Every quarter Compeer Financial compiles a database representing approximately 20% of the U.S. swine industry. We capture a wide range of financial and business-related information, from all different types of production systems with sales to all major packers in the industry all across the United States.
I believe the annual third quarter analysis gives us the best metric of our industry’s financial health. The reason third quarter results are so valuable, is because the majority of tax planning decisions have not hit producers’ balance sheets.
There are several metrics that, together, give us a great picture of the swine industry’s financial state.
A producer’s balance sheet includes two very important line items: owner’s equity of the operation and working capital. Having a solid owner’s equity percentage is important — particularly during challenging times or times of exceptional opportunity — because it provides options.
For the third quarter ending Sept. 30, owners’ equity in our study was 70%, down from 72% from the third quarter 2017, but still is very strong.
Working capital, which is basically liquid cash on hand, also remained very strong at $1,252 per sow. Even though working capital is down $190 per sow from a year earlier, the measure is quite strong relative to the industry, which has a standard of $400 per sow.
With the slippage in owners’ equity and working capital it would be assumed that producers lost money year to date ending the third quarter of 2018. This is not the case, however, as the average producer showed a profit of $5.08 per head. The profits can be explained by hedging activity, as the typical gain was $5.13 per pig. I believe the lower owners’ equity and slippage in working capital is the result of lower fixed asset debt and, most likely, leveraging working capital to wrap up expansion projects.
Costs drive profitability
As expected, costs continue to be a major driver in the profitability of operations. Increased costs were another notable change from one year ago. Year-to-date cost is up $7 per head from 2018. This is due to slightly higher feed costs, rising labor costs and slightly lower production, most notably in third quarter inventories.
Comparing costs and profitability within our database to the Iowa State University hog model showed the ISU model losing $6.12 per head. This was driven by the largest one-month projected loss under the ISU model ($44.18) per head since we began tracking that number in 2013.
Why does our report model indicate a gain per head and the Iowa report show a loss per head? One major difference is the amount of hedge activity. Another issue is individual productivity factors and individual costs.
A week before Christmas, the U.S. swine industry posted the biggest slaughter numbers on record with 2.737 million head and year-to-date our participation in our study increased sales by 3.7%. As the industry continues to grow, knowing how you are getting paid for your pigs is extremely important as we have seen a large variance in revenue between producers. Having more than one pricing mechanism to sell your hogs will take the risk out of having the wrong contract. I recommend having two or three different indexes for pricing your pigs. Even if you have very good cost of production, if you haven’t been selling on the CME index or cutout, your operation most likely lost money in 2018.
Opportunities for 2019
Margins for the second quarter of this year are currently $11.50 per hundredweight and $7.55 per hundredweight for the third quarter. We are heading into a seasonal high for these contract months, so you will have limited time to add additional coverage if you continue to be open.
Historically, June futures contract peaks in January and the low is recorded in April. With more pork currently, compared to any other time in the history of the United States, the biggest opportunity since, porcine epidemic diarrhea virus in 2014, lies in selling pork to China. Consider an option strategy to keep some of the top side open in case we work out a trade agreement with that important consumer of U.S. pork.
Malakowsky is a senior swine lending specialist, with more than 21 years of experience at Compeer. For more insights from Malakowsky and the Compeer Swine Team, visit Compeer.com.
Source: Steve Malakowsky of Compeer, who is solely responsible for the information provided, and wholly owns the information. Informa Business Media and all its subsidiaries are not responsible for any of the content contained in this information asset.