Equity Drain, Margins Reflect Price Woes

Farrow-to-finish producers have lost money raising hogs four out of the last six years, including 2003, says Iowa State University agricultural economist John Lawrence.

Farrow-to-finish producers have lost money raising hogs four out of the last six years, including 2003, says Iowa State University agricultural economist John Lawrence.

If you raise hogs, you have become all too familiar with low cash hog prices in the last half-dozen years. And, at this point, 2003 looks like a breakeven year overall.

Single-digit market prices in late '98 were the lowest recorded in modern times. That was followed by red ink in '99 and a modest recovery in 2000 and 2001, only to have prices fall surprisingly flat in 2002. Prices have been slow to recover in 2003, and it appears that summer may be the best bet for black ink.

Even more troubling for struggling producers than hog prices are profit margin trends and the overall equity drain plaguing U.S. operations.

Yet as bad as all that news is, record low interest rates, coupled with profitable hog prices projected to return during the last half of 2003 — and all of 2004 — should provide for some recovery.

Profit Margin Plunge

Since 1998, the pork industry has experienced an average profit margin of only about 64¢/cwt., or about $1.70/hog, says Chris Hurt, agricultural economist at Purdue University. That makes the hog business just a little bit better than a breakeven business in the last five years, he says.

Hurt illustrates the downward profit margin trend in Figure 1. It tracks hog prices from 1974 through projections for 2003. Prices are based on the national average value of 51-52% lean carcass quoted on a live weight basis.

Hurt declares: “The point is that profit margins have narrowed by about 13¢/cwt./year on average over the last 27 years (or a total decline in margins of $3.51/cwt. based on 27 × 13¢).

“The profit margin trend in 1974 was $5.23/cwt. But in 2003, it is running only $1.21/cwt.,” he continues.

Hurt acknowledges the price margins in Figure 1 could be underestimated due to the wide variation in price quotes published by USDA, and higher prices based on higher lean percentages, now estimated at 53-54%.

Hurt estimates that a producer raising 1,000 hogs in 1974 would have generated $12,020/year in returns above projected costs. In 2003, 1,000 hogs would only generate $3,146/year, emphasizing the decline in profit margins.

For today's family to achieve an income comparable to the 1,000 hogs' 1974 profits, they would have to market 14,203 head/year (an income of $44,684), based on changes in the Consumer Price Index, he explains.

“The point here is margins are much more narrow today, yet family living costs have risen sharply, requiring a family to have 14 times more income from hogs (in 1974 dollars),” Hurt stresses.

Equity Drain

The equity drain felt by pork producers from 1998-2003 is borne out in Figure 2. It shows that the large losses experienced in 1998 weren't fully recovered until the first quarter of 2001. Producers raising 1,000 head of hogs/year would have slipped over $20,000 into debt based on accumulated returns. Those losses would have been recovered in the following two years and returns leveled out from losses in 2002 and early 2003.

“Producers would have worked for six years (1998-2003), paid all of their bills, including depreciation on their buildings and a labor wage rate, but have only $10,000 ahead after this long period,” points out Hurt.

Hog, Price Cycles

Iowa State University (ISU) agricultural economist John Lawrence predicts this latest downturn in the hog cycle will last 19-20 months, ending by late May or June 2003. “People tend to forget that when we go into downturns, they typically last 18-24 months,” he says.

Several issues have made this cycle seem longer. The Russian poultry ban last year dampened meat demand and eliminated the summer price rally many analysts had predicted, he says.

The fallout from the '98-'99 price crash is still fresh in people's minds, compounded by the depth of hog expansion going into that crisis, recalls Lawrence.

Actually, 2002 was more economically devastating, he says. Producers suffered through a slow profit drain throughout the year, as prices seemed stuck in the $30s.

The result was an average equity loss for 2002 of $16.20/head for Iowa pork producers, based on ISU's Estimated Return Series, says Lawrence. That loss bounced between $16-19/head during the first quarter of '03.

Purdue's Hurt is predicting prices should climb from the mid-$30s in March to the low $40s by the end of May, and reach an average return of $40/cwt. for the second quarter. For the year, prices should average $39/cwt., with the cost of production dipping to $38/cwt. with a near-normal corn crop, he says.

Provided the hog cycle turns as expected, all of 2004 should be profitable, short of some demand or feed surprise, says Lawrence.

New Economics

The four articles featured in the following special section touch on the dawning of a new economic model for the pork industry.

This opening article acknowledges the equity drain experienced throughout the pork industry and tells how average profit margins have narrowed over the course of almost three decades. Economists share their thoughts on what this troubling trend means to producers today.

The impact of these difficult economic times is providing strong motivation for a growing number of producers to restructure their hog operations. Several producers from Indiana talk about the financial and emotional struggles facing them as they confront their future in the hog business.

In a rare twist, an Ohio farm family returns to the hog business after a 30-year absence. They built a 5,000-head contract finisher so their son can stay on the farm.

A final article delivers some powerful lessons on survival. Two AgStar lending officials bluntly point out that only low-cost producers will survive the financial crunch, and emphasize the importance of becoming more efficient. They also suggest producers should consider partnering arrangements. There are profits to be made in contract production, and marketing groups can provide volume clout.