Kentucky Ag News
Summer stocker outlook for 2017
University of Kentucky College of Agriculture, Food and Environment
LEXINGTON, Ky. - With the warmer temperatures and the start of spring grass growth, stocker operators are contemplating placement of calves into summer grazing programs. Calf prices typically rise in the spring but have done so more than usual this year as the entire cattle complex has been supported by stronger fed cattle prices.
For example, the October CME© feeder cattle futures contract has increased by about $8 per hundredweight (cwt) in recent weeks. This, combined with the onset of spring pasture growth, have fueled calf prices. Some operations likely placed calves during the winter with the intention of purchasing stockers before the typical spring price peak. However, many more will place calves as pastures green up in the coming weeks. It is imperative that stocker operators pay careful attention to the market, their costs, and what can be paid for stocker calves this spring.
The year 2016 was another tough year for stocker operators that did not utilize some form of price protection on the calves they placed in the spring. The overall calf market declined significantly enough from spring to fall so that most stocker operators would have lost money in 2016 if they were not hedged. Hedging offered some opportunities to place calves at a profit at the time of placement, but profits were generally only modest last year given the high price of most calves. Weather also factored into profitability last year. Even though spring and early summer were wet, the rains stopped coming in the late summer through fall. It is very likely that stocker operators who were stocked heavily were forced to sell feeder cattle earlier than they had originally planned, thus reducing profits.
The purpose of this article is to assess the likely profitability of summer stocker programs for 2017 and establish target purchase prices for calves based on a range of return levels. While it is impossible to predict where feeder cattle markets will end up this fall, producers need to estimate this and not rely on the current price (March or April) for 750- to 850-pound feeder calves. The fall CME© feeder cattle futures (adjusted for basis) is the best way to estimate likely feeder cattle prices for fall. Grazing costs including pasture costs, veterinary and health expenses, hauling, commission, etc. are estimated and subtracted from the expected value of the fall feeders. Once this has been done, a better assessment can be made of what can be paid for stocker cattle this spring in order to build in an acceptable return to management, capital, and risk. One should also remember that the CME© feeder cattle futures contract has shifted upward by 50 pounds last fall. So, CME© feeder cattle futures are most representative of an 800-pound steer out west.
Key assumptions for the stocker analysis are as follows: Graze steers April 1 to October 1 (183 days), 1.5 lb./day gain (no grain feeding), 2% death loss, and 4% interest on calf. Given these assumptions, sale weights would be 775 pounds and 875 pounds for 500-pound and 600-pound purchased calves, respectively. Using a $134 CME© futures contract for October 2017 to estimate sales price, a 775-pound steer is estimated to sell for $129.50/cwt, and an 875-pound steer is estimated to sell for $124.50/cwt. This amounts to a $5-per-cwt price slide for heavyweight steers. We have reduced price slide expectation again from last year as the feeder cattle market has continued to drop year over year. These sale prices are also based on the assumption that cattle are sold in lots of 40 or more head. Stocker operators who typically sell in smaller lots should adjust their expected sale prices downward accordingly.
Estimated costs for carrying the 500- and 600-pound steers are shown in Table 1. Stocking rates of 1.0 acre per 500-pound steer and 1.2 acres per 600-pound steer were assumed in arriving at these charges. Most of these are self-explanatory except the pasture charge, which accounts for variable costs such as bush-hogging, fertilizer, and re-seeding. The last of these pasture costs are on a pro-rated basis and are considered a bare-bones scenario. Sale expenses (commission) are based on the assumption that cattle will be sold in larger groups and producers will pay the lower corresponding commission rate. However, producers who sell feeders in smaller groups will pay the higher commission rate, which will likely be around $30 per head based on the revenue assumptions of this analysis. Any of these costs could be much higher in certain situations, so producers should adjust accordingly.
Target purchase prices were estimated for both sizes of steers and adjusted so that gross returns over variable costs ranged from $25 to $125 per head. This gives a reasonable range of possible purchase prices for each sized calf this spring. Results are shown in Table 2. For 500-pound steers, target purchase prices ranged from $1.50 to $1.69 per pound. For 600-pound steers, target purchase prices ranged from $1.37 to $1.53 per pound. When targeting a $75-per-head gross profit, break-even purchase prices were $1.60/lb. for 500-pound steers and $1.45/lb. for 600-pound steers.
For heifers, sale price for heavy feeders will be lower than comparably sized steers, and they will not generally gain as well. In this analysis, we assumed the price discount for 800-pound heifers is $8 per cwt lower than 800-pound steers, and we assumed heifers would gain 10% slower than steers. With these assumptions, purchase prices would have to be $.17/lb. lower for 500-pound heifers and $.15 lower for 600-pound heifers compared to the steer prices found in Table 2. Thus, when targeting a $75-per-head gross profit, break-even purchase prices were $1.43/lb. for 500-pound heifers and $1.30/lb. for 600-pound heifers.
Of course, it is highly likely that your cost structure will be different from that presented in Table 1. If this is the case, simply shift the targeted gross profit up or down to account for this. If your costs are $25 higher per calf, then you would shift each targeted profit down by one row: For example, you would use the $125 gross profit to estimate a $100 gross profit. Another way to evaluate this is that a $1 increase in costs would decrease the targeted purchase price by $.20 per cwt for 500-pound steers and $.17 per cwt for 600-pound steers.
It is important to note that the gross profits in Table 2 do not account for labor or investments in land, equipment, fencing, and other facilities (fixed costs). Thus, in the long-run, these target profits need to be high enough to justify labor and investment. In many locations, calf markets are already at levels that would place expected returns on the lower end of the range analyzed. This is all the more reason that stocker operators should carefully think through their budgets and make rational purchasing decisions.
There is a tendency for calf prices to reach their season price peak when grass really starts growing in early spring. If calf prices do increase further, this would result in even tighter expected margins for stocker cattle placed in the upcoming weeks. Further, the last couple of years have taught us how volatile feeder cattle markets can be and how much impact that can have on profitability. Thus, price risk management will be critical for calves placed this spring.
Hedging, through the sale of futures contracts, provides solid downside risk protection but will subject the producer to margin calls if cattle prices increase. Entering a cash forward contract with a feedlot or order buyer, or offering cattle through internet sales with delayed delivery, will reduce or eliminate price uncertainty, but will also limit marketing flexibility should weather conditions necessitate sale at a different time. Finally, strategies such as put options and Livestock Risk Protection (LRP) Insurance offer a less aggressive strategy that provides downside price protection (at a price), but more ability to capitalize on rising prices.
Regardless of what makes the most sense for the individual producer, time spent considering price risk management is likely time well spent in these volatile markets. Links to two publications on using futures markets to manage price risk in feeder cattle and a publication on the use of Livestock Risk Protection (LRP) Insurance can be found on the livestock page of the UK Agricultural Economics website, uky.edu/Ag/AgEcon/extcrops-livestock.php. The best way to ensure profitability is to budget carefully and to manage downside price risk.
This article was written by Kenneth H. Burdine and Greg Halich, assistant Extension professors at the University of Kentucky College of Agriculture, Food and Environment. The article first appeared in the March 27 edition of Economic and Policy Update.