The following commentary and analysis is provided by John Nalivka, Sterling Marketing.
There is never a lack of “hearty” conversation when it comes to the topic of packer margins, particularly this year when those margins have been at record levels for a sustained period of time. I firmly believe an overview of margins across the industry is important information in assessing market outlook. Individual and business decisions are made with regard to making or losing money. That behavior in total generates and defines markets. Consequently, the outlook to a large extent rests on an important assumption – who is making or losing money.
Beef packer operating margins (Sterling Marketing estimates) have averaged $169.85 per head for 2018 year-to-date compared to $111 per head in 2017. There is no doubt that sustained margin strength is noteworthy, and while I understand how the cost of cattle enters the equation, it is important to note key drivers on the revenue side of the profit equation.
With regard to fed cattle costs, I would much prefer a packer margin that has room for higher cattle prices than one that it is in the red with little room for raising bids and worse, dropping it significantly! Packer margins have displayed a definite upward trend that reflects truly positive changes in the industry. Average per head packer margin estimates are: 2013-2017 = $47 per head; 2000-2012 = $18 per head; 1990-1999 = -$4 per head; and 1980-1989 = -$14 per head.
Beef prices (i.e., the cutout) definitely indicate strong beef demand in the face of a 3% increase in year-over-year fed cattle numbers and beef production coupled with 3% more pork and 1% more chicken. But, this growing demand while a reflection of a strong U.S. economy, labor market, wage gains, and consumer tastes did not just start in 2018. Growing consumer demand for beef is the result of changes in the industry that have occurred over at least the last decade. These changes were further supported by drought-forced liquidation that pushed the cow herd to a 60-year low.
Improvements in beef quality are easily seen in the quality grade. In 2018, 82% to 85% of fed cattle are grading Choice compared to 2009 when 68% to 70% of fed cattle reached Choice. In addition to improved quality as shown in the grade, packers have taken on many value-added operations in the plant which has supported demand, albeit added to plant operating costs which have been further increased as packers have put food safety initiatives in place. There is no doubt that value-added production supports margins, but it also supports demand.
Liquidation took the bottom end of the breeding herd out leaving a genetic pool with the greatest potential for improvements in quality and consistency – the most significant drivers of consumer demand. At the same time, premiums attached to branded beef programs and quality cattle have provided the incentive to keep the ball rolling that direction. Without the significant changes that have supported growing beef demand, prices and margins across the industry would be substantially different than they are today.
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By: Drovers