By some estimates, cattle herds in drought areas in the western U.S. and Canada have depopulated by 20-40%. This suggests a demand for replacement heifers once the drought ends and herd rebuilding begins. This month, I'll detail my process for determining the economic value of a bred heifer.
The spot market price of bred heifers is highly correlated with current calf prices. For example, when calf prices were high in 1993, bred heifer prices in the Northern Plains were $1,000+ per animal. Some sold for more than $1,400.
On the other hand, the economic value of a bred heifer is the sum of that heifer's generated future annual “net cash incomes,” plus her final cull market value. My calculated economic value of a bred heifer in 1993 was $640 due to the projected low calf prices for 1994, 1995 and 1996.
A spot market price of $1,000+ and the calculated economic value of $640 isn't a recipe for profit. But remember that the spot market for bred heifers tends to be based on current calf prices, while the economic value of a bred heifer is based on future calf prices.
Beef cow producers should add replacement heifers whenever their economic value is greater than the spot market price. The greater the difference between economic value and acquisition cost, the higher the herd's profit potential. Maximizing the difference between the economic value of a bred heifer and her acquisition costs is a key determinant in the long-run profitability of any drought repopulation strategy.
If a drought rancher overpays for replacement females, his business can easily feel the negative economic effects as long as those females are in the herd. If purchased with borrowed money, it can get even worse.
Couple that with running these females in the “falling market” phase of the cattle cycle projected for 2006-2008, and the current drought could be felt well into year 2008. Thus, it's absolutely critical that all repopulation strategies employ proper economic valuations for replacement females.
Determining Economic Value
Calculating the economic value of a pregnant-checked bred heifer in fall 2003 is a five-step process. Here's a brief description of those steps. More detail is available at www.ag.ndsu.nodak.edu/cow/lsmanews/5-1-97.htm.
Develop a set of calf planning prices for the expected life of a bred heifer in your herd. For this analysis, I'll assume that a bred heifer will have seven consecutive calves starting in the spring of 2004.
Figure 1 presents my latest suggested set of planning prices. The only change from previous versions is that my projected double top occurs with the sale of 2004 calves rather than for 2003, an adjustment forced by the extended drought in the West.
Prepare a cash flow budget projecting the net cash returns to labor, management and equity capital for each of the seven years the heifer is projected to calve in your herd. I've elected to use the average net cash flow summary from my Northern Plains 1999/2000 Integrated Resource Management (IRM) herds as my net cash flow budget.
These 1999/2000 IRM herds had a relatively high economic efficiency, and most of these managers had multiple years of formal cost control management participation in North Dakota State University's IRM program. These tend to be low-unit cost, economically efficient beef cowherds.
These herds generated a $433/cow average gross cash income in 1999/2000 from the cash sale of calves and cull animals. It cost them $170 cash to raise the feed and provide summer pasture. Debt service was $55/cow — $22 for interest, $33 for principal.
Total feed and non-feed cash costs brought total cash costs to a $346/cow average. These herds generated an average cow net cash flow of $87/cow before family living draw.
Since past debt service needs to be assigned to existing cows and not new replacement heifers, I'll add the debt service ($55) back in with the $87 to generate a total $142 projected net cash income for adding replacement heifers to these herds. This $142 is the projected net cash that can be applied toward newly purchased heifers in these herds.
I then re-calculated a net cash flow budget annually for 2003- 2009 based on my long-run planning prices. These annual net cash flow projections are shown in Figure 2.
Project the salvage value of these bred heifers after seven calves. My published long-run cull cow planning prices suggest $37/cwt. for cull cows in 2009.
Determine the appropriate discount interest rate to use in calculating the time value of money. Use the interest rate you're paying on current long-term debt. In this example, I will use a 6% discount rate.
Calculate the net present value (NPV) of the future net cash incomes from calving this heifer over the next seven years. Figure 3 presents my calculation of the NPV of a bred heifer at pregnancy check time in fall 2003.
The total “net income” column in Figure 3 is the income from her seven calves, plus her $480 cull value in 2010 — a total of $1,309 nominal dollars. This projected $1,309 nominal dollar value generated over the seven years discounts to a NPV of $1,024 expressed in today's dollars.
What This Tells Us
This $1,024 NPV suggests that if this bred heifer were purchased for $1,024 at fall pregnancy-check time, and if my net income projections come true, the investment in this bred heifer is projected to earn a 6% rate of return. If I paid more than $1,024 for this bred heifer, I'm projected to earn less than 6%. If I pay less, I'll earn more than 6%.
My advice to ranchers repopulating their herds: Evaluate the spot market carefully.
Harlan Hughes is a North Dakota State University professor emeritus. He lives in Laramie, WY. Reach him at 701/238-9607 or [email protected].
Figure 3. Economic value of a bred heifer
Year of economic analysis: 2003
Discount factor: 0.06
|Year||Net Income||Discount Factor||Discounted Value|
|7||Value of cull cow||480||0.6650||$319|
|Total cash income||$1,309||$1,024|