“The feedlots we see staying the fullest are taking on the added risk of feeding a higher percentage of the cattle themselves,” says Kevin Good, senior analyst at CattleFax. “With that added risk they are also utilizing risk management to a much higher degree than in the past. They’re also more likely to be involved in owning or contracting the cattle longer through the calf and feeder phase before getting to the feedyard.”
That’s the nutshell perspective of how cattle feeders are battling against dwindling cattle numbers, historically higher input costs and gut-wrenching volatility.
“Capital requirements are so high that you have more risk. You have to do more with less,” Good explains.
Feedlot profit center drivers
More feedlots owning more of the cattle in them also means more folks are fully vested in each of what Good defines as traditional feedlot profit centers: the feedlot itself, the profitability of the cattle flowing through it, and the risk management of commodity inputs and outputs.
In order to maintain feedyard occupancy levels, Good explains, “One thing we’re seeing is yards reaching further back into the feeder supply. They’re owning cattle longer (grow yards and backgrounding) to minimize some risk and to maximize returns by owning cattle in two different segments.”
On the other end of the equation, Good explains, “As we think about methods of merchandising fed cattle, a higher percentage are being marketed on some sort of grid or formula marketing arrangement. The vast majority offer some sort of premiums, whether yield-based or quality-based. We’re trying to maximize the dollars per head that we can spread over the input costs, and one of the ways we’re doing that is adding value to the carcass.”
In between, with performance critical to fed cattle profitability, Good explains, “There’s less margin to work with so you have to use any and all technology to be competitive. Even if you’re not using it, your neighbor is… Cattle feeders are utilizing all of the technology they can get their hands on to remain competitive in a very competitive business.”
With competition so fierce and margins so thin, in part because of excess bunk capacity, Good says, “The feedlots that are making it, and will make it, are those that adapt to technology and are on the forefront of it.”
Understanding technology value
With that said, Derrell Peel, Oklahoma State University Extension livestock marketing specialist, explains high input costs are also changing the relationship between technological and economic efficiency.
“When inputs are cheap, technological efficiency equals, or is very close to equaling, economic efficiency (average daily gain, conversion, etc.),” Peel explains. “When inputs are expensive, technological efficiency becomes a less reliable indicator of economic efficiency.”
Fertilizer application relative to crop yield serves as an example. When fertilizer was cheap, maximizing technological efficiency (as in applying the maximum) resulted in economic efficiency(maximum yield). As fertilizer costs grow, however, economic efficiency means optimum fertilizer application and crop yield are somewhere short of maximum.
“To some extent, that’s like feedlots,” Peel says. “For the last several decades, anything that promoted corn consumption (technical) was good economically.”
With higher grain costs, Peel explains, it’s not a question of whether or not to use current technology but re-evaluating its role. “Re-examine the rules of thumb that have driven our decisions in the past,” Peels says. “When inputs are cheap, you tend toward maximum production. When input prices increase, the cutoff for the value of the technology comes sooner.”
In other words, those most successful at navigating that gaping maw of recent changes seem to be those most adept at collecting data and transforming it into decision-enabling information.
Conversion and In-Price Drive P&L
Consider a recent financial analysis conducted by Elanco Animal Health.incremental change in decreasing in-price by $1/cwt. increased profit $7/head (Table 1). Reducing feed conversion by 0.1 lb. increased profit by $10.45/head
“We analyzed performance data from Elanco’s Benchmark® database for 7-cwt steers in the High Plains, Central Plains and North Plains regions that closed over the period January to April 2013. A total of 1,394 lots (247,800 head),” explains Michael Genho, technical services consultant with expertisein analytics at Elanco.
Keeping in mind that the analysis includes deads, the profit drivers explaining 97% of the variation in profit and loss were: in-price (35.97%), average feed conversion (25.00%), ration price (19.92%) and out-price (15.85%).
Spun differently, the incremental change in decreasing in-price by $1/cwt. increased profit $7/head (Table 1). Reducing feed conversion by 0.1 lb. increased profit by $10.45/head.
That may not surprise some, but the relative opportunities available might.
For instance, Genho says, “Depending on the operation, if you see out-weights creep up, that’s something to visit.” With feeding to optimum out-weights a key driver of average feed conversion, he explains there is merit in understanding the cost of chasing additional yield.
“Sit down and look at the economic tradeoffs of what heavier out-weights are costing you,” Genho suggests. “If you’re losing 0.2 lbs. in conversion by feeding them longer, are you making up the lost $20 on grade and yield?”
Incidentally, Genho explains a profitable exercise Elanco uses to help customers. They sit down with customer yards, and get the entire crew together – pen riders, hospital crew, feed callers, feed truck drivers, everyone.
Each is asked to list the things that impact feed conversion. It’s a long list, of course, everything from bunk management, to subclinical disease, to ration quality, to dirty waterers.
“Pick four or five items you want to address and get the crew to set goals and then have weekly accountability meetings to monitor the progress,” Genho says. “Over time, you will see improvement. I think we sometimes underestimate the opportunity that comes with this.”
As for in-price, Genho sees opportunity in more accurately evaluating the worth of specific cattle to specific operations, based on knowing and tracking more information about cattle.
Everyone has a breakeven tool, but Genho thinks both sides of the equation could be improved with precision.
“The input that goes into breakeven calculators is not specific enough,” Genho explains. “It doesn’t account for where the cattle are coming from, how they’ve been handled in terms of nutrition and health, things that better inform you of the value the cattle have to you.”
More precise input information yields more accurate estimates of when cattle can be marketed.
“Risk management tends to be viewed in terms of market risk, but we need to account for performance risk, too” Genho says. “If you’re off by a contract month (when cattle finish), that impacts the P&L… It’s easy to say, ‘If they convert an extra tenth of a pound…’ but is it realistic for those specific cattle?”
Risk management essential for all
Risk management seems to be the growing constant amid cattle feeding evolution.
Whereas market risk management was historically regarded as the adhesive to hold the money together, Good explains the risk management department is being relied upon more as a profit center.
“A lot of it is necessity,” Good says. “The tighter supplies, with the feed yard entity feeding a larger percentage of the cattle themselves. The capital requirement to feed more cattle is a lot greater. There’s a lot more risk associated with volatility. Therefore, out of necessity, we’re seeing a lot more interest in risk management.”
He points out markets still swing by the same percentage (high to low) during the year. But that percentage today represents significantly more dollars. CattleFax looks for fed cattle to average $126/cwt. this year. A normal change would suggesta low of $114 to highs in the upper $130s. That’s a swing of $300/head.
Good points out that profitable risk management sometimes revolves around minimizing economic loss.
Though most risk managers are reluctant to hedge a loss, Good uses this past winter as an instance when that may have been the most profitable strategy.
“Futures were trading at $130 for summer contracts, but we had breakevens in the mid $130s and a lot of managers didn’t want to hedge a loss,” Good explains. “But the right decision would have been to hedge the cattle, experience the $10 down we had in the futures, put $10 in their pocket and, in a lot of cases, mitigate the losses in the cattle.
“It’s a tough decision, but equity preservation should trump the thought of making money at times…
“As you think about the volatility we’re seeing in the futures market, the swings not only in the futures but in the basis, within the cattle feeding period, there are typically some very good opportunities for the cattle feeding entity to take advantage of risk management and put some of the movement and volatility in their pocket,” he says.
Good adds that more cattle feeders are looking to manage different risks than in the past.
“Energy costs are something that we haven’t looked at a lot historically,” Good says. “With energy costs as high as they are, and it looks like they will stay that way, that’s caused a lot of folks to purchase energy further out – either physically if they have the facilities or in the futures market – because there is strong seasonality to the energy market as well.”
As more components – and more diverse components – impact the price of cattle feeding inputs, Good stresses the need for more information. But he emphasizes there is a mighty difference between information in general and the kind of timely information coupled with analysis that enables informed decision making.
“With risk management almost a must in the cattle feeding business today, how you analyze and look at futures trends, basis trends, cattle placement numbers, the fundamental trend, money flow, there are so many things we look at today compared to 5-10 years ago – the analysis of that information is becoming more and more valuable,” Good says.
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