For those clients who we have worked with over the years, they’ve come to expect a consistent message from Compeer. Do you know your cost of production, what are you doing for risk management and how is current production on your operation today?
By default, the first two are dependent on each other. After all, how can you put together a risk management plan for your operation if you don’t know your true cost of production? This includes all costs, along with depreciation and financing costs, in addition to any necessary family living draws on the business.
For most operations, it is a given that production is good or trending in the right direction. Granted everyone will go through a porcine reproductive and respiratory syndrome or porcine epidemic diarrhea virus break or other challenges attributed to disease, but how they position themselves prior to a break can have a tremendous impact on long-term costs for your operation. An example of this would be having the appropriate amount of working capital in your operation to withstand a temporary production problem, or you need to restructure your balance sheet to create working capital that will add financing costs to your business.
However, that still doesn’t tell you how you stack up against your peers. That is one of the most commonly asked questions we get. One thing that we have done for several years now is to put together a database of financial information from clients who use generally accepted accounting principles accounting practices in their operations. This has given us a pretty good litmus test on how the industry is doing financially while granting us an opportunity to let individual operations know how they measure up to their peers.
Financial database results
At Compeer Financial we look at the results of the database quarterly. Having just completed the analysis of the third quarter information, our expectations of an extremely strong industry financially were confirmed. When looking at the database over the years, we have found that the third quarter data give us the best results to compare operations. Typically at the end of the third quarter, most operations have not started deferring hogs sales for tax reasons and all prepaid expenses have been used. This gives us the best baseline when discussing how operations stack up against each other.
First, I will explain how we compile this information. The information for the database spans across the entire United States, encompassing approximately 20% of the country’s production. The information is representative of a variety of different types of production systems and includes sales to all major packers in the United States. To determine the cost of production number we take the total revenue number for an operation, less GAAP profit. We use this method simply to take out other management decisions on hedging that would impact the cost of production.
As stated earlier, we do have a very strong industry today. Owner’s equity in our database is at 72%, which is as high as I have seen it in the 21 years I have been working at Compeer. Just as impressive is the level of working capital. We try to normalize this number by using a calculation of working capital per sow or sow equivalent for operations that purchase some or all of their wean pigs. The typical operation in our database today has over $1,400 per sow of working capital. A good target would be $700 per sow with $500 per sow used as a baseline number as a minimum.
It goes without saying that those operations with extremely high levels of working capital can take advantage of opportunities quickly and for a period of time are insulated from severe health challenges. A good way to look at that number, for example, is to look at an operation with $1,400-per-sow working capital, selling 26 grade A pigs per sow per year, could lose $17.30 per head for two years and still have a working capital of $500 per sow. So when I have a conversation with clients, I stress it is this number to see how they compare when implementing their risk management strategies. With the number of current unknowns regarding diseases, trade concerns, industry growth and labor issues, to name a few, it could be vital to your operation to know how much cushion you have in your operation to withstand a prolonged downturn and have a risk management strategy that helps you manage through those unknowns.
The last two numbers I am going to talk about through the third quarter are profit year-to-date and total cost per head. Through the third quarter, the average producer had made just over $17 per head. However, based on revenues in the fourth quarter, this average will drop the profit per head in 2017. Average costs per system today are $141 per head at the end of the quarter.
My recommendation would be to look and see how you stack up, especially on working capital for your operation and design a strategy around your liquidity that keeps your business profitable.
Malakowsky is a senior swine lending specialist, with more than 20 years of experience at Compeer. For more insights from Malakowsky and the Compeer Swine Team, visit Compeer.com.