Can You Make Money and Preserve Equity This Winter? Dean Dyck, P. Ag. Farm Business Management Specialist Alberta Agriculture and Forestry Stettler, AB Mountainview County

September 15, 2015

COW OVERWINTERING ECONOMICS & STRATEGIES

Let’s Set The Table • Cow-calf industry looks profitable in 2016 – Prices are strong relative to previous years

• Take advantage of the good times and prepare for lower prices in the future • Now is the time to watch input cost • One of the common pitfalls is increased expenses • If income goes up and expenses also increase we have lost a profit opportunity

AgriProfit$ Cow Herd Analysis - Alberta

Hay, Greenfeed and Silage Prices 2002 - 2015 $160.00

$140.00

$120.00

$100.00 Hay $80.00

Greenfeed Silage

$60.00

$40.00

$20.00

$2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: Alberta Agriculture & Forestry, Statistics and Data Development

2011

2012

2013

2014

2015

Storm Clouds on the Horizon Price Range First cut hay, good quality, baled FOB farm

$0.08 to $0.12 per lb

Second cut hay, good quality, baled FOB farm

$0.13 to $0.15 per lb

Greenfeed, baled

$0.065 to $0.10 per lb

Silage, barley

$38 to $44 per wet ton (standing) $60 per wet ton (in the pit)

Wheat straw, baled

$30 to $40 per 1000 lb bale

Barley straw, baled

$35 to $45 per 1000 lb bale

Good rules of thumb: - Greenfeed: 80% of the price of first cut hay - Silage: 8 times the price of barley (standing); 12 times the price of barley (in the pit)

Step 1 – Knowing your costs • What percentage of your costs are – Winter feeding? – Pasture? – Yardage?

2010 Central Alberta costs $/cow wintered Paid labour 1%

Unpaid labour 6%

Fixed cost 7%

Yardage 8% Vet & med 3%

Pasture 33%

Bedding 3%

Winter Feed 39%

Feed Cost Benchmarks • Based on Barry’s numbers, average feed cost per head is $684 or $3.04 per head per day. • Once you have your benchmark, do some price risk analysis on the major inputs – straw, grain and hay.

Prices

Low

Average

High

Straw

$35/bale

$40/bale

$45/bale

Barley

$4.50/bu

$5.00/bu

$5.10/bu

Hay

$160/ton

$200/ton

$240/ton

$595/head

$684/head

$757/head

$2.64/hd/day

$3.04/hd/day

$3.36/hd/day

Feed costs

For every $5/ton increase in hay prices, cost per day increases 3 cents/hd/day For every 10 cents/bushel increase in barley prices, cost per day increases 2 cents/head/day

Yardage – The Cost Beyond Feed • Daily non-feed costs not associated with ownership of the cattle • Operating costs – labour, vet/med, processing, fuel, utilities, office, repairs, etc. • Fixed costs – taxes, insurance, depreciation, interest on long term assets

How Do Your Numbers Compare? 100 head on feed, 215 days Veterinary, medicine and induction costs Fuel Machinery repairs Repairs - buildings and corrals Utilities and miscellaneous Custom work (incl pen cleaning) Paid labour and benefits Interest on operating capital Taxes, licences and insurance Unpaid labour and management Depreciation on equipment and buildings Allowance for risk (25%) Total Yardage Cost ($/head/day)

Total $ $1,770 $1,300 $570 $1,990 $5,000 $900 $325 $1,015 $3,700 $3,500

$/head $17.70 $13.00 $5.70 $19.90 $50.00 $9.00 $3.25 $10.15 $37.00 $35.00

$/hd/day $0.10 $0.08 $0.06 $0.03 $0.09 $0.23 $0.04 $0.02 $0.05 $0.17 $0.16 $0.23 $1.27

Source: AgriProfit$ 2010 cow-calf benchmarks indexed to 2015

Depreciation on equipment and buildings 17%

Fuel 9%

Machinery repairs 6% Repairs - buildings and corrals 3%

Unpaid labour and management 18%

Utilities and miscellaneous 10%

Custom work (incl pen cleaning) 25%

Taxes, licences and insurance 5% Interest on operating capital 2% Paid labour and benefits 5%

Head Days Are Important! Yardage = Daily non-feed costs Head Days

Economies of scale • So…if it costs you $65,000 to own and operate your facility • Feeding only 100 cows over 215 days = 21,500 head days or $3.02 per head per day! • Feeding 300 cows over 215 days = 64,500 head days or $1.00 per head per day!

Variation in yardage • • • • • • • • •

Age and cost of facilities What is and isn’t included Owned versus leased equipment Custom work Labour Allowance for risk Economies of size Capacity is a major factor One size does not fit all!

The Bottom Line • No death loss, debt repayment, return on assets or management salary $/head/day

Lower

Average

High

Feed cost

$2.64

$3.04

$3.36

Yardage

$1.00

$1.20

$1.40

Total cost

$3.64

$4.24

$4.76

Cost per head

$819

$954

$1,071

What’s the break even price for calves? • Cash cost per head/(calf crop x average weaning or market weight of calves sold) 500 weight calves, 4% shrink, 85% calf crop Lower

Average

High

Cash cost

$819

$954

$1,071

Break even

$2.00

$2.33

$2.62

Break even 90% calf crop

$1.89

$2.20

$2.48

No debt repayment, return on assets or management salary

What’s the maximum cash cost you could handle? • Calf crop x average weaning or market weight of calves sold x market price 500 weight calves, 4% shrink, 85% calf crop Lower

Average

High

Market price

$2.80

$3.00

$3.20

Maximum cost

$1,142

$1,224

$1,305

No debt repayment, return on assets or management salary

When Is Hay Too Expensive? • Depends on calf and input prices • Using a $3.10/lb calf price and our assumptions of feed and yardage cost…. • For every $10/ton increase in the price of hay, profit decreases $12.54 per head

Strategies & Managing Risk • Know your feed costs and yardage • Know your break even prices for calves and how much you can afford • Assess your herd productivity especially calf crop

KEEPERS OR CULLS?

Economics of keeping cows in the herd • Dry conditions and higher feed costs are forcing producers to make tough decisions on keeping or culling cows • How do you decide whether to keep or sell a cow or replacement heifer? • Use the expected value of the animal compared to the current market price

What’s a cow worth? • The simple answer – look at the market reports from the auction barn • However, a cow is just like any other asset… – She has a productive and salvage value – Her worth is the sum of all the cash she can earn over her lifetime less all the expenses

Dependencies • • • • • •

Future prices of calves Farm cost structure Retirement plans Salvage value of the cow Size of cash flows Timing of when the cow generates income and expenses

How Do I Value My Cow as an Asset? • First, you need a budget • Then use 4 common investment analysis tools: – Payback period (how long will it take me to recover my investment) – Net present value (profitability) – Internal rate of return (what interest rate do I need for my investment) – Maximum feasible bid price (what is the maximum price I can pay)

Steer Weight (Pounds/Head) Heifer Weight (Pounds/Head) Cow Price ($/Head)

Year

550 530 $2,200

Cull Cow Sale Weight (Pounds/Head) Number of Calving Opportunities (Years) Discount Rate (%)

1,400 Lb. 8 5.00 %

Net Present Value (NPV) $174.31

2015 Year 1 85 $280 $260 $0

2016 Year 2 85 $280 $260 $0

2017 Year 3 85 $270 $250 $0

2018 Year 4 85 $250 $230 $0

2019 Year 5 85 $250 $230 $0

2020 Year 6 85 $240 $220 $0

2021 Year 7 85 $240 $220 $0

2022 Year 8 85 $230 $210 $135

$1,240

$1,240

$1,194

$1,102

$1,102

$1,057

$1,057

$1,011

Cow Operating Cost/Year

$900

$920

$940

$960

$980

$1,000

$1,020

$1,040

Net Above Operating Cost

$340

$320

$254

$142

$122

$57

$37

Calf Crop or Weaning % Steers Price ($/Cwt) Heifer Price ($/Cwt) Cull Cow Price ($/Cwt) Gross Receipts (Calf Sales)

($29)

Financing Information Equity Requirement (%) Length of Note (Years) Interest Rate (%) Interest Payment Principal Payment Debt Service Requirement

75.0

Equals

$1,650.00 Per Head

3 5.00 Totals $55.90 $550.00

$27.50 $174.46 $201.96

$18.78 $183.19 $201.97

$9.62 $192.35 $201.97

$0.00 $0.00 $0.00

$0.00 $0.00 $0.00

$0.00 $0.00 $0.00

$0.00 $0.00 $0.00

Cash Flow Available for Debt Service

$340

$320

$254

$142

$122

$57

$37

($29)

Net Cash Flow

$138

$118

$52

$142

$122

$57

$37

($29)

Steer and heifer sale prices are net of shrink & selling cost Source: Texas Agrilife Extension

What does this mean? • Positive net present value means this is an economically feasible investment • An internal rate of return of 6.6% indicates the cow is making more than our projected discount rate • The payback period is 8 years meaning she needs to produce a calf for that long to justify her value

What does this mean? • We can spend no more than $1,200 to maintain the animal in the current year • Net cash flow (pre tax) for years 1 to 7 is $174 before discounting. After discounting at 5%, the NPV is $26 – Compared to a $2,200 cow value, we would be better off selling IF we have to spend more than $1,200 to maintain the cow

What is the maximum I can bid? Cow Value 2000 2100 2200 2300 2400 2500 2600 2700 2800 2900 3100 3200

NPV $ 374 $ 274 $ 174 $ 74 $ (26) $ (126) $ (226) $ (326) $ (426) $ (526) $ (726) $ (826)

• Using all the assumptions, we can bid no more than about $2,400 • This is the value of the cow! • If you increase the weaning percent to 90%, the value increases to $2,800

Risk & Decisions • Calf crop – If the market value of the cow is $2,200, you will need an average calf crop of 83% to break even

• Future price of calves – If you think prices will drop dramatically, you will have to either (a) increase calf crop or (b) consider selling if the cow is underperforming

Risk & Decisions • Farm cost structure – Feed costs will be high this year due to drought – Increasing cow operating costs by $50 per cow makes the investment unprofitable! – In other words, look for savings in feed costs

• If you can’t lower costs, reduce the herd

Risk & Decisions • Borrowing – Doesn’t affect investment decision but affects cash flow – If you have to borrow, don’t go any lower than 60% equity position

Strategies • Consider keeping if… – Your calf crop is 85% or better – Your costs to maintain a cow are lower than $1,200 per head

• Consider selling if… – Your feed costs are greater than… – Your borrowing costs are more than $290 per cow

Federal Tax Deferral • Qualifications – Farming business is in a Prescribed Drought Region – Breeding herd was reduced by at least 15%

• If you reduced the herd by at least 15% but less than 30%, you can defer up to 30% of net sales • If you reduced the herd by more than 30%, you defer up to 90% of net sales • Income will have to be declared in the 2016 tax year

Tax Deferral Implications and Strategies • Tax decisions seldom make good management or cash flow decisions • If you must sell, the Federal Livestock Tax Deferral will help offset tax consequences this year • The definition of “breeding herd” is important – If first calf bred heifers exceed 50% of the cow herd, the inventory is limited to that 50% restriction

Tax Deferral Implications and Strategies • Could you form a corporation and access the low corporate rate on the sale of cattle and gain an extra year of deferral? – Yes, if you structure it right

• AgriStability – Deferral is included in eligible income but inventory should offset the amount – Next year when the deferral is collapsed, the amount is excluded

FEED ECONOMICS

Move the Feed to the Livestock or the Livestock to Feed? • Feed is expensive this year. – First cut hay = $200/ton FOB farm – Feed barley = $4.50 per bushel

• So what to do? • The answer is….it depends on the cost!

Buy & Ship

Custom Feed

Pounds of feed per head per day

35

35

Days on feed

215

215

Total feed needed (tons per animal)

3.75

3.75

Price of feed per ton

$200

$200

Hay shipping cost per ton (100 miles x $6/loaded mile/18 tons per load)

$33

Total cost of feed per ton

$233

$200

Feed cost per animal

$876

$750

Round trip shipping cost per animal (100 miles x $5.50/loaded mi x 50 cows per load) Yardage on the farm ($0.70 per head per day)

$22 $150

Yardage at custom feeder ($0.85 per head per day) Total cost of buying feed for the farm per animal

$183 $1,026

$955

What does this tell us? • Using a 100 mile radius, it is more cost effective to custom feed by $71 per head • If you can secure feed for $20 per ton less than a custom feeder, then it pays to feed at home. • Look at the differential between the yardage between your farm and the custom feeder

Buy Hay or Raise It Myself? Buy Hay

Grow Hay

• • • •

• • • • •

• • • •

Limited land resources Limited time Short on labour Have to purchase or update hay equipment Facilities to handle byproduct/alternative feeds Access to reliable hay source Limited market for excess hay Unable to store and carryover with little waste

Land available for hay production Adequate time Labour is available Equipment available Facilities geared toward feeding hay • Demand for hay in the area • Can store excess hay and carryover with little waste • Capable of updating equipment and supporting payments

What Does the Economics Tell Us? • Economics based on: – Custom harvest rates – Nutrient removal costs

• Ignore: – Land value – Forage quality – Opportunity cost of the land

Cost to Make Hay Practice

$/acre

$/bale

Cutting

$21.00

$3.30

Baling Hauling/stacking Labour Total

$36.67 $8.33 $7.00 $73.00

$11.00 $2.50 $2.10 $18.90

Based on 2014 Custom Rates in Alberta Assume 2 tons per acre = 3.3 - 1200 lb bales

Fertilizer Value Per Ton of Alfalfa Hay Nutrient

Nitrogen Phosphate Potash Sulphur Total

Lbs/ton

$/ton

58 4.6 36 6.2

$33.64 $2.76 $15.84 $1.67 $53.91

Assume N at $0.58 per lb, P at $0.60 per lb, K at $0.44 per lb and S at $0.27 per lb

Comparison Raised Hay Cost Cut, bale, haul Nutrient value Total

$/bale $18.90

Purchased Hay Cost* Purchase

$/bale $120.00

$32.35

Transport

$19.00

$51.25 $85.41/ton

Total

$139.00 $231/ton

*Assumes $200 per ton and a 50 mile trip @ $6/loaded mile

Bottom line – if hay costs more than $117 per ton, then you are better off producing hay at home

Comparison Raised Hay Cost Break & reseed

$/bale $9.30

Purchased Hay Cost* Purchase

$/bale $120.00

Cut, bale, haul

$18.90

Transport

$19.00

Nutrient value Total

$32.35 $60.55

Total

$100.91/ton

$139.00 $231/ton

*Assumes $200 per ton and a 50 mile trip @ $6/loaded mile

Bottom line – if hay costs more than $132 per ton, then you are better off producing hay at home

Comparison Raised Hay Cost Cut, bale, haul

$/bale $18.90

Purchased Hay Cost** Purchase

$/bale $120.00

Nutrient value

$32.35

Transport

$19.00

Opportunity cost of land*

$73.00

Total

Total

$124.25 $207/ton

*Assumes 60 bu barley crop @$4.50 per bushel

$139.00 $231/ton

**Assumes $200 per ton and a 50 mile trip @ $6/loaded mile

Buy Hay versus Silage • Compare on a dry matter basis • Use the “Feed Systems Cost Evaluator” on the Alberta Agriculture and Forestry website

• As a buyer, silage costs less in the yard by $47/DM ton • Silage has lower storage losses so standing hay price would have to drop below $140 per ton ($0.07 per lb) to break even

Greenfeed or Silage Decisions • Do I buy or sell greenfeed/silage? • A partial budget will determine which choice is the most profitable • Assumptions – A 10 bushel barley crop = 1 ton of silage or 1 – 1000 lb bale of greenfeed – Only machinery operating costs are included – Labour is not included

Should I Buy Standing Barley for Greenfeed? Disadvantages Added Costs Purchase of standing crop Swathing ($6.23/ac x 1 bale/ac) Baling ($49.08/hour @ 10 bales/hr) Hauling Twine Subtotal

Advantages $/bale $60.00 6.23 4.90 5.00 2.00 $78.13

Reduced Revenue None

Total

$78.13

Net Advantage (Disadvantage) = $21.87/bale

Added Revenue None

Reduced Costs Purchase of hay (per 1,000 lb bale) Feed hauling costs Subtotal

$/bale $ 80.00 20.00 $100.00

Total

$100.00

Where Is The Breakeven? • It’s actually quite close • Using $36 per ton to cut/bale/haul greenfeed and $40 per ton to haul hay… Standing Price $/ton

Total Cost $/ton

Equivalent Hay Price $/ton

Today

$120

$156

$196

Historical

$ 25

$ 61

$101

If you can land hay into your yard for less than the equivalent, you are money ahead to buy hay

Should I Buy or Sell My Standing Cereal for Greenfeed? Disadvantages

Advantages

Added Costs Value of straw removed ($34 per ton)

$/acre $ 41

Added Revenue Sale of crop for greenfeed (3 tons per acre @ 6 cents/lb)

Reduced Revenue 60 bushels of barley @ $4.50/bu

$270

Reduced Costs Swathing Combining Trucking Subtotal

$ 6.23 14.82 12.00 $33.05

Total

$311

Total

$393.05

Net Advantage (Disadvantage) = $82.05/acre

Based on these assumptions, it’s better to sell the crop as greenfeed

$/acre $ 360

Where Is The Break Even? • It depends on the prices for both barley and greenfeed in a given year • Let’s take a 20 bushel barley yield which equates to a 1 ton/acre greenfeed yield

Barley Price $/bu

Greenfeed price $/ton

Greenfeed Advantage $/acre

Today

$4.50

$120

$36.00

A few months ago

$5.00

$120

$31.00

Historical greenfeed price

$4.50

$60

($9.00)

Higher barley price

$5.00

$60

($19.00)

3 year average barley price

$4.00

$60

$1.00

MARKET OUTLOOK AND PRICE INSURANCE

Market Outlook & Price Insurance • Many expected 2015 to be a year of expansion for the Canadian cattle industry • Drought affected pastures and reduced carrying capacities • Expansion is underway in the U.S. – Cattle up 2.5% on July 1, 2015

November 2015 CME Feeder Cattle

April 2016 CME Feeder Cattle

Cattle Inventory July 1 Canada 2014

Canada 2015

% Change

Alberta 2014

Alberta 2015

% Change

Total Cattle

13,290,000

13,005,000

-2.1%

5,455,000

5,300,000

-2.8%

Beef cows

3,926,600

3,792,200

-3.4%

1,579,100

1,509,100

-4.4%

Replacement heifers

616,200

612,600

-0.6%

252,100

248,100

-1.6%

Cattle Inventory • Continues to show signs of liquidation • The last time numbers were this low was 1991 • Canadian cattle herd peaked in 2005 at 16.88 million head and has fallen 23% over the last 10 years • Why? – Producers aggressively marketed as prices increased for feeder, fed and cull cows

Exports • Since the start of 2015, feeder exports to the US are on par with 2014 • Fed exports are down 47% • Slaughter cow exports are down 18% • Higher US dollar and US expansion continue to pull feeder cattle south

YTD Live Cattle Exports to US (week ending September 5, 2015) 300000 250000

200000 Feeders Fed

150000

Cow 100000

Bull

50000 0 2013

2014

2015

Beef Cows • Alberta’s beef herd is at the lowest level since 1991 • Why is it decreasing? – Increased cattle shipments to the US have limited heifer retention – Average age of producers is increasing and more appear to be postponing herd expansion and recouping previous losses

Beef Cow Herd Decreasing – Why? • Pasture availability and capacity limits • High cost of breeding stock. Over the last 10 years bred cow prices have more than doubled and top prices for bred heifers have more than tripled • Profitability in the cow/calf sector has been inconsistent and may move lower with higher feed costs, US beef herd expansion and global economic concerns

Calves • Beef calves under 1 year were down 4.0% for Canada and 3.8% for Alberta • Why? – Lower beef cow and replacement heifers – Lower reproductive efficiency (87% versus 91% in 2011)

• Calf crop in 2016 is expected to be lower due to current liquidation and lower reproductive efficiency

Factors Affecting Canadian Beef Herd in the Future • Effect of drought on western Canadian cow marketings • Weaker Canadian dollar • Fall and winter moisture conditions • Winter feed prices and availability • Increased beef imports • Lower consumer demand and competition from pork and chicken

What Does This Mean? • Expect negative growth rates in the Canadian beef cow herd • Expect prices in Canada to remain strong for the next 1 to 2 years – Lower inventories – High US demand – Weak Canadian dollar

Livestock Price Insurance • Objective is to protect against price decline • Simply, if you think the price will fall below your break even, then insure. Otherwise, it’s better to save your money and self insure.

Does It Make Sense? • If your break even is $212 per cwt, then the cost to insure to April is $4.72 per cwt (32 week policy) • But….are prices going to sink to $212? • Right now, 500 lb steers are going between $300 and $318 per cwt (VJV Ponoka) – They would have to drop 29%!

AgriInvest • A long term savings program • Each year, you can deposit 1% of your annual net sales and receive a matching government contribution • Maximum annual net sales is $1.5 million – Largest matching government contribution would be $15,000

• You can withdraw at any time – Government $ + interest comes out first and is taxable – Producer $ come out last

AgriInvest Strategies • Let’s say your annual net sales are $500,000 – You could contribute $5,000 and the government matches that for a total of $10,000 – You could withdraw all of it next year and buy bred cows. However you are taxed on the government matching $, so you really only have $8,750 available – If bred cow prices hold, you could buy 4 bred cows (the government helps you buy 1.7 cows

Be Careful • If you use the livestock tax deferral this year, this is subtracted from your annual net sales and will reduce your contribution • View it as savings account, with the added bonus of the government kicking in money