Market Changes Bring Opportunity… But You Have To Pay Attention

Editor’s Note: This is the third installment in a 12-part series on stocker cattle management. This series has been created in partnership with Chris McClure, Gold Standard Labs (bvd-pi.com), a lab services company based in Hereford that specializes in BVD-PI testing and blood pregnancy tests; and Danna Schwenk and Karla Whitmore, CattleXpert Management Software (cattlexpert.com), a software company based in Elkhorn, Neb., that specializes in feedlot and stocker management applications.

Stocker cattle management is fraught with risk. Stocker operators have to contend with weather, animal health, input availability and costs, and market volatility.

“From the outside looking in, stocker operations appear to be pretty simple, but they’re not,” says Jerry Armstrong, owner of the Diamond A Ranch in Dime Box. “There is risk when you get the cattle, there is risk while they’re on your place and there’s risk when you sell them. All of the risk has to be managed to make a set of cattle work for you.”

Jerry and his wife, Julie, started out in the cow-calf business, including running a large registered herd. Over the past 15 years, they added a stocker element. Today, preconditioning stockers is their main business.

They manage cattle for themselves and for customers. At any time, they have between 3,000 and 5,000 head on hand. As a risk management strategy, the Armstrongs try to keep a 50:50 balance between the number of cattle the family owns and the number of client-owned cattle. Unlike feedlots, the Armstrongs don’t finance, and their clients are billed monthly for the costs incurred by their cattle.

“When we get cattle in, we know that we’re not going to keep cattle forever,” Armstrong says. “Our forte is straightening out cattle and preparing them for the next phase. Generally, we’re trying to produce a 750-pound feeder.”

Armstrong says, “To be successful in the stocker business, you can’t be casual about the way you care for the cattle or the numbers that drive it. It’s a full-time job that requires your full attention. One of the best ways to manage risk in any endeavor is to know everything you can about what you’re getting into.”

For cow-calf operators who have never retained ownership, it’s important that there are adequate facilities for weaning and doctoring. Acquiring these facilities adds to overhead costs that have to be recovered by the cattle.

“With a cow-calf operation, it’s possible to get lucky and avoid health issues in some years,” Armstrong says. “In a stocker operation, where cattle are commingled, your luck will run out.” Poor health management will increase death loss and will impact the surviving cattle’s productivity. It will also increase time and labor costs.

“Health challenges change as the seasons do, but they can’t be ignored,” Armstrong says. “If you’ve got a sick yearling, it has to be treated right then, not on the weekend when it’s more convenient.”

Each stocker operation is unique, so it’s no surprise that there is no 1-size-fits-all approach to managing risk.

Jay W. Johnson, owner of C&R Land and Cattle near Happy, says, “In this business, you have to gather all the information you can on every topic you can, including health and vaccine protocols, feed and mineral supplementation programs, and marketing strategies. You’ve got to keep your eyes on the performance of your cattle, but you can’t lose sight of the rest of the world. Read everything you can get your hands on, get data from trusted sources such as CattleFax, and talk to people in all facets of the cattle industry to keep a handle on what’s going on locally, statewide, nationally and even internationally.

“Reliable, current information allows managers to make good decisions and avoid falling into the trap of ‘doing it because it’s always been done,’ ” Johnson says.

Originally, the Johnson family “bought sale barn cattle that had been mismanaged, and straightened them out.” These cattle had a lot of health problems that required several work crews and extensive facilities to care for them. In recent years, because of the rising cost of labor and a shortage of help, the Johnson’s have begun sourcing a majority of their cattle from ranches that have good health programs.

“Of course, these cattle cost more up front, but when we put a pencil to it, we found out that we’re better off buying calves that come in healthier because we can have them up and going within a week with a lot less labor.” Today, the operation is run by Jay, his father and a high school student.

Historically, the Johnsons have run stockers on wheat pasture, but are moving toward an operation that grows cattle on summer grass.

Although heat brings its own set of concerns, health issues are minimized in the warm months and cost of gain on grass can be more affordable, Johnson says.

“The ultimate goal with stocker cattle is to make money,” Johnson says. “You have to spot opportunities and be flexible enough to grab them.”

The decision or whether or not to retain ownership of a calf crop should be an annual decision, he says. One year the market conditions and break-even price may indicate that keeping the calves until they’re 700-pound feeders is the best decision; the next year, the market and break-even may indicate that it’s best to sell them as 400-pound weaned calves and lease out any extra grazing.

“When we buy cattle, I try to buy them as light as possible, because at some point in their lives they will make money,” Johnson says. “It may be when they’re 500 pounds, 650 pounds or 800 pounds. The key is paying attention and recognizing when those cattle are poised to make a profit.” While he has endpoint in mind, he is constantly evaluating the cattle against current conditions.

“For example, my original projections may have shown that I would make $50 per head in May when the cattle reach 750 pounds, but if market conditions change and I might be able to make $50 per head in February,” he says. “It makes sense to take the profit when it’s available.”

Pay attention to the numbers
When determining whether or not to buy a set of cattle, the first thing that Johnson does is to calculate his break-even price and set a realistic profit target, such as $50 per head. Then, he works backward, completing the calculations to determine what he can pay for the cattle to hit those end targets.

“In our business, one of the biggest considerations is buying cattle at the right price, so we can hit our endpoint,” Johnson says. “I ask, ‘If I want to make $50 per head, what can I give for an animal and still make money?’ ” This formula holds true for the plainest cattle to the fanciest, he says, but the key is being honest about the cattle’s current value, the real costs associated with the cattle and their future value.

“If the figures say don’t buy them, then don’t buy them,” Johnson says. “Don’t let other factors cloud your decision.” For instance, operators shouldn’t buy a set of cattle just because they’ve got some extra grazing. If the numbers aren’t right, an operator will be dollars ahead to lease that grazing out.

Armstrong says, “People need to be pessimistic when they’re doing their projections. It’s better to base your planning on worst-case scenarios than on best case. If a group of cattle look like they’ll work, even when everything else is going to hell, then it might be worth doing.”

He says a common mistake that new clients make is being unaware of the true cost and the true potential value of their cattle. He cited a recent example of a client, who brought in 30 head of recently weaned calves saying they weighed 400 pounds. The calves actually weighed 525 pounds, which impacts their current value, their potential gain and their potential value. The client’s goal was to hold them for a specific period of time.

In this scenario, Armstrong ran the numbers for him and figured that the cattle would have to bring at least $1.42 a pound, when they were sold in the future, to breakeven and bring the producer the same amount that they would if he sold them at 525 pounds in the current market.

“Many times people don’t factor in the market slide that occurs,” Armstrong says. “Heavier cattle generally bring less per pound and that can really affect how much money you make on the other end, especially if you’re not certain how much money you’ve got in the cattle.”

No guessing allowed
Armstrong and Johnson agree it’s vital to conscientiously assign all the applicable costs to the cattle when figuring cost of gain. Obvious costs include purchase price or, in the case of retained ownership the costs incurred in producing the calf to its weaning weight, medicine, feed — either grazing or purchased feedstuffs, and labor. Other costs can include opportunity cost, facilities cost, equipment payments, loan interest and salary.

“What an operator includes in a measure of cost of gain can be different depending on the operation,” Johnson says. “You have to include everything that’s necessary for your specific operation.” If Johnson has an opportunity to put together a set of cattle on a wheat pasture for himself and not as part of the family corporation, then the cost the cattle have to recover is smaller because the cattle he runs independently do not have to contribute to the corporation’s infrastructure costs.

There are software programs available to assist in computing breakeven and cost of gain and project profits. According to Armstrong, some are better than others, but they all help an operator determine true costs. Armstrong says, “Even the worst ones help an operator consider all of the costs.”

In his business, clients who have never kept their calves before tend to have sticker shock when they realize the true cost of putting on the additional weight, he says. For example, if it averages about $100 per head per month, he says and the client has retained ownership of 30 head, then they’re getting a bill for $3,000 month.

“I’ve seen the sticker shock trigger other management mistakes,” Armstrong says. “The natural reaction to cut costs is to cut feed, but then an operator has cut his productivity and has a pen of cattle that aren’t doing anything. Create a realistic budget in the beginning, because you can’t manage costs or risks if you don’t know what they are.”

In his operation, Armstrong says that price and rate of gain are the biggest factors determining his profitability.

“For us, the difference between a 1 percent death loss and a 3 percent death loss is not as important as the difference between a 1.6-pound average daily gain and a 2-pound average daily gain,” Armstrong says. “You’ve got to know how your cattle are performing.”

Johnson likes the convenience of computerized records because it makes the information easy to record and easy to access.

“If information is easy to get to, then you’ll use it,” Johnson says. However, he doesn’t keep printed records because that information can get stale. He prefers to rerun the breakeven and other pertinent information every time he has a question about a set of cattle, to keep the numbers fresh in his mind.

Borrowing power
Johnson says it was possible to “hit a home run” with stocker cattle, but in recent years his definition of success has been to make a consistent profit. With the volatility of the market and with a shrinking cattle supply, the cost of entry into the stocker business may rise even higher. A factor that will come into play under these circumstances is the effect of high cattle prices on an operator’s borrowing power.

“People are projecting cattle prices are going to skyrocket,” Johnson says. “Bankers’ equity standards haven’t changed, so an operator will need more borrowing power to purchase the same number of cattle.”

For example, if 400-pound calves start $1.50 per pound, each calf will cost $600. Bankers require up to 30 percent equity, meaning a producer will need $180 per head equity.

If those same 400-pound calves cost $2 per pound, each calf will cost $800 and producer equity will have to be $240 per head. The $60 per head equity difference between $1.50 and $2 reduces buying power by a third, he says.

Volume has an effect
Many of Armstrong’s clients are small producers, so he’s seen first-hand the effect of volume.

“Smaller numbers magnify management decisions,” Armstrong says. For instance, if an operator has 40 head and 4 die, the death loss on those cattle is 10 percent, which is catastrophic; whereas, if an operator has 400 head and 4 die, the death is 1 percent, which is within normal projections.

Obviously, smaller numbers also impact return, he says. If a producer has 40 head and the profit per head is $40, the total profit is $1,600 for several months of intensive work.

“Under this circumstance, an operator really needs to determine whether or not the additional $1,600 is worth the time and effort,” Armstrong says. “For some people, it may be and for others it may not.”

Johnson says that huge numbers aren’t necessary to make a profit if the cost of gain is kept in check with affordable grazing and limited number of fixed costs charged against the cattle.

“If the costs are right, it’s possible to make a profit on 100 or 200 head,” Johnson says. “For someone just starting out, it makes senses to start small, take care of business, learn and then expand.”

Begin with the end in mind
Operators considering retaining ownership or purchasing stocker cattle should develop a marketing plan when they’re developing their management plan; otherwise, months of input and labor could be wasted.

“To receive benefit from the value you’ve added to the cattle, you have to do more than just deliver them to the local sale barn,” Armstrong says. At a minimum, the operator should consider enrolling the cattle at a consignment sale or locate a buyer who will recognize the value of the extra management, he says.

“The best advice I could give anyone is to dig into the markets and get as much information as possible,” Armstrong says. “It changes every single day and you can’t rely on what you think you know.”

Both Armstrong and Johnson use the futures market, which is a subject for a different article. It is useful, but to succeed requires a high level of understanding and information. One of the tools that Johnson uses when trading options is purchasing “puts,” akin to insurance to protect his investment in the cattle if the market breaks.

If Armstrong is unable to secure a contract that makes money when the cattle reach feeder weight, he is prepared to retain ownership and deliver cattle to the feedlot to help secure a profit.

“Holding on to them through the feedlot is not my primary plan, but I’m prepared to do it if that’s what conditions dictate,” he says. “Being prepared to respond to changing conditions is the key to this whole business.” 

“Market Changes Bring Opportunity” is excerpted from the March 2012 issue of The Cattleman magazine.