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Lender Predicts More Market Volatility in 2009

Article-Lender Predicts More Market Volatility in 2009

Ups and downs in the market should equal breakeven year for many. If anything is for certain in 2009, it is that volatility has become the norm in the hog business, according to Mark Greenwood, AgStar Financial Services vice president of Agri Business Capital. I think pork producers are going to have to continue to reassess their operations and manage their risk as they go forward, because I think

If anything is for certain in 2009, it is that volatility has become the norm in the hog business, according to Mark Greenwood, AgStar Financial Services vice president of Agri Business Capital.

“I think pork producers are going to have to continue to reassess their operations and manage their risk as they go forward, because I think volatility is going to continue,” he says.

Figure 1 represents a snapshot of that volatility in recent months, as fluctuating higher feed costs have caused overall cost of production to spiral. Costs have dropped almost $40/head from their peak last August, but still produced “ugly” returns in the fourth quarter of '08 and January '09.

Every day Greenwood gets asked when the hog economy will stabilize, but he admits there are no easy answers to those questions.

He expects the roller coaster ride to continue in 2009, with the first and fourth quarters drawing red ink. Still, producers should see periods of profits in the second and third periods, he says. And, there will be periods of small profits and small losses, which means 2009 looks like a breakeven year for many.

Factors Affecting Prices

In Greenwood's view, three major factors will affect pork prices:

  • Producer Action

    Canada and the overall supply of pigs in the United States: Canada's hog imports declined drastically in 2008, but the weakening Canadian dollar and strengthening U.S. dollar may mean a return of higher imports in 2009.

    By this summer, there will be less total meat protein in the U.S. food supply, including 3-4% fewer hogs.

    “Producers have cut some sows, but still managed to improve their productivity, so production has remained fairly stable,” he points out.

    Greenwood repeats his appeal from a year ago: producers still need to cull the bottom 10% of their sows. This action does two things — it reduces pig numbers and removes the least-efficient sows. The nation's sow numbers must be cut by 200,000 to 300,000 head to boost prices appreciably, he says.

    “It is going to make the rest of your business more efficient and provide a better chance of survival because the bottom 10% is not profitable anyway,” he reminds. Of course, not all of his clients have followed through on this recommendation, but he says he is “beating on them pretty hard” to take the step.

    Greenwood says a prime example of this strategy is companies laying off workers or cutting back, eliminating inefficiency. Producers need to look at their operations as a business and make the hard decisions to make them better.

  • Exports: “We had a tremendous amount of exports last year, and for us to stay at that sustained pace is not a realistic expectation,” he says. The '09 forecast is for pork exports to be down at least 7%. The projections from the U.S. Department of Agriculture (USDA) suggest that it may take until 2011-2012 before exports return to the record levels of 2008.

    “Exports will still be good, but they won't be great like they were in 2008,” predicts Greenwood. Global demand for pork is escalating, particularly in the developing world. But the wild card is grains. If grain prices slide, world pork production could expand.

  • Pork demand: There will be less meat protein produced in the United States in 2009 — but the big question is whether consumers will spend their dollars on meat protein, specifically pork.

    “I do think in a recession period that pork is pretty well-positioned and can be more competitive than other protein sources,” Greenwood says.

Surviving Volatility

Certainly, there has been some liquidation in the hog industry. Greenwood estimates losses averaged $20/head in 2008, with a range of $10/head profit to losses of over $30/head.

Coming on top of losses in 2007, the swine industry has lost equity nearing $2.5 billion, and most operations have lost 30-35% or more of their equity positions, Greenwood says.

However, don't believe rumors that a lot of producers are currently exiting the pork industry. “The people who are left are very good,” he declares.

Still, to survive this widening downturn will take even better production numbers and a solid risk management plan.

“Don't fool yourself into thinking you will survive — somehow,” Greenwood remarks. “It is up to you, the producer, to take the initiative to contact your lender and get on the road to a risk management strategy.”

A lot of the large pork production companies have hired risk managers or specialists whose sole job is to manage margins.

Likewise, smaller producers (see adjacent articles) who raise a lot of their own corn know their costs and track them monthly, and document solid financial numbers that allow them to make better decisions.

These producers understand the value of working closely with their lenders and investing in a team of advisors who can help them with marketing and financial decisions.

For his part, Greenwood says AgStar is working hard with their clients to help them stay as viable as possible, interacting with most producers on a monthly basis to review their profit and loss statements.

He stresses it is more important than ever to have a close working relationship with your lender to keep him informed of your plans for survival.

Surviving Volatility

Surviving this volatile hog economy requires locking in prices in your “crush margin,” the three key factors to profitability — corn, soybeans and hogs. Overhead costs and the cost of production must also be monitored.

Watch for windows of opportunity. In early December, the actual price for corn in southern Minnesota dipped below $3/bu., soybean meal was at $240/ton and overall breakeven costs hovered at $120-125/head. With April hog futures then at 70¢/cwt., or $140 for a 200-lb. carcass, a $15/head profit was possible.

Also that month, July hog futures hit $78/cwt. or $156 for a 200-lb. carcass, with costs around $130/head, producing a profit margin of $26/head.

Moreover, with a production cost of $621/acre for corn, the value of manure and land rent at $190/acre, southern Minnesota farmers could have achieved a breakeven cost of around $3.18/bu. of corn in 2008. And with soybean meal available at $350/ton, that put a number of those producers who raised a lot of their own grain in position to make some money on hogs.

Lock in prices and profit margins when they cover your costs — and don't wait for a windfall before you sell. “If your cost of production is $135/head and you make $10/head, dividing that by $135 equals a 7% return on investment (ROI). If you turn that investment twice a year, you double your ROI to 14% — which is good by any standard,” Greenwood says.

These returns are possible, provided you have an understanding lender who is willing to fund margin calls when the opportunity arises on the Chicago Board of Trade, he stresses.

Don't Look Back

Some producers locked in profits in that December period when commodity prices fell — but plenty more didn't. Now, they are upset because they failed to act.

Greenwood says don't worry about what happened in the past, whether it was missed hog profits or, in his case, a failure to move money out of his 401K plan before the stock slide started.

Producers who plan to “hang tough” need to execute a plan that incorporates hedging hogs and inputs, plus possessing adequate working capital, strong management and excellent production.

“Our long-term model says you need to be farrow-to-finish, or if you are buying weaned pigs, have ownership of the sows,” Greenwood adds.

Too many times, weaned or feeder pigs have been purchased at prices that don't pencil out, resulting in negative returns for growers and a slew of broken contracts.

TAGS: Business