Facing the Forces of Change

February 3, 2010 06:00 PM


Watching the television news this past summer taxed Mark Hansen's patience. "Every time they referred to H1N1 as ‘swine flu' I had to change the channel,” recalls the veteran Truman, Minn., hog producer, reflecting the exasperation of his colleagues across the nation.

As if the global recession wasn't bad enough for pork demand, the effects of the H1N1 virus and a downturn in export markets all but killed off profits for hog producers, such as Hansen. High-priced corn and soy meal nailed the coffin on two years of record hog market lows—a total of $5 billion in losses for the pork industry.

For Hansen and his brother, James, who have partnered in their 350-sow operation for 35 years, the worst came when their herd contracted Porcine Reproductive and Respiratory Syndrome (PRRS), an economically devastating disease. The Hansens were forced to downsize their herd and now are reconsidering where their operation is headed in the future.

"We're running through our heads whether to shut down farrowing altogether,” Hansen says. "Maybe we'll buy pigs or finish out for someone else.”

Pork producers across the nation are cutting costs of production in every way imaginable in order to convince lenders to hang in there with them. Some are opting out of farrowing, while others are renting out facilities to other producers or consortiums—desperate moves in attempt to stem the average $31 per head loss in 2009.

The result is that producers are facing a new norm in profitability that amounts to a paradigm shift within the industry.

Profit Model Shift. The past six years have marked two very different periods of profitability for pork producers, says Mark Greenwood, swine analyst and a vice president of AgStar Financial Services, a major lender to Minnesota hog producers. 

Greenwood points out that 2004 to 2007 was the longest period in history that hog producers made money every month—around $15 per head to $20 per head. From 2007 to 2010, however, marks the longest period where producers have lost money every month.

Cost of production was much different between the two time frames. The old norm saw a cost of production of around $110 per head to $115 per head; the new norm is more like $130 to $140 cost of production per head.

Greenwood believes a realistic new profit norm will more likely be $5 per head to $10 per head.

After seeing hog earnings down in 22 of the last 24 months, it's understandable that lenders may be leery of extending credit to new customers, instead sticking with long-time, trusted clients, he adds (see sidebar below).

An Unclear Future.
Uncertainty paints the hog industry going into 2010 like never before. What is certain, according to analysts, is that the hog supply must be reduced in a sustained manner for several months to come.

While December hog prices approached the break-even point (flitting around the $65 carcass per cwt. mark) the year-end USDA hog and pig report states that the September 2009 to November 2009 pig crop was up. Only about 2% fewer sows are expected to farrow during the December 2009 to February 2010 quarter. 

"We're reducing numbers, but not at a pace that's needed to reduce overall supply and bring the industry to profitability,” Greenwood says. To correct the market, analysts say reductions must be from 3% to 5% or even higher.
"Everyone is looking for that magic number, but I'm not quite sure what it is,” Greenwood says.

Looking ahead through 2010, he believes prices will average $66 to $70 carcass per cwt. "If this holds true, 2010 would be a break-even year.” While some producers will lose money, Greenwood adds, his anticipation is that there won't be a string of absolute devastation like experienced the past two years.

A major caveat is demand for pork. If actual pork supply is less than recent USDA reports suggest, and exports—which dropped 17% in 2009 from 2008 levels—stay at the same level, it will create what is called a ‘disappearance' of meat. "With less meat to buy, prices go up,” he says.

Operating Adjustments. Struthers Farms of Collins, Iowa, has made massive cuts during the past two years to shore up losses and demonstrate to their lender their ability to change. David Struthers, who farms with his brother, Dan, and father, Don, has gone from 1,000 sows in 2007 to 300 today. During the process, they downsized from four employees to one.

Struthers, like many in the industry, is keeping older sows farrowing longer and delaying weaning from 18 days to 28 days. "Weaning later is much easier on the sows so they can carry more pigs later. It saves substantially on expensive starter feed rations,” Struthers says.

In recent months, the Struthers have fed all their corn to their hogs while still purchasing expensive soy meal. However, with significantly fewer sows, they now have corn to market. They continue to sell pigs on the local cash market, rather than on contracts, which gives them flexibility in market timing.

The Struthers have also found a new lender who better understands the hog industry's cycles. "We keep them informed of our plans and have shown them where we can cut back due to the hog price situation,” Struthers says. "Our buildings are aging but usable, and we've brought our numbers down. We've shown we can be grain marketers, not just purchasers.”

Because the Struthers have kept their banker abreast of every move, the bank works with them, allowing them to pay off feed and veterinarian bills before the bank note.

Struthers, a board member of the Iowa Pork Producer's Council, has another suggestion for his industry: "The industry just has to promote the quality of pork … its nutrition, taste, versatility,” he says. "You walk into the grocery store and see a million things they do with chicken. We just haven't gotten there yet with pork.”

Lenders Remain Leery

Pork producers aren't the only ones under the financial gun; banks in these economic times are in various financial positions, as well, and are now requiring producers demonstrate their operation's strength before issuing loans, says Jerry Fast, agricultural loan officer at Bank Midwest's Fairmont, Minn., branch.

According to Fast, lenders now are looking at a customer's past financial history beyond two years. "If a producer hasn't shown profitability over the past 5 years, it's hard for most lenders to stay with them,” Fast says. "They have to be willing to accurately know their cost of operation and where to factor in changes to keep it afloat, whether that's juggling employees, reigning in inputs or downsizing the herd.”

Producers now must provide the latest, accurate financial data to their lender and truly understand it, says Mark Greenwood, swine analyst and a vice president of AgStar Financial Services. 

Most of Greenwood's top producers keep a constant eye on the futures market a full year out. Looking ahead through 2010, Greenwood points out that hog futures prices appear to be break-even 10 out of the next 12 months. He suggests producers look for strategies to ensure that break-even point, including locking in feed prices.

Many of his clients also employ 12-month forecasting. "It depends on the strength of the balance sheet, but you need a realistic plan of profitability,” Greenwood says. "If you and your lender sense a weak spot, that's what you need to get a handle on.”

Top Producer, February 2010

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