Tuesday, August 31, 2010

Opportunities to Background Calves This Fall?

This could be a good year to think about backgrounding calves, especially with the cash and futures we have seen this summer. Although I think the current spike we are seeing will fade within the next couple of weeks, I think there are some really amazing opportuntiies to add value to this years' calf crop.

There are however, two key factors to consider:

1) Using price protection is a must
2) COG must be kept to an absolute minimum

Last week I talked about how the value was in the market positions and not so much in the cattle themselves. But when the calves you are feeding are out of your herd, the value is in the cattle themselves and not so much in the market positions. In this situation, the position in the market is purely protection with little to be gained on the turnaround.

Earlier this summer I wrote a piece on how the cash market was not valuing the feed that was being put into calves in the eastern part of the state. As a rule that is still true, however, the futures market is valuing that feed very nicely at this point in time. The problem is that the cash market right now also is valuing that feed, which may lead some to believe that price protection is not necessary. I respectfully disagree as I expect that will change as we move into the weaned calf run later this fall. Therefore, price protection on backgrounded calves is going to be critical to retain that value.

At this point, I think an LRP is the best option for the average rancher that doesn't regularly use market protection tools. An LRP works basically like crop insurance and functions basically the same as an Option Put without the need to buy back an opposite position in the market. With an LRP, you can protect the bottom side and let the top ride. If cash prices at market time are higher than the value of the LRP, you are simply lose out on the premium cost of the insurance, which is really peanuts in the grand scheme of things.

Short hedging and Options Puts are still great tools for those that are familiar with how they work, but for the average Joe Rancher who doesn't want to mess with buy backs or margin calls, I think LRP's will work nicely for them.

Let's look at some examples:

I'm going to use a group of 600# East River weaned calves as an example.
Calf breakeven off the cow: $550/head or $0.92/lb
If these calves are marketed off the cow November 1 at $117.00, gross revenue will be $702.00/hd less commission.
Net return on these calves will be $152/hd

Now let's say these calves are short hedged on the JAN 11 and backgrounded for 75 days:

Weight in: 600#
Short hedged at $115.67
ADG: 2.5#/day
COG: $0.65/lb
Weight out: 790#
Breakeven: $85.57
Net return: $237.02/hd less basis and commissions

So the value of backgrounding these calves was $85/hd which was about 36% more than if they were sold right off the cow.

Now let's look at a group of 600# West River weaned calves as an example.
Calf breakeven off the cow: $475/head or $0.79/lb
If these calves are marketed off the cow November 1 at $117.00, gross revenue will be $702.00/hd less commission.
Net return on these calves will be $227/hd

Now let's say these calves are short hedged on the JAN 11 and backgrounded for 75 days:

Weight in: 600#
Short hedged at $115.67
ADG: 1.5#/day
COG: $0.40/lb
Weight out: 712#
Breakeven: $72.84
Net return: $305.14/hd less basis and commissions

Don't be fooled by the larger net return on these West River calves, most of the higher net return was realized by slightly cheaper cow cost before the calf was weaned. The actual value of backgrounding these calves was $78.14/hd. This is still a very nice return on the gain and is 25.6% higher than if these calves were sold off the cow.

I used a short hedge for ease of calculation, an Option Put or an LRP will provide similar protection with some variation in implementation and payout.

The bottomline here for ranchers is that I think there is some money to be made this year with a backgrounding program, but protecting your bottom side will be the key to turning this value into cash in your pocket.

Thanks for stopping by and have a great day!!

1 comment:

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