“Management isn't just about production; it's about marketing and analyzing the markets,” says Dave Delaney, vice president and general manager of ranching operations for King Ranch at Kingsville, TX. “The lesson is that a good manager retains marketing flexibility and options, and looks for buying and selling opportunities.”
He's referring to the startling results of a study recently completed by the King Ranch Institute for Ranch Management (KRIRM). It reveals that over the past eight years King Ranch has made the equivalent average profit of $300/calf raised by selling those calves and then buying back others to background, stocker and feed. If King Ranch had simply retained ownership in its own calves through its own feedyard, the average profit for those eight years would have been $8/head.
Delaney is quick to point out that the study doesn't account for risk management. In fact, he was reluctant to make the study public out of fear the results would blind folks to the reasons that such a profit swing is possible.
It has everything to do with financial concepts that allow cattle producers to overcome two basic but vexing marketing challenges: low margins and infrequent sales.
“A critical concept to understand is that in a low-margin business such as groceries, the merchandise usually turns over rapidly,” explains Barry Dunn, KRIRM executive director, who directed the study. “In a high-margin business such as diamond jewelry, the turnover is usually slower. Cattle marketing typically represents the worst of both worlds: it's both low margin and low turnover.”
Exploiting value difference
A common practice called arbitrage counters the margin challenge. Many producers, especially those in the stocker and cattle-feeding sectors, utilize it without necessarily thinking of it by that term.
“Cash market arbitrage is selling what is overvalued and replacing it with something that is undervalued,” says Ann Barnhardt, who owns and manages Denver-based Barnhardt Capital Management, Inc. Be it exploiting weight-based value differences in calves and feeders or age-based value differences in heifers and cows, she explains arbitrage revolves around constant market analysis in search of selling what's overvalued and buying back what is undervalued.
In the King Ranch example, Delaney sells the ranch-raised calves, which are a popular commodity with buyers and bring more than the market average. He replaces them with calves purchased in the soft parts of the commodity market.
“I'll buy and sell if I can make at least as much return on investment (ROI) on what I'm buying as what I'm selling,” Delaney says. “When I started in this business in the 1970s, if you made $20 or $25/head, that was a home run. Now, you can make $40/head, but the ROI might only be 2% or 3% because costs have increased so much.” He targets 10% ROI.
King Ranch also increases what is termed the asset turnover ratio (ATR). In basic terms, it's capturing the profit margin multiple times with the same assets invested.
“If a business has a 3% return and sells once a year, it will make 3¢ on every $1 it has invested in its business,” Dunn explains. “However, if it's able to maintain that same margin and sell three times each year, it will accumulate 9¢ on every $1 it has invested in its business.”
King Ranch has utilized this principle by having multiple enterprises and calving seasons, which increase the frequency of its sales into more markets, while leaving its asset base unchanged, Dunn says. The result is they have an increased ATR compared to production or marketing programs with fewer enterprises that sell less frequently.
“If you can retain ownership in your calves and make $30/head, as an example, of if you can sell them and make $30/head, sell them,” Delaney adds. “Every time you do that you multiply your return on assets. Why do it just for fun?”
ATR is one challenge Dunn sees to retained ownership. “Marketing strategies that slow your business should raise a red flag. You want to find ways to speed up the business cycle,” he says. That's not saying retained ownership doesn't work for some folks. It is saying that ATR is another opportunity to consider.
The King Ranch arbitrage and ATR opportunities are fairly well defined, yet flexible. They're marketing calves from a cowherd with spring and fall calving seasons and replacing them with calves of lesser value to background, stocker and feed in some combination.
There are more aggressive versions of these concepts, though. In the Bud Williams Marketing School that Barnhardt teaches, the mantra is, “Sell when you can replace at a profit.” Period. Practitioners of the Bud Williams approach sell and buy as many times as possible during the year with the aim of building cash equity.
For more information about Barnhardt and the Bud Williams Marketing School, see www.barnhardt.biz.
Next Page: Pulling the trigger
Pulling the trigger
All of this obviously is a simplified presentation of concepts that require plenty of brain sweat, if not complexity, in their application.
In some cases, like the Bud Williams approach, exposure to market movement is minimized by selling and buying within the same week. For others, who buy replacements later, likely future value must be analyzed.
Delaney tends to utilize futures market prices with his local basis. He points out there are three other common proxies for assessing future value: an index of monthly historical average cash prices, the current cash market and the venerable school of wild guesses.
With those predictions in place, Delaney utilizes a decision-making spreadsheet that evaluates comprehensive costs and calculates profit scenarios for a given set of calves. Last spring he ran the numbers for King Ranch calves using five different marketing scenarios. The projected ROI ranged from -10.5% to +27.4%. He's quick to add that he's not a market guru; he tries to be right 51% of the time.
Barnhardt emphasizes, “You have to know the cost structure in every business. Few cattle producers calculate their cost of gain when they buy, and when they do it's often woefully incomplete.”
Delaney and Barnhardt also stress that applying these concepts requires discipline.
But, Barnhardt adds with the excitement of a kid at Christmas, “You can make fantastic money in this business consistently. The profit opportunities are out there everywhere all of the time.”
For the full KRIRM study, go to http://krirm.tamuk.edu.