LIVESTOCK MARKETS: Analyzing cow/calf financial conditions post-boomLIVESTOCK MARKETS: Analyzing cow/calf financial conditions post-boom
Declining revenue, stubborn variable costs and low contribution margins plague producers.
August 23, 2016
Fifty years from now, agricultural history books will likely devote a chapter to the recent run-up in commodity prices and the farm income boom, according to agricultural economist David Widmar.
While much attention during this period focused on corn and soybean production, cow/calf operators also experienced the historical financial conditions. As the industry begins transitioning away from the boom era, Widmar said it’s worth pausing to reflect on recent conditions and financial drivers.
To do this, financial data collected and published by the Kansas Farm Management Assn. was utilized. A summary of farm-level data was not available for every state, but general trends of the Kansas data are applicable and valid across most cow/calf operations and region, Widmar noted.
Widmar explained that a key metric of an operation’s financial performance is the contribution margin, also known as the "return over variable costs." Contribution margin is what remains after producers have paid all variable costs.
At a contribution margin of $576 per cow, 2014 was the most impressive year, with levels more than double a previous record high of $218 per head reached in 2004. Also, 2014 levels were more than four times greater than the 15-year average contribution margin of $122 per cow. For context, contribution margins of less than $100 per cow are quite common, occurring eight out of the past 15 years, Widmar explained.
“In 2015, contribution margins were quite sobering, at only $53 per cow. These levels represent a 91% decline from 2014 and the fifth-lowest margin in the last 15 years,” he said.
According to Widmar, cow/calf producers experienced extremely challenging financial conditions in 2008 and 2009, with negative contribution margins, which means revenues failed to cover 100% of variable costs.
“During this period, one could expect producers to limit herd expansion plans and potentially considering herd size reductions,” he added.
Revenues and variable costs
To understand the changes in contribution margins, Widmar said it is important to dig into revenues and variable costs, which provide two clear takeaways.
First, he said total variable costs trended higher at a slow but fairly consistent rate. On average, total variable costs increased at an annualized rate of 5.3%. Also, declines in total variable costs per cow happened only twice (in 2003 and 2004). The magnitude of these declines was very small, at -1% and -3%, respectively, Widmar noted.
Second, as many would expect, revenue (per cow) cycles from periods of declines to periods of increases. For instance, Widmar said cow/calf producers experienced less revenue per cow each year from 2005 to 2009. During this period, revenues declined by a total of 29%. From 2010 to 2014, however, revenue per cow trended higher each year.
“While each of these points are, by themselves, interesting, it is the interaction of these two factors that is perhaps most noteworthy,” Widmar said. “Even with total revenue lower than variable costs (in 2008 and 2009), variable costs did not adjust lower. It wasn’t until revenue increased (in 2010) that producers returned to positive contribution margins. Put in other words, even in the face of tight margins, cow/calf producers, on average, were not able to adjust their cost structure lower.”
This will be an important factor to keep in mind in 2016 and beyond as the gap between revenue and variable costs tightens, he said.
Wrapping it up
During a favorable trend of revenues outpacing variable costs, cow/calf operators enjoyed impressive returns and profitability in 2014, according to Widmar.
“In 2015, revenues dramatically decreased, while variable costs increased. This left producers with significantly smaller contribution margins," he explained. "Over the last 15 years, variable costs have resisted significant declines. This will be important for producers to keep in mind in 2016 and 2017, especially if calf prices trend lower.”
Widmar said it's hard to imagine producers being economically motivated to expand their cow herds, should the environment of declining revenue, stubborn variable costs and low contribution margins continue.
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