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Build, Buy or Expand?

Ongoing consolidation has made for larger capacity feedyards. But bigger isn't better unless it can be done profitably. The trick is to get bigger without going broke.There are three ways to expand:* Add on to what you've got;* Buy an existing lot; or* Build a brand new lot.It sounds simple, but each option courts disaster. The fed-cattle market could collapse, leaving a heavily indebted feedyard

Ongoing consolidation has made for larger capacity feedyards. But bigger isn't better unless it can be done profitably. The trick is to get bigger without going broke.

There are three ways to expand:

* Add on to what you've got;

* Buy an existing lot; or

* Build a brand new lot.

It sounds simple, but each option courts disaster. The fed-cattle market could collapse, leaving a heavily indebted feedyard unable to pay for its new facilities. Or, environmental regulators could wrap the project in costly red tape. It doesn't matter whether you own a small feedyard with a few hundred head or a mega lot with more than 40,000 head, the hazards are the same.

While there is no way to sidestep every hurdle, feedlot specialists say you can avoid many hazards by anticipating the business and regulatory environment of the future.

"You've got to be looking 15 to 30 years ahead," says Bill Helming, head of Bill Helming Consulting Services, Olathe, KS. Helming, who works closely with large feedlot organizations on expansion projects, recommends this strategy:

* Determine whether expansion is likely to be profitable.

* Check out the regional water supply. Fed cattle guzzle an average of 12.5 gallons each per day. For a 40,000-head lot, that's 180 million gallons a year.

Can you get that much water now? Can you get that much 20 years from now when you may still be paying off the facility? Also, make sure water quality is high. High levels of impurities, such as sulfates, will impact an animal's performance.

Investors should also make sure the region has enough water for grain and forage crops. If irrigation water runs short, local feed supplies could be impacted.

Plan for tougher environmental regulations. "It's a moving target," says Helming. "The environmental regulations are becoming more demanding all the time."

Problems And Benefits The above-mentioned rules apply whether you are buying, building or adding on. There are also potential problems - as well as benefits - associated with each option. Here's a look at some of those alternatives:

If you build a new feedlot, you gain the latest bells and whistles and avoid mistakes of the past. You also don't have the headaches of an old feed mill, used rolling stock and an aging physical plant. But, you'll pay dearly for these things.

"The purchase of existing capacity is virtually always cheaper than new construction," says Tull Bailey, assistant director of the ranch management program at Texas Christian University.

The trick is to figure out when the economies of a new lot outweigh the costs. If you decide to plunge ahead, expect more headaches getting the necessary building and environmental permits to build from scratch than you would if you chose to buy or expand. "It's a much steeper hill to climb," says Helming.

Location, Location, Location And if you do build a new facility, you can still hit turbulence if you choose the wrong location. Avoid sites near water. They could be contaminated if something goes wrong. And stay away from residential development. New subdivisions and feedlots don't mix.

Buying an existing facility can save money, says Todd Milton, a feedlot management specialist at the University of Nebraska. But, he advises would-be buyers to ask some very basic questions before proceeding. How close to town is it? Is the waste management facility up to par? Can it be expanded easily?

If you buy or build from scratch, you have the option to relocate, perhaps to a state where taxes or workers compensation costs are lower. If this option looks attractive, remember that a distant location is full of unknowns. It may prove too far from packing plants or reliable feed supplies.

"Feed source is absolutely essential," says David Saxowsky, assistant professor of agricultural economics at North Dakota State University. "You ship cattle to the feed. You don't ship feed to the cattle."

And be sure to check the weather at your proposed locations. "You want to be in an area that can produce grain economically," says Milton. "But if you can be in a low rainfall area, that's going to help you as far as the mud."

Expanding Is A Sensible Option Adding to an existing lot can make sense. "If you've got a feedlot that's big enough to handle the expansion and you don't have neighbor problems, you're usually better off expanding what you've got," says Milton. "But if you've got to revamp the feed mill and you're on the edge of town, then often it would be advantageous to move to a new site."

Again, pay particular attention to the neighbors. They may tolerate a 1,000-head lot, but wince at the thought of seeing it triple in size. No one wants an ever-expanding feedyard next to his or her subdivision.

And if you do expand at your current site, there are two options:

You can add more pens and rolling stock but continue to use the mill you've got if it has excess capacity.

Or, some very large feedlots have found it makes sense to build a second fully-equipped lot with its own mill next to an existing one.

"Operators say there's a point where you might be better to have two duplicate operations, even if they're side by side, rather than one huge facility," says North Dakota State's Saxowsky. "If you build one very large mill, for example, you're going to have so much traffic at that point that you might have traffic congestion."

Evaluate The Timing Among the many factors that must be considered, timing is an important one. If you borrow to buy, build or expand when interest rates are high, you raise the breakeven point. A high breakeven point can put you out of business when fed-cattle prices fall or feedlot occupancy drops.

Another factor is the fed-cattle cycle. "When we're in the liquidation phase, virtually every yard is full and everyone is contemplating higher capacity," says Texas Christian's Bailey. "As a result, the purchase price of existing capacity is much higher than it would be five years later in the cycle. By that time, the numbers are down and there's overcapacity in the industry. When you get overcapacity, the yards trade much more cheaply."

Finally, it won't hurt to ask whether it makes financial sense to expand, whether you contemplate buying, building from scratch or adding on. Feedlots are in the business of making money. If the expansion won't make money, it doesn't make sense.

If you think you're just buying a piece of real estate when you purchase an existing feedlot, think again. You're also acquiring existing customers, personnel, management and the facility's reputation.

Feedlot consultant Bill Helming advises potential buyers to look at such issues carefully, asking, "What is the overall reputation of the facility, the customer base and the personnel?"

You may be looking at a first-rate facility with top-notch workers and a reputation for service. Or, you may be looking at a facility with sub-par performance, high customer turnover, a low occupancy rate and a lousy reputation.

If the lot you buy falls in the second group, you may be able to turn it around. But it might be difficult. Would you go back to a restaurant that made you sick last time you ate there, even if it were under new management? Maybe not.

"Even though you bought the feedyard, the old reputation can stay with you," cautions Todd Milton, a feedlot specialist and assistant professor of animal science at the University of Nebraska.

"Maybe the old manager didn't get along with the people in town," he says. "Even though you're a new owner, you've still got to battle perceptions created by previous management. Rather than managing a new facility, you may end up spending time mending fences. You may be the world's best manager and have good intentions, but you may have to overcome those things."

If you're going to spend millions to buy or build a feedlot, gather as much information as possible. Here are some tips:

If you're buying an existing feedlot, talk to the lot's employees. See if you can ride around the operation with them in a pickup. They may tell you if the equipment doesn't work, employee morale is low or the place has a second-rate reputation.

If you plan to relocate, do two things. Check the weather for the period of a number of years. Checking a single year won't tell you much because the weather can change from year to year. Then, find out as much as you can about taxes, water, feed supplies, regional attitudes toward agriculture and laws and taxes that will impact your operation.

Friends are one obvious source of information. But there are many others, including state legislators, local Extension agents and the farm reporter at the local paper serving the area where you may locate. By checking these sources, you can detect potential problems, such as anti-agricultural groups that might file a lawsuit if they don't like the idea of a feedlot in their area. You can also find out whether the legislature is sympathetic to agriculture.

The cost in time and money to make these checks is minimal. The potential savings are enormous.

Smart buyers don't purchase a used car or an old home without inspecting them. Why would you make a multi-million dollar investment in a feedlot without doing the same?

"Every feedlot is different, including the quality of original construction, and the quality of maintenance and repairs," cautions feedlot consultant Bill Helming. "It's just like anything else, whether it's a home or an automobile."

Several measures will help ensure an effective inspection. First, list items that must be checked, such as the condition, capacity and efficiency of the mill. Find out the mill's hourly processing capacity and its operational cost. Compare the numbers to the design specifications to see how much mill efficiency may have deteriorated. Then compare those numbers to a modern mill.

Ask to see mill maintenance records, much as you might ask to see how often the oil had been changed on a used car. Also, check maintenance records of rolling stock such as feed trucks, front-end loaders and pickups.

Look for shoddy construction. Failure to do so can lead to big-ticket repairs. How many home buyers have discovered too late that the foundation of their new home requires major repairs, or that supporting timbers have been devoured by termites and must be replaced?

If you find problems, you have two options: You can look elsewhere or you can lower your bid to reflect what you expect to spend on repairs.