Looking at the hog industry and the level of growth we have experienced in 2016, we’re pushing packing capacity this fall. Unfortunately, for hog producers, getting cash bids has been difficult.
Two weeks ago we exceeded 2.4 million hogs processed. This number has dropped to just over 2.3 million hogs last week due to Hurricane Matthew, and the subsequent closing of Smithfield’s Tar Heel, Clinton and Virginia plants. It is estimated that 150,000 hogs did not get processed last week due to the plant closures.
This would have put production at 2.45 million hogs. As an industry, we can continue to process these large numbers over a short period of time, but it will put extreme pressure on the packers to maintain the pace necessary to alleviate the capacity issues.
As employees for the packers will be feeling the pressures of working six days a week to keep up this pace, getting to 2.4 million hogs processed this early in the year looks troublesome. I think we can all agree that the timing of increased production is too far in advance of the new plants, and this will keep pressure on cash bids through the fourth quarter this year.
Exports year-to-date have been 3% higher in pounds but slightly lower in value versus 2015. For 2016 and 2017, we will be looking at a 4.5% increase in production in the United States. This will be a challenge for the United States to increase their market presence abroad and move the additional pork.
Typically all of the recent increases in production have needed to be exported, and this increase will not be any different. For the past year, it seems there has been euphoria around the additional packing plants that are under construction. Yes, this industry does need to continue to invest in new infrastructure to remain competitive in the world market. However, U.S. consumption of pork has been stagnate over the past several years and with anticipated growth at 4.5% coming online we will need to continue to develop additional markets.
China imported $4.5 billion of pork in the first half of 2016, and only 7% of that amount was from the United States. The largest beneficiaries of the additional exports were the European Union and Brazil. With the EU being the No. 1 exporter of pork in the world, they are our primary competition. The EU was experiencing losses over an extended period of time, but they have scaled their production back and are marginally profitable again. Under that scenario, typically U.S. pork would become more competitive for export into China. This hasn’t been the case, as U.S. pork is exported based on the cutout value, not cash. Currently the spread from cutout-to-cash is over $50 per head.
This has kept EU pork competitive in China (a market they were able to penetrate when Russia stopped importing pork from the EU). It is good that the cutout remains strong across the United States, but it will take the completion of the new plants for the momentum and margins to shift back in favor for the producers.
Protecting your bottom line
Looking at the forecast for the next 12 months, the only opportunity to lock-in small profits in 2017 is during the summer months. It looks like on average, U.S. producers will lose $20 per head.
As a lender, I would make this recommendation to all producers: prepare a budget for 2017 that takes your operation’s market conditions into consideration. Take into account any of your contractual arrangements with packers and any risk management strategies you have already implemented.
Lastly, prepare a budget that reflects market conditions against the balance of your production. Then, test your loan covenants to your projected balance sheet, and if it appears you might violate a covenant, start having conversations with your lender today. We have been through high and low cycles; it’s the unknown surprises that concern a lender. So, have the conversations with your lender up front.
Malakowsky has more than 19 years of experience with AgStar Financial Services. For more insights from Malakowsky and the AgStar swine team, including their weekly video Hog Blog, visit AgStar.com. If you’d like more information on AgStar’s Margin Manager Tool check it out at AgStar.com/MarginManager.