It’s incredible how quickly situations — and producer attitudes — can change. Having just returned from the National Pork Industry Conference in the Dells, it was evident that producers are genuinely concerned for the future of their operation and the industry. You can put lenders in that category as well, but now is not the time to panic.
Over the past three days the average margin for the next 12 months reduced by over $15 per head. From September through March of 2019 the hog crush margin ranges from a negative $20 per head to a negative $50 per head for a typical operation (assuming you are completely open to the market today). This is approximately a $34 per head loss over that timeline. Yes, there is some coverage through the end of this year, but very little protection for 2019. Unfortunately, the hedge opportunities for the 4th Quarter of 2018 and 1st Quarter of 2019 were limited, reducing the overall coverage compared to what we’ve seen in the past.
Recently I’ve had quite a few conversations with producers regarding what strategy they should use to try and minimize losses. My response to that is typical for a lender. It depends. The first thing I look at is your current balance sheet and how much working capital your operation has. The pork industry has been fortunate to have an extended period of profitability heading into this downturn.
Some top producers report working capital equivalent over $1400 per sow, which is as strong as I have ever seen. As a rule of thumb, a financially sound operation would have a target of $700 per sow working capital and $400 per sow as a threshold. If this level of losses did materialize over that seven-month timeframe mentioned above, working capital would move from $1400 per sow down to $890. That is still at an acceptable level, but puts stress on the operation.
My recommendation is to look at your budget to actual and run a new budget that would give you your loss of working capital over this timeframe. That will give you the time and information necessary to make business decisions and work with your lender to develop a strategy that will keep your operation viable.
What are the key areas to watch for over the next few months when making your marketing decisions? Trade is an obvious one, as we currently are in a trade war with three of our top markets, Canada, Mexico and China. Having resolved the disputes over the South Korean Free Trade Agreement there is an opportunity to continue to expand this market.
Mexico buys more volume of product than any other trading partner, Mexico — and specifically the NAFTA — should be the priority. Duties on U.S. Pork by Mexico began on June 5 with a 10% tariff and increased to 20% on July 5. Mexico also opened up a 350,000-metric ton quota for duty free pork for suppliers with no Free Trade Agreements with Mexico. It will be vital for the U.S. to finalize the negotiations on these free trade agreements soon otherwise we risk losing market share to other countries.
Outside of trade, other areas that are a concern for the U.S. hog producer is labor (both on farms and in the packing industry). Depending on timing of adding the second shift for the Seaboard Triumph Foods plant and the opening of Prestage Foods plant there could be capacity concerns in the 4th Quarter this year. If these plants have a delay the burden will fall on the existing plants to operate at capacity for an extended period. With the labor shortage the packing industry is currently experiencing, this could be a challenge.
Even though it can be challenging to find positives in the pork industry today, there will be opportunities ahead. Low grain prices mean lower input costs. When the trade agreements are finalized it will give the U.S. pork producer better opportunity than we have ever seen. The thing to remember is U.S. pork producers have the lowest cost structure anywhere in the world and quality is second to none.
There will be opportunities again. Just don’t hit the panic button! You just need to be willing to devise a strategy around your current financial position, work with your lender and develop a plan that will allow you to weather the storm.
Malakowsky is a Senior Swine Lending Specialist, with over 20 years of experience at Compeer. For more insights from Steve and the Compeer Swine Team, visit Compeer.com