Reflecting on 2014 and where it compares to the most profitable year ever depends on if you were hit with porcine epidemic diarrhea virus (PEDV) and how active you were in hedging production. Looking back 16 months ago most producers would not have been able to hit their 2014 profitability targets. The average 12-month return was between $10 and $15 per head profit. Many producers did hold off from hedging all production at that level and we should see a range of profitability between $20 and $30 per head for most producers in 2014.
With that said, I believe producers’ financial position by year-end 2015 will be much better than in 2007 prior to expansion, high corn costs and H1N1. With the current cost structure and depending on when a producer placed hedges, you can safely anticipate profits of $30 to $40 per head-plus for 2015. With that level of profitability, most operations will have little if no operating debt in 2015. The question remains: how or where should you deploy the excess capital and what are the risks associated with that decision?
As of now, everyone is holding their breath to see if PEDV will strike like it did a year ago. If we can make it through the next couple of months without a major outbreak what will happen to the hog markets? All you need to remember is corn farmers thought there would be a $5 floor on prices once ethanol was at capacity. There are tremendous opportunities available now but you still need to be positioned in case the market runs again like it did in March 2014. With the volatility in the industry are you prepared for a wild ride again or are you comfortable in locking-in above-average profits?
When reviewing an individual’s budget for the upcoming year, I tend to compare the risks involved and their end financial position between whether or not the budget materializes. Although I am still a strong proponent of risk management, I believe the answer lies in your future plans. Are you planning on an acquisition or growth through construction? When mapping out your pig flows and negotiating contracts I also believe it is vital to look at your level of capital after these growth plans materialize.
Based on the level of volatility we have seen over the past few years here are some recommendations when looking at your financials. With aggressive growth plans I would recommend staying above 50% equity and more importantly, maintain a minimum of $700 per sow/sow equivalent working capital. What you have to remember is if you have 26 pigs/sow/year productivity out of your sow unit with 10% pre-wean mortality and you sell 93% top pigs you have a cushion of $32.17 per pig for one year before turning negative with working capital. Most owners will also have working capital covenants. It’s vital to understand how much can you lose before you trigger that covenant. The answer to that question should help you make your decision on how aggressively to utilize a sound risk management strategy.
As you navigate through your company’s financial performance for 2014 there are a few things to remember when communicating with your lender. First, if you are deferring income, when will you start? If you are prepaying expenses how long will the prepays last? As I have meetings with clients on this topic it is important to structure a loan that will fit the needs of the business. Another thing to consider is how much availability is necessary on your operating line after deferrals and prepays? That should be an easy number to come close to projecting.
The hard part is trying to determine what can happen to the markets between now and Jan. 2 when those deferrals come back to the company. There are two events that could have a major impact on that decision. First would be driven by PEDV and the need to purchase additional wean pigs. Second, and also driven by PEDV, can be a market reaction to above-normal death loss due to the disease. I believe at a minimum you need to have three to four limit moves available for margin calls if you are subject to them. For those of you who are not subject to margin calls because this risk has been moved to a packer, you should be able to manage your revolving line of credit availability effectively.
Malakowsky has more than 17 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.