August 22, 2016
Labor Day is just around the corner, and soon we will see school buses rolling up and down the dirt roads we all love. While growing up, I always wondered, “Where did the summer go?” whenever we hit this time of year.
This summer started off reasonably well in the pig market with profits close to the 75th percentile through the second quarter. We’re all too familiar with what the markets have done the second half of summer, as profits dipped to the 25th percentile. Beyond the futures markets crash, basis has added additional challenges. From July 4 through Aug. 15, the Iowa/southern Minnesota cash market basis has averaged minus-$2.32 per carcass hundredweight wider than the three-year average from 2013-15. This equates to operational profits being minus-$4.83 per head lower than normally expected. Iowa State’s Farrow to Finish Estimated Returns Model reports a $15.57 per head profit for July. We appreciate that this is a positive figure, but this level of profitability isn’t what we’re used to for this time of year.
The good news is, as a whole, balance sheets have remained strong. Through the year-to-date reporting period ending June 30 (six months), most producers will be able to post positive earnings. A large segment of the producers we work with added hedge positions to lock-in profits during the brief rally, earlier this summer. With the futures market tailing off in July, there have now been tremendous market-to-market gains which have resulted in our revolving lines of credit falling from 22% disbursed down to 17%, on average. Not all producers are at this low level of financing. There are always health challenges, recent expansions and family dynamics that can cause a need for additional borrowing.
For producers who are looking to add to cushion to their working capital, now is the time to seize opportunities and rebalance your balance sheets. Long-term fixed interest rates are near the lowest we’ve seen all year. Rebalancing isn’t adding debt; it’s moving existing debt down the financial statement and stretching payments over a longer period.
Earlier this summer, we saw slaughter runs pick up more than ever before. Producers are working hard on marketing pigs to ensure they are prepared for the slaughter capacity challenges we’ll see this fall. This is crucial as they work to keep late-fall weights within their packer grid and look to minimize sort loss deductions. The June Hogs and Pigs Report showed a 2.2%-2.5% fall in pig inventory increases over 2015. This will impact the number of pigs that will go to town in the fourth quarter, which will test the slaughter plants across the United States. With these large forecasted slaughter runs, basis will continue to be a challenge.
In recent weeks, margin money from hedge positions has flowed back to the farmer. That margin money was generated from positions on pigs that will be delivered through the winter. As we look ahead, farmers will lose $25 to $30 per pig in the fourth quarter. Producers will want to provide peace of mind about the true net earnings that are realized and factored in the hedging gains that were booked earlier this year to key stakeholders. Accurate production and financial records will continue to be increasingly important to tell the full financial story.
Now is the time to revisit cash flow projections. Most folks will not like what they see through the winter, but it provides clarity and peace of mind. There will be operational losses that need to be accounted for. Farmers will also begin year-end income tax planning soon. It is important to have a firm grasp on cash flow projections to ensure sufficient reserves are available just in case you need to fund operations, and to keep a cushion for margin calls if we do get the bump in the markets we’re all hoping for.
The year 2017 will be an exciting one. We will see the new packing plants up and running which should help basis. We will also see the ever-anticipated increase in pork production from the sow expansion that has ramped up through 2016. It remains to be seen how the U.S. dollar will trend and where we stack up with maintaining access to China and our key foreign markets. With all these changes, it is important to know where your cash flow will be positioned and to stay focused on daily production. Make sure you work with peers to identify opportunities to drive down costs and maintain a disciplined approach to risk management.
Winter isn’t even here yet, but I’m already excited for spring.
Timmerman is a senior financial services executive for AgStar Financial Services. For more insights from Timmerman and the AgStar Swine Team, including their bi-weekly video Hog Blog, visit AgStarEdge.com.
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