Over the past year, I’ve received many inquiries from cow-calf producers regarding the margin structure for packing plants.
Wholesale beef prices have been trading near historical highs, but this hasn’t translated into significantly higher feeder cattle prices. Cow-calf producers often believe they are at the bottom of the ladder when it comes to profitability throughout the chain of beef production.
Feedlot operators realize that their business is extremely competitive margins tend to be razor-thin. Many operators have an aggressive risk-management program.
The packing industry is heavily consolidated. Despite government efforts and academic studies, the margin structure for a beef packer is convoluted and difficult to understand on the best days.
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I hope this column can serve to explain the margin structure for each beef production segment. I’ll hopefully clear up a few misconceptions regarding the packing industry. Finally, I’ll have a few tips for the cow-calf producer to capture additional margins that occur after the feeder cattle leave the farm.
Cow-calf returns
The returns for the cow-calf producer are extremely variable from year to year. According to Statistics Canada, nearly 55 per cent of the calves under one year old were in Alberta as of January 1, 2021. Approximately 27 per cent of the calves under one year old were in Saskatchewan. These two provinces produce 82 per cent of the calves in Canada. There are several reasons for this.
A recent study from the government of Alberta showed that the average return on a cow for the five years from 2015-19 was $75 per head. However, the variation stretched from negative $160 per head in 2016 to positive $199 per head in 2017. A different timeframe would likely have different values, but there would most likely be the same extreme year-to-year variation. Keep in mind it is possible to have four to five negative years in a row depending on weather in the specific area and of course the feeder cattle market.
The finishing feedlot
The next segment of production is the finishing feedlot operator. There are also many studies on both sides of the border comparing financial returns over the long term. The result is always the same. In the long run, if a feedlot bought feeder cattle every week and sold fed cattle every week of the year, the average return per head would range from negative $5 per head to negative $15 per head. This is the average — the full range runs from a negative of $250 per head to a positive of $180 per head — a wide variation. Again, the numbers vary depending on the timeframe of the study or analysis.
For the beef packer
The margin structure for the beef packer is extremely complex. Therefore, it is important to understand that the reported wholesale values for beef do not represent the daily margin for the beef packer. Beef is sold on six- or 12-month contracts, not daily. When analyzing the beef market, I seldom focus on cold storage supplies. For example, U.S. frozen beef supplies on Nov. 30 were 493 million pounds. Total beef production for the week ending Dec. 4 was 562 million pounds. Beef is non-storable. Before the animal enters the plant, that beef is sold. As one beef salesman told me, “sell it or smell it.” Don’t view daily values of wholesale beef as an indication for profitability of every animal going into the plant.
The second point to remember is that all parts of the animal are sold. While producers may have an idea of the carcass value, they don’t know the values of the hides, oils, livers and other products. More importantly, beef products from the plants are sold all over the world. Therefore, it is impossible to know this cost structure. If a plant doesn’t have the multinational sales, it won’t be successful.
Thirdly, it is important to realize that the packing industry is capital intensive. Data is not readily available for fixed or operating costs. One cannot view the price spread between two segments of the industry as the “profit.” The spread between the packer and retail is not a measure of profit. After BSE was discovered in Alberta in 2003, there were an estimated 15 proposed plants to be built in Western Canada. How many were built despite government support, producer backing and consumer loyalty? Not one, after doing all the feasibility studies. It’s what economists call a “mature industry.” It’s highly concentrated.
Some cow-calf options
What can cow-calf producers do to capture some of the profitability down the production chain? I always advise them to pencil out the costs and profitability of placing the feeder animal in a custom lot for backgrounding or finishing. The finishing feedlot operator is one of the first segments to realize profitability in a rising market. This trickles down to the cow-calf producer as the feedlot bids up the price of feeder cattle. If cow-calf producers sell too soon in a rising market, they will miss out until the next year. However, by then things can change.
I always tell subscribers that they should own some shares in a packer such as Tyson Foods for educational purposes. The dividend yield is 2.14 per cent. More importantly, the best investment for cattle producers is to own some shares in McDonalds, the world’s largest hamburger chain. The dividend yield for McDonald’s is about 2.6 per cent. Cow-calf producers can choose to be more involved in the chain of beef production. Take some of the profits from your segment and invest in these segments down the line. Read the annual reports of these companies. You will have a greater appreciation for different segments of beef production and distribution.
The cow-calf producer may be a price taker at the auction market but this is by choice. Cow-calf producers have options to background the feeder animal or place it in a custom lot. Cow-calf producers can take advantage of different segments in beef production or distribution by owning shares in packers or restaurant chains.
Keep in mind the packer is not your enemy. Profit is not a four-letter word. If the packer is making money, trust me, it’s only a matter of time before it trickles down to the cow-calf producer.
