Back on their feet

Survey of Ontario farm lenders following the price trough suggests pork producers are a reslient bunch

BY ROBERT IRWIN

No one knows exactly how much of their equity was swept away when pork prices sank last fall, but Ontario pork producers appear to have weathered the price crisis well. Bob Zidichouski, Ontario general manager of the federal government's Farm Debt Mediation Service, which helps farmers facing insolvency, confirms that between April 1, 1998, and May 11, 1999, he processed just eight pork producers out of a total of 118 applicants from all sectors.

All pork producers who applied were successful in remaining in business, Zidichouski reports.

Like other lenders contacted by Farm & Country PORK, the federal government's Farm Credit Corporation (FCC), a large Ontario pork lender, is reporting no foreclosures since hog prices plunged last fall.

The pork industry accounts for about 12 per cent of FCC's loan portfolio. The corporation has about $220 million in pork loans on the books.

"We've been very impressed with the business ability of the producers. They are very astute people to have managed their businesses through one of the toughest down cycles in recent memory," observes Paul Reeds, account manager, agribusiness.

By comparing a rough average producer break-even cost of $1.35 to $1.40 per kg with the Ontario weekly pool price during the downturn, Reeds estimates the loss of producer equity could be "in excess of $100 million."

Still, Reeds says from the outset FCC has remained confident the Ontario pork industry is a sustainable industry. One sign of that is the fact FCC continues to issue loans for new and expanding facilities, albeit at a slower pace than the two previous years.

In the 12 months ending March 31, 1999, FCC approved 267 new loans worth $48 million. That's less than the 299 new loans worth $58 million in 1998. But it compares favourably with 269 new loans worth $45 million in 1997.

Reeds says some producers expand when things look bleakest because it's easier to get builders. Gilts are cheaper, too.

Bob Richards, senior manager, risk management, agriculture, for the Royal Bank in Ontario, confirms that "there is expansion on the horizon. We are entertaining some proposals."

Like FCC, the Royal didn't carry out any foreclosures during the downturn, according to Richards. He says producers felt pain and suffered serious damage to their balance sheets, but he maintains "high liquidity" established during recent years helped sustain his pork borrowers.

If there is any redeeming feature of the crisis, Richards thinks it may lie in the fact some producers, who had become "a little casual" during good times, were forced to "fine tune management skills." Cost cutting and elimination of poor-performing animals led the list of improvements.

Data wasn't available from the banks, but FCC reports the number of loans in arrears rose modestly from 95 during the 12-month period ending March 31, 1998, to 176 during the same 12 months ending March 31, 1999. The number of dollars in arrears jumped from $700,000 to $1.5 million.

As a percentage of total FCC loans, arrears went from 0.4 per cent to 0.7 per cent during the above period.

Land-based operations, which could build equity before the price crash when feed prices were high, fared best, according to Reeds. He says 85 per cent of FCC pork accounts are family farms.

Most Royal Bank pork loans go "to some form of farrow-to-finish operation," Richards says. He is seeing a new trend, however: "More of our customers seem to be quite happy to own the sows and let somebody else feed them."

Richards, whose brother Doug is Ontario Pork's senior field services representative, predicts successful operations in the future will make greater use of risk management tools such as futures or packer contracts, or the programs offered by Ontario Pork. "I think producers will be managing margins and not just prices," Richards predicts.

Dennis Crone, manager of CIBC's agricultural department, notes some customers had production costs as low as $1.10 per kg, which kept losses to a minimum, but like Richards he stresses risk management.

Richards says many producers only became aware of many marketing options during the latter part of the downturn. "The time to do that was probably last summer, and they could have still been making some money during the downturn, too.

"Maybe it will help us the next time out. Being aware of it is part of the battle. Doing something about it is the other part."

© copyright 1999 Agricultural Publishing Company Limited.



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Looking for an edge

In the high-stakes swine business, Tavistock producer Clare Schlegel has a few tools in his risk management toolbox

By ROBERT IRWIN

Friends outside the industry are often shocked when they learn of the financial risks involved in pork production, observes Tavistock producer Clare Schlegel. Vice-president of Ontario Pork and a highly regarded innovative producer, Schlegel emphasizes risk management in his business.

As the price crisis descended on the industry last fall, Schlegel and a group of fellow MBA candidates at the University of Guelph were putting the finishing touches on an analysis of his enterprise and a marketing strategy designed to ensure a minimum margin of $25 per finished pig.

But nothing could have prepared Schlegel for the price crash that followed in November when he began selling hogs for less than he had bought them for as weaners. "In my 20 years of farming it was rare that you couldn't cover the cost of a weaner pig plus feed," he recalls.

Schlegel ended up having to refinance, "something I don't want to have to do again."

Still, he is determined to stick to his risk management protocol, which includes a comprehensive spreadsheet he has designed to help guide decisions. As he purchases each group of weaner pigs, he completes a three-part Microsoft Excel template that monitors how many kg. of pork he has at risk and how much it will cost to bring them to market.

The template also tracks margins as he commits groups of hogs to a specific market strategy. The emphasis is on managing margins rather than price.

Schlegel, who began farming in 1979, has expanded his business to include three companies that produce hogs, chickens and crops. With former pork board chairman John Lichti and Richard Yantzi, president of Perth County Pork Producers Association, he is part of the 30,000-hog AYS production loop.

Schlegel buys and finishes about half the 25 kg weaners the loop generates. Weaner price is calculated using a formula based on 50 per cent of the cash market and 50 per cent of the futures market.

Nursery pigs are raised on contract. Margins, whether positive or negative, are split between farrower and finisher.

"Our cash cost of production is extremely high compared to a farrow-to-finish operation, because we're paying the contract fees and a lot of us are also buying feed rather than growing feed."

In late May, AYS weaner price was $60. Schlegel estimates feed costs at $45 to $50.

Futures prices show returns at more than $150 per 100 kg so he is counting on a comfortable gross margin of around $40.

Schlegel says he hasn't forward-sold any pigs since the price crash, "even though my model suggests we should have." He prefers to deal with "seasonality of price and the price cycle" intuitively.

"No software can tell you that," Schlegel reasons. Right now both his intuition and software are telling him to forward sell in the next few days.

"If I sell pigs for $1.40 and cash turns out to be $1.50 there's a tendency to say I've made a mistake. The challenge is for us to move to the point where if we sell, for example 30 per cent of our pigs at $1.40, we actually want the price to go up because we have 70 per cent left to sell at whatever the cash is offering."

Schlegel forward sells pigs to a packer as one means of hedging. He finds this works well for holiday weeks and guarantees a fixed price; but, he notes, "Packers are very conservative on the basis."

Forward sales through Ontario Pork are another favourite. He likes the fact he gets a specific price in Canadian dollars and doesn't face margin calls.

The downside has been having to accept the basis risk and slightly higher fees.

Sometimes, Schlegel sells his hogs short on the futures market. To date, he has found this is more cost-effective than packer contracts or Ontario Pork's programs.

There's also the added advantage of being able to lift his hedge any time. He notes, however, that producers need a margin account with a broker to do this, and they must accept the risk of currency fluctuation as well as basis.

In the past, Schlegel has used options to hedge currency. However, "through the Ontario Pork program the currency is hedged because you're agreeing to a forward sale in Canadian dollars," he says.

Schlegel has bought put options because they keep the "upside potential on price open." Nevertheless, he finds they are a more expensive form of price insurance.

Like futures contracts, puts allow him to lift his hedge anytime; but unlike futures they don't require a margin account.

© copyright 1999 Agricultural Publishing Company Limited.



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Loop lessons

U.S producers who survived downturn are rethinking fixed-payment schemes

BY STEVE MARBERY

Pork prices have rebounded this spring, after a shocking tumble last fall when market hogs hit US$10 per cwt, and weaner pigs actually hit point zero. Contracts were dissolved and networks disintegrated, but those who survived the market chaos are remapping their alignment strategies.

The big lesson learned by the loops, which had their first acid test since the concept emerged during the strong markets of 1996-97? Fixed-payment schemes are out and formulas are in, notes Mike Brumm, University of Nebraska swine specialist.

Kevin Dhuyvetter, Kansas State University economist, says fixed-payment contracts might work over seven to 10 years. But formulas are more practical, he says, because they are based on external market factors such as production costs, corn and soybean meal values, market hog weights and prices.

For farmers who invested heavily in facilities to produce improved single-source weaners on contract with grower-finish alliances, it was a hard-learned lesson. They thought they were immune to cyclical downturns. A shortage of early-weaned pigs propelled prices to US$38 for 10- to 14-pound pigs. But when the market plunged, contracts imploded.

Formed during the strong hog market of 1996-97 and rising pork exports, strategic partnerships typically revolved around US$32-per head pig prices and US$45-per-cwt market hogs. Premiums were based on growth potential of segregated early weaned (SEW) pigs. When cash flows were basedon at least 20 pigs sold per sow per year, these arrangements left no room for error. The industry was in uncharted territory.

Dhuyvetter says he cautioned farmers back in 1996 not to ignore free-market fundamentals when forming alignments. "The value of segregated early weaned pigs is best determined by market supply and demand," he says.

Traditionally, values were based on 40- to 50-pound pigs sold at public auction. But as multi-site systems emerged, producers added premiums for improved performance from early-weaned pigs, which lacked a public reporting system.

The fundamentals may not have changed much in three years, but it's now obvious that fixed-pricing schemes leave little margin for error, he says.

What formula is right for you? Some are based on production cost; others assume expected profitability, but don't always weigh costs across the production system. Others allocate profits and losses across the alliance. Still others are based on fixed pig prices.

As producers rethink their alignment strategies, fixed-pricing schemes are less likely, says Dhuyvetter. He advocates a simple formula that allows producers to base profits and losses on the price of a market hog and feed cost. They can use percentages pegged to predetermined corn and soybean meal price on a per-group basis.

Crop-sharing agreements have been used by grain farmers for years to spread profits and losses. Similar schemes are emerging in the pork industry, Dhuyvetter says.

They also involve minimal bookkeeping, he says, adding that "no formula will be best in all situations. As producers develop formulas, knowing production costs is critical."

The downside to formula pricing is that most producers do not know their production costs, says Bob Aukes, a financial consultant from Des Moines, Iowa. Nine of 10 producers do not have sufficient data, and seven of 10 probably cannot break even at US$32 per pig, Aukes says.

Good producers, however, can push their costs into the mid-US$20s, depending on equity, performance level and willingness to hedge, says University of Minnesota economist Bill Lazarus, who has developed a computer accounting program to help producers pencil out their costs.

Lazarus agrees that fixed-pricing methods may not be the best alternative: "Flat price provides the most consistent income and returns to farrowers, but this type of arrangement leaves all hog price risk and nearly all feed price risk with the feeder."

Formula pricing based on the hog futures shares price risk, but producers must be careful of the percentages they use. Formula prices that attempt to equalize profit may be fairest in theory but are the most complicated to administer, Lazarus says.

What's the ideal formula? "Good question," says U. of Nebraska's Brumm. Besides formula pricing, hedging and risk management strategies across the pork chain, hog farmers must find a way to capture value, Brumm says.

Producer-owned packing plants are one way to maintain shackle space, but Brumm believes a more practical alternative is buying stock in a packing company to counter production losses when processors are making big profits.

Whatever the answer, producers don't have much time to find one, Brumm cautions: "This thing could happen again within two years."

© copyright 1999 Agricultural Publishing Company Limited.



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Nebraska case study

Some U.S. networks survived the hog market crash by sharing the pain and minimizing costs. While most such arrangements usually involve a firm packer contract, one exception is a southeastern Nebraska producer group that formed several years ago. Hogs are sold on the open market. Lactation feed is used as the primary benchmark.

Producers share profits and losses. SEW pig prices within the network over the past year have ranged from US$34 to US$26.25, even when the spot market for weaned pigs was below US$10.

Involving more than 20 farmers, the network includes two farrowing operations, one 1,300-sow and the other 700-sow. Participants have not invested heavily in facilities, though they have modernized barns across the system.

Bob Tamms, network co-ordinator from Syracuse, Neb., says the key limitation is cost accounting. He and partner Dave Umbarger adjust profits and losses at the end of each group.

"We need to find a simplified way to account for feed usage, but this is the fairest and most equitable risk-sharing method," he says. - Steve Marbery

© copyright 1999 Agricultural Publishing Company Limited.



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Swine industry snapshot

The average Ontario pork producer is middle-aged, farrow-to-finish, worth a half a million, and in the black, according to exhaustive survey

BY KEN McEWAN

The Ontario swine industry has changed dramatically at the production level in the last few years. Many small producers have left the industry, while others have chosen to expand or join a production loop that focuses on one stage of hog production.

To identify and understand some of the trends occurring in producer numbers and pork production, a study was undertaken in 1998 to profile the Ontario hog industry, collecting and analyzing descriptive statistics on Ontario's hog production, and developing producer profiles.

A database of 6,660 names was complied. A questionnaire was developed, and each producer within the database was contacted to establish inventory levels and general farm characteristics.

Of the 6,660 farms contacted, 5,494 completed the survey to some extent, 468 would not complete, 638 had no phone number, and 60 could never be reached. Gratitude is extended to Ontario Pork for funding this research.

The preliminary findings shown below verify that most of Ontario's hog production is still raised on small to medium-sized farms; and that prior to hog prices falling through the floor during fall 1998, most operations were modestly indebted and profitable.

Age of producer

The bulk of producers (59 per cent) involved in pork production are between the ages of 36 and 55. Findings indicate about 20 per cent of the producer base is likely to retire in the next few years. Fewer than two per cent of producers are under 25 - not surprising given that more producers are continuing with their education prior to returning to the farm.

Age of producers

Age < 25 years 25 to 35 36 to 45 46 to 55 > 55

% 1.7 19.4 33.2 25.9 19.8

Business type

Surprisingly, over 80 per cent file tax as either a sole proprietor or partnership. It was speculated that a greater percentage would have filed as family corporations given industry consolidation. It was also found that 12.8 per cent of producers had a fax machine, while six per cent had e-mail.

Business Types

Business type Sole proprietor Partnership Family corporation Business corporation Co-op

% 55.8 26.8 14.8  2.4  0.2

Production type

The two largest categories were farrow to finish (57.2 per cent) and finisher (17.6 per cent). Historically, industry analysts have suggested farrow to finish represented close to 66 per cent.

Production Types

Production type Farrow to finish Farrow to early wean Farrow to feeder (50 lb) Nursery Feeder to finisher Finisher

% 57.2  4.0  8.2  0.3 12.7 17.6

Age of pig facilities

There have been many new buildings built in the last few years (11.6 per cent of facilities) but the majority of barns are greater than 20 years old.

Building Age

Age of buildings < 5 years 5 to 10 11 to 15 16 to 20 > 20

% 11.6 12.7 12.5 15.0 48.2

Sales & sow numbers

A substantial number of producers (37.7 per cent) have farm sales less than $100,000. Farms with sales greater than $1 million represented less than five per cent of the producer base. The majority of sows were on the larger farms, with 32 per cent of the sows on farms with sales greater than $1 million.

Gross Farms vs Sows

Gross sales (thousands) < $50 $50-$100 $101-$250 $251-$500 $501-$1,000 > $1,000

% of farms 20.2 17.5 30.6 18.9  8.0  4.8

Sows  7,840 12,395 42,917 62,389 54,556 92,399

Fair market value of total farm assets

In exploring the average asset base of swine producers, the survey found that 80.3 per cent of the operations are valued at $1 million or less.

Farm assets

Total farm assets < $100,000 $100,000-$500,000 $500,001-$1,000,000 $1,000,001-$1,500,000 $1,500,001-$3,000,000 > $3,000,000

% 13.2 41.4 25.7  9.1  7.5  3.1

Profitability & debt level

When producers were asked about their profitability and debt levels, surprisingly, only 11 per cent thought they were unprofitable and had high debt levels. The majority of producers surveyed felt they were profitable and had low debts - i.e. less than 30-per cent debt.

Profitability & debt level

Profit Debt level profitable low break-even medium not profitable high

% % 55.4 55.8 32.9 33.0 11.7 11.2

Ken McEwan is lecturer/ researcher at Ridgetown College, University of Guelph
© copyright 1999 Agricultural Publishing Company Limited.



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