Making Money in a Down Market

Two Minnesota farm families share their risk management strategies. Without a risk management program, the Becker family of Fairmont, MN, admits they wouldn't have made money on hogs in 2008. Put another way, using trades on the Chicago Mercantile Exchange (CME) resulted in a positive cash flow for the three partners, whereas relying on selling on the open cash market would have sunk them in red ink.

Two Minnesota farm families share their risk management strategies.

Without a risk management program, the Becker family of Fairmont, MN, admits they wouldn't have made money on hogs in 2008.

Put another way, using trades on the Chicago Mercantile Exchange (CME) resulted in a positive cash flow for the three partners, whereas relying on selling on the open cash market would have sunk them in red ink.

“The last couple of years, our risk management program has made our production enterprise profitable. Because the cash market for hogs has been so lousy the last couple of winters, and we protected a profitable margin in our hedge account, the hedges more than offset our losses on the production side,” says Lynn Becker, past president of the Minnesota Pork Board.

Lynn and older brother Lonny and dad Larry form LB Pork, Inc., a 3,800-sow, farrow-to-finish operation that markets 75,000 hogs annually. The home farm includes the nursery operation, corn storage, a 2-ton-capacity feedmill, gas and diesel fuel storage facilities and the trucking operation. Breed-to-wean sow farm sites in Minnesota and Iowa are managed by outside staff, but LB Pork retains ownership.

Lynn manages the physical aspects of the hog operation and calculates the amount of feed and other inputs they will need, plus keeps track of how many hogs they will have on hand to market next week, next month and next year.

Lonny coordinates the risk management duties, charts feed prices and other inputs and projects the potential return on their hogs through marketing.

Larry is nearing retirement, but still helps manage the 1,500 acres of cropland, typically planted to corn. The three-man team meets to finalize the annual plans for the operation, including major purchases.

Lynn says sharing the group decision-making process helps ease the burden and the stress in a family-run business.

“It's been one of our assets in being able to delegate part of the responsibilities to someone else instead of thinking that you have to do it all yourself,” Lynn says.

Making Trades

Being a traditional crop-hog farmer normally has only brought a slight advantage — up until recently, Lynn notes.

The Beckers' risk management program led them to add grain storage capacity so they would have a full year's worth of storage.

“Having the storage to be able to buy all of our corn in the fall of 2007, when we saw prices rising, vs. the summer of 2008, when prices skyrocketed, was a huge advantage ($3 vs $7 corn),” Lynn recalls.

Similarly, the trio has “pulled the trigger” on numerous CME hog trades since 2004, when their Hormel packer contract expired and left them vulnerable to the open cash market.

Lonny figures during the first few years selling hogs on the CME (2004-2006), they left some money on the table, since they didn't hit the top prices offered. But they could still sleep at night knowing they locked in a small profit. That more than balanced out in 2007-2008, when they locked in much better returns on the futures market.

The key is to stay consistent with trades and not be afraid to look farther out to lock in better profit margins, Lynn says. “There are opportunities there. Don't be afraid to take them; what part of black ink don't you like?” he asks.

Trusted Advisors

The Beckers' farm team relies on a number of outside advisors to guide their decisions. The Beckers were one of the first hog farms in the area to sign on with Commodity & Ingredient Hedging (CIH) back in 2004, a consulting service based in Chicago.

The Beckers hedge an average of 70% of their hog sales on the futures market, more in the winter and less in the summer, when cash hog prices typically are higher.

They also buy options on their futures contracts as an insurance policy that locks in any possible gains on their contracts, Lonny says.

Those futures prices are locked in after their costs are established for all three major production factors — corn, soybean meal and hogs. “It is so important to start by knowing what your costs are,” Lonny reminds.

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Lonny says CIH maintains an interactive Web site where he can plug in costs and price basis for their area, providing a tool to calculate profit margins.

Lynn and Lonny also rely on other market advisory services that provide up-to-the-minute price quotes and outlook information for grains, hogs and other factors impacting the global economy and long-term trading opportunities.

Their lender is AgStar Financial; Mark Greenwood, vice president of Agri Business Capital, conducts an annual review of their operation, as well as stays on speed dial on the Beckers' phones and in frequent contact via e-mail.

“Don't be hesitant to find and pay for those services that can help you make better decisions, especially if you are the sole proprietor of your operation,” Lynn urges.

Contact with peers is also important, Lynn says. “Be a sponge and absorb information from other producers.” For example, he visited with fellow southern Minnesota pork producer Kevin Hugoson at a ballgame a year ago about the value of buying fuel in bulk. From that visit, Lynn ended up purchasing two storage facilities for the farm that enabled the Beckers to buy large quantities of gas and diesel in early 2008, ahead of the energy price surge.

In-house recordkeeping, supervised by Lynn's wife, Julie, helps keep close tabs on production and financial figures.

Monthly profit and loss statements are compiled, quarterly cost of production is analyzed and an annual meeting of team members to discuss overall performance is held.

Boosting Herd Health

Changing production flow has been a big part of Kevin Hugoson's efforts to improve risk management. “Our home farm (at East Chain, MN) used to be a continuous-flow, farrow-to-finish farm, and we would end up weaning once a week and commingling groups, increasing health challenges in the nursery,” he says.

Compounding problems is the fact that facilities were built in the '70s and '80s, keeping overhead costs down, but limiting the ability to easily update to improve efficiency.

Ten years ago, the home farm was converted to a 750-sow, breed-to-wean operation. In August 2007, Hugoson started batch farrowing approximately 650 pigs every two weeks.

“By weaning once every two weeks, we get bigger groups that are closer together in age,” he says. “We wean just about as many pigs as we would on a continuous-flow basis, gaining group integrity and significant health benefits.” Weaning age is 19-20 days of age.

Batch farrowing requires more farrowing crates because the sow and litters stay in the farrowing house a little longer. Downtime is extended from 3-4 days to 6-7 days, but Hugoson believes more downtime enhances health as well.

Hugoson also purchased a nearby 1,500-sow, breed-to-wean operation about a year ago, and leases with an option to buy a nearby 2,500-sow, breed-to-wean unit.

The weaned pigs remain as separate flows, with one flowing into a nursery and others into wean-to-finish barns. The contract grower barns and Hugoson's wean-to-finish barns are all within a 15-mile radius.

“Each wean-to-finish site is single-sourced, and that has minimized our health risk in hog-dense Martin County,” he states. Barns are 600-, 1,000- and 1,200-head capacity.

Hugoson has retained ownership of the finished pigs under contract and provides feed and veterinary care as needed. Contract growers get to keep all of the manure produced, and in turn, Hugoson often gets priority access to their corn production.

A sow site in west central Minnesota supplies 20-50-lb. replacement gilts for the three sow farms.

Dealing with PRRS

When the gilts arrive, they are isolated and acclimated for 120 days. “The goal is for the gilts to match sow herd immunity by the time they enter the herd for breeding at 8 months of age,” Hugoson explains. Planned PRRS exposure (PPE) of farm isolates is part of that strategy. Sows receive PPE 30 days postbreeding.

Hugoson regards the introduction of a new PRRS (porcine reproductive and respiratory syndrome) strain as a real risk to his operation. “That is our biggest health risk. If we can keep the same strain, then we are fine. When we get mutations or a whole different strain of PRRS, it is a killer. That is why we have this type of risk management strategy in place.”

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Plans are to install air filtration systems on the gestation-farrowing barns. “I think it will be a given to do that just to minimize the risk, and I feel the filtration could almost pay for itself by eliminating just one break with a new strain of PRRS,” he says.

Hugoson says maintaining regular vaccinations are especially critical when high feed costs make hogs so valuable. Pigs receive vaccine for circovirus and Mycoplasmal pneumonia at weaning and about 2-3 weeks postweaning.

Early diagnosis of health issues has become vitally important to avoid the big outbreaks that are costly, he asserts.

Marketing Risk

Hugoson used to think that health was the only area of risk until high grain prices escalated marketing risk. He looks at seasonal trends, usually trying to buy as much grain in the fall as possible, because grain prices traditionally are lower then. He buys 75% of his grain, using the futures market, to feed out 100,000 pigs.

Another early CIH customer, Hugoson hedges 25-75% of his hog contracts at times, but not always, and perhaps should have in 2008 when cash markets soured.

“Probably the biggest challenge in futures marketing I've experienced is when grain and hog prices are moving in the wrong direction from the positions I've had, and the psychological part of that can be so overwhelming. I know I don't have all of the answers, so I just turn it over to God and pray for peace and wisdom,” he says.

Don't get too emotional when the futures hog market drops a dollar or two — because if you sit tight, it may soon rebound as it often does in this volatile market, he assures. Hugoson analyzes his marketing plan weekly and quarterly. Risk management advice is also supplied by North Star Commodities of Minneapolis.

Most hogs are sold to Hormel, targeting a 200-lb. carcass, and heavier hogs are shipped to Tyson plants in Iowa.

Selling to Hormel, Hugoson must meet pork quality assurance-plus program standards and have site assessments completed by the end of the year.

“You have to have an excellent protocol, and provide a quality job of pig management and a good environment for the animal,” he comments. So far, inspections have gone well and the biggest change recommended has been to enhance recordkeeping on each site.

More diligence in tracking observations and treatments are planned, providing a paper trail from the barn to the office where his wife Mary and their office manager tabulate production information.

Newly installed software will help provide more information on how pigs are processed, track fluctuating breakeven prices and, in the end, help Hugoson get a better handle on whether his operation is staying competitive.

Hugoson leans on advisors to help with production and marketing decisions. “To me, it is just a necessity for risk management. Sometimes we have to spend money to make money, and that can be one of the hardest things for farmers to accept, especially in the last year and a half when profitable times have been seldom.”

And in the end, he says success wouldn't be possible without the positive contributions from employees, contract growers and the Fairmont (MN) Veterinary Clinic.