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When Opportunity Knocks

Disaster for some often spells opportunity for others. On one hand, producer Dave Hinman sees "maybe our biggest transfer of wealth from the hog industry ever." On the other, he sees opportunity for some producers to update and/or expand at "fire sale" prices.Hinman owns an 800-sow, farrow-to-finish operation called Jen-Rae Pork Farm near St. Ansgar, IA. He expects to see some modern hog facilities,

Disaster for some often spells opportunity for others. On one hand, producer Dave Hinman sees "maybe our biggest transfer of wealth from the hog industry ever." On the other, he sees opportunity for some producers to update and/or expand at "fire sale" prices.

Hinman owns an 800-sow, farrow-to-finish operation called Jen-Rae Pork Farm near St. Ansgar, IA. He expects to see some modern hog facilities, built within the last year or two, sell for 30 cents to 40 cents on the dollar in the next few months.

In mid-January, a consultant representing an equity-strong producer called Hinman, asking if he knew of any recently built facilities for sale.

"Their goal was to buy at 40-50% of cost to lower their existing, average facility cost," says Hinman. "If you can buy near-new facilities at 40 cents on the dollar, it can be a good investment."

Circle the word "can" in that statement. A bargain basement price for facilities doesn't guarantee success.

"Our budgets suggest building and equipment costs, for a building with the technology we want for modern hog production, will be $6-7/cwt., farrow-to-finish," says Chris Hurt, agricultural economist at Purdue University. "If you can buy those buildings at 40% of the replacement cost, that cost would drop to about $3-3.50/cwt. Don't discount the full 60% because some costs will not be affected by the low purchase price."

If you figure breakeven at $36/cwt. with current feed prices, Hurt explains dropping to $32.50-33/cwt. is a savings of about 8.3-9.7%. "That's very substantial," he adds. Plus, you have that savings for the life of the facilities.

Analyze what you're buying very carefully, urges Hurt. He offers a 9-point checklist.

1. Determine why the facility failed. "The assumption is going to be that the owner was over-leveraged," says Hurt. "But sometimes the facilities just don't work well."

Are there inherent things about the physical part of the facility that simply do not allow it to function well? What are the bottlenecks?

Maybe high nursery death losses resulted from poor design, for example. Dig deep to figure out if those things might have contributed to the financial difficulties, he says. Can the problem be corrected? If so, will correcting it be cost effective?

2. Analyze whether or not this facility fits with your present operation.

You may have a pretty strict system and the target facilities just won't fit in. Will it create inefficiencies in your system? Is it in a good location? Does the equipment match the production system? How good is the security? How does it mesh with the labor and management of your present operation?

"We will see some pretty big operations shut down simply because they don't fit in the modern hog production scheme of things," Hurt predicts.

3. Check for other liabilities that come with the operation. How much mortgage comes with it? Are there liens on facilities, feed or supplies?

Hurt suggests that you go to the courthouse to check for liens. Also talk to lenders and suppliers.

4. Find out if a "discouragement factor" set in before the operation failed. Sometimes, the owners and managers get so sick of it that they just walk away, he explains.

That often creates another set of liabilities. "You find a lot of things that haven't been done," says Hurt, admitting he has first-hand experience after closing down his hog operation in the early '80s.

"You'll find fans that haven't been serviced, pens that haven't been cleaned, repairs that have been neglected. There can be a lot of loose ends when that discouragement factor hits," he adds.

5. Look for other assets of the operation that can be beneficial. Contracts, for example. Maybe there's a management team, even family management, that can continue.

"Some of the neatest deals going are that a family finds somebody to buy the business before it collapses financially and the new owner wants the family to stay in that operation as managers," says Hurt.

"The family mindset has to be right so it doesn't interfere with their management abilities," he warns. "First, that family has to get to the point where they understand that they have lost everything. Then if they can look at the offer to stay on as an opportunity, it can be valuable to the new owner."

If you can pick up a decent marketing contract, that may add value too. But check your obligation. You don't want to be tied to a contract that's not beneficial.

6. Study all the records you can get your hands on. Go back much farther than the last disastrous year. Performance records are especially important. In times like this, people with excellent performance can still go broke.

"In fact, the ideal purchase could be a business that was excellent in production," says Hurt. "There may have been nothing wrong with the management. They just couldn't financially get through the period of low hog prices."

Paul Gogerty, an Iowa Farm Business Association consultant at Osage, IA, points out that once hog prices dropped below $20, his farrow-to-finish clients have lost about $1/head/week for every hog produced annually.

"For a 500-sow operation, finishing about 10,000 head per year, that eats up $10,000 of equity per week," he explains. "That started in November for a lot of producers and means an operation that size lost $50,000 by year end." Plus, of course, open market prices weren't profitable for some weeks before that.

"If the previous owners are willing to quickly provide you with production records, that's an indication in itself that they were probably doing pretty well," says Hurt. "If they really don't want to show you the records, be suspicious."

In either case, scrutinize those records closely. A business that has been doing well with production is obviously worth more than one that hasn't.

7. Don't assume it's a bargain, just because the price seems low.

"As a buyer, there's something in our psyche that wants to believe that just because it's 30% or 50% off, it's a bargain," warns Hurt. "Don't buy into that. There are some hog operations that, if you were given them for free, they still wouldn't be a bargain."

Don't get caught up with the idea that if it is cheaper than it would be to build new, it will work and, therefore, I want it. Try this as a reality check - drive around and look at closed restaurants, gas stations, hotels and motels. In many cases, there's a good chance something was bad from the start. Even the best manager couldn't have made them work. The same thing can be true with some hog facilities. They won't work at any price or any level of management.

Bring that investment into a projected cash flow and a profit and loss statement and then ask: Would this be a profitable business?

8. Are you determined to be in the hog industry for the long run?

Hurt tells about a long-term producer with an 800-sow operation who feels there won't be a place for an independent producer of that size in the hog industry in the near future. So, he's getting out of breeding and farrowing and centering his future around the finishing part of the business.

This producer may not be correct about the number of sows it takes, but he makes the point that the size of an operation is going to be big enough that it takes a long-term commitment if you're going to be a major player in the business from here on.

9. Catch the cycle at the right time - and this may be that right time.

"If you believe there will be a continuing hog cycle - and I do - the cycle timing could be very good for buying good, used facilities at bargain prices now," says Hurt. "If we believe the USDA Hogs and Pigs Report, we should be seeing very good profitability of hogs by the spring and summer of 2000."

Hurt is looking for hog prices to average in the low $40s during the last quarter of 1999. Over the last three cycles, we have averaged from the lowest price on the cycle to the highest price on the cycle in 19 months, he notes. Assuming December 1998 was our low, that puts us out to mid- to late summer of 2000 as the projected highest prices on the next cycle.

When will it happen? Nobody knows how many producers will be wiped out - or simply choose to quit. Hurt and Hinman agree, there will be some fallout.

"What we are talking about is right around the corner," Hinman predicts. "I think it will start in March and continue into the spring as borrowers and lenders sit down and realize they have lost more money in hogs than they ever thought they could. They're going to find that the 'mortgage lifters' have become 'mortgage makers' in the last three to six months."

Hinman also sees some of the networks and sow coops being hit.

"The producers involved agreed to buy the feeder pigs at $28-30 for an early weaned pig," he explains. "It worked good when market price was $50-60, but now, as the weakest link in that system of owners sees his equity getting used up and is unable to buy those pigs, we are starting to see some real meltdown in some of those systems."

As those pigs have to go on the open market at a $20 or so loss, Hinman sees some of those facilities going on the market at 30-40 cents on the dollar.

"Producers are having a hard time paying the feed bills and all the other bills," Hinman adds. "When they have exhausted their resources and their ambitions, some are going to say: 'That's enough!' Some will call their lender and say, 'The hog farm is yours, be ready to do the chores tomorrow morning.'

"The reality is that anybody connected with hog production ownership has been butchered up mentally," Hinman adds. "When we get in a negative attitude, it's hard to see any opportunities. But they are there."

You might be dealing with a friend or neighbor's hogs, buildings and business. That can make the usual negotiations emotionally painful and even embarrassing.

People will ask, "What's fair?" says Purdue economist, Chris Hurt.

"A fair price is what two, at least reasonably informed, individuals can negotiate," he says. "You might run through the various methods of valuing the assets and determine that you could afford to pay 80% of replacement cost for nearly new facilities.

"But the reality is that, in most cases, there are not a lot of buyers for those facilities. If there are no other buyers within a reasonable distance, you may not have to pay anywhere near what it might be worth to you.

Is that fair?

"I would argue that it is fair," says Hurt. "I might, however, advise that seller - or the bank if it has to take possession of it - to wait it out three months, if possible, to see if we do get a return to $40 hogs because that building could increase in value substantially if the outlook and people's attitudes improve."

The same is true with sows. A gestating sow might be worth only $50. But looking at summer and fall futures markets, the pigs inside her could make $10-20/cwt. profit. Those gestating pigs are more valuable than the sow.

If you're the buyer, you'd prefer the $50-sow price. But if advising the seller, you'd suggest he sell on the futures market, not on today's market price, says Hurt. Then you negotiate toward "what's fair."

Pork producer Dave Hinman, admits it's a mind struggle anytime you deal to gain from an associate's misfortune. But, it's not the time for the faint hearted, he adds.

"If it is a long-time friend or associate, it is going to be hard. But if the guy is crying Uncle, you just have to cut the emotion out of it and be hard nosed because it's going to happen anyway," he says. "It's better if he has two bidders rather than one - even better to have one rather than none."

For more information, Chris Hurt can be reached by e-mail at