysmal record, packers successfully pushed margins back to longer-term averages by mid-July when a few reduced-throughput days drove cutout values higher. Those did not last long, however, when packers returned to more normal hours and chain speeds. Cutout values fell back to pre-slowdown levels and packers have reduced hog bids since that time in an effort to maintain margins.
So, is this good or bad? The answer is “Both.” Packers cannot operate forever on low margins. They proved that by reducing throughput in July. While not popular with producers, packers are in a much better position to manage margins and they will do so. Higher margins will keep hogs moving – an imperative given the size of the hogs coming to market. We have to keep animals moving and low packer margins may not get that done.
Finally, these packer margins are not large by any stretch – and probably do not represent net profits after packers pay for labor, utilities, packaging, transport and fixed costs. Their misery may not be as large as producers’, but they aren’t rolling in the roses, either.
The Question of “Accuracy”
There is just one more point to make: Are these computed gross margins accurate? I compute them using the best information I can access, but the fact that gross packer margins were so low for so long makes me question how accurate they may be.
I’m confident about the hog price. I use the national total net weighted average price, which should reflect the average hog cost for packers. Further, it comes from the mandatory price reporting system. USDA audits the packer data, so it should be dependable – at least over time.
I’m reasonably comfortable about the by-product value. It comes from the Livestock Marketing Information Center in Denver, uses publicly quoted prices and has been computed in the same manner using the same weighting factors for the entire position in question.
That leaves the cutout value. I know how USDA computes it and I know that their procedure changes from time to time. It changed rather sharply in 1998 and has changed some since then as USDA has updated yield coefficients for various cuts. I’m not aware of any changes during the period in question, but it appears from Figure 2 that the relationship between hog price and cutout value began to change in 2007. The cutout has fallen so much relative to hog prices that the difference (i.e. the “meat margin”) has been positive in only four of 32 weeks thus far in 2009.
Can that be? Is there something amiss here? UDSA’s computations do not include “overages” that packers get for certain specifications. So, have base values fallen and “overage” increased over the past two years? Has the growth in the number of hogs priced off the cutout value caused packers to report lower product prices? That hardly seems reasonable since a high proportion of pork cuts are formula priced but . . .
I don’t know the answer to those questions, but I will try to find out more. And there is, hopefully, some help on the way. The Obama Administration finally got some key positions filled at USDA this summer and that got a Congress-mandated study of wholesale pork price reporting off dead center. The project will be carried out by researchers from Kansas State University, Michigan State University and the University of Missouri with results reported back to USDA this fall. The ultimate question is whether the pork industry would benefit from a mandatory wholesale pork price reporting system similar to the one that already exists for beef. The entire industry is, I think, looking forward to that answer.
Click to view graphs.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.