Tight Packer Margins

Live cattle prices in January were better than expected, rallying more than more than $5/cwt from the first to the third week of January.  During that same time period, Choice boxed beef prices dropped nearly $10/cwt, while beef byproduct values were relatively constant.  The result of these price changes was a dramatic reduction in beef packing margins, which will likely weigh on live cattle prices in weeks and months to come.

Figure 1 illustrates the live to cutout beef price spread for the past two years and the previous 5-year average.  This spread approximates the gross processing margin for beef packers by subtracting the cost of a live steer from the sales value of boxed beef and beef byproducts.  Note that this represents a gross margin and does not include all the costs for operating a beef packing plant, like labor, equipment, energy, etc.  These operating costs are highly plant and company specific and data are not available to estimate them accurately.  However, they are likely to average in the $125-150/head range for many plants.  Thus, based on the average gross margin spread in Figure 1, it is evident that beef packers have relatively tight margins overall and many often lose money at the beginning and end of the year.

There is a strong seasonal trend in the live to cutout spread shown in Figure 1.  The spread tends to be highest from April through July and lowest in September and October.  The late spring/early summer high in the spread occurs because slaughter cattle numbers are most plentiful then as feeders are selling calf-feds during that time of year.  Thus, fed cattle prices are seasonally low or declining then.  Additionally, boxed beef is seasonally at its high at the beginning of this same time period.  Even beef byproduct values tend to be strongest in the summer months, further strengthening the live to cutout spread.  Lows in the spread later in the year correspond to tighter cattle supplies and lower boxed beef prices.

The historically tight cattle supplies that were discussed in last week’s Cattle & Corn Comments eventually have to have an impact on beef packer margins, and this last month may be some of the first signs of that.  Interestingly, beef packers were able to maintain near average margins through 2011 (Figure 1) despite record high fed cattle prices.  Even though high boxed beef and byproduct values were supportive to packer margins, packers largely accomplished this by keeping their weekly slaughter numbers in check.  While weekly slaughter numbers in January 2012 were near their historical average, packers had to bid aggressively to procure cattle even as boxed beef prices dropped precipitously.  By the third week of January, the live to cutout spread had dropped to $25/head, the lowest in at least two decades.  Despite some recovery in the last week of January, the spread still averaged about $74/head, almost half of its value in January 2011.

After all the discussion following the monthly cattle on feed reports showing increased cattle on feed numbers, it might be difficult to see why packers have had to bid so aggressively for slaughter cattle in January.  Recall, though, that much of the increase in cattle on feed numbers is due to larger numbers of lightweight feeders being placed as forage supplies in the south were limited by drought.  Thus, many of these cattle have not yet reached slaughter weight.  Eventually, these cattle will come to market (mostly in the late spring and early summer months), which will ease gross packer margins.  Following that, though, beef packer margins are likely to tighten as cattle on feed numbers fall dramatically.  And, there isn’t much hope on the horizon as calf supplies have grown increasingly tight and cattle on feed numbers will significantly decline later this year and into 2013.  Even with the 73,000 head increase in beef heifers retained for breeding purposes as of the first of the year, available slaughter numbers will not appreciably increase in 2013 or 2014.  Only about two-thirds of these heifers will calve in 2012, so presumably this would equate to about a 48,000 head increase in available slaughter cattle in 2013.  Recall though that daily beef cattle slaughter is 130,000+ head.

Reduced slaughter cattle supplies now and the forecast for still smaller supplies in the future underscore the problem packers have with maintaining their gross margin:  overcapacity.  Actually, the industry has had excess capacity for some time, despite some plant closures, but it is growing worse as North American cattle numbers decline, the U.S. feeds fewer cattle, and fewer slaughter cattle are imported from Canada.  Measuring packing plant capacity utilization in real time is limited by data availability; however, one useful metric to observe is Saturday slaughter numbers.  Figure 2 illustrates federally inspected Saturday slaughter cattle numbers in 2011 and 2012, as well as the historic average.  Saturday slaughter averages about 35,000 head per day, but is highly variable because packers fill their Saturday shifts with more cattle when processing margins are positive and less when they are unprofitable.  Note then that Saturday slaughter (Figure 2) follows the same seasonal trend as the live to cutout spread (Figure 1).  Weekday federally inspected slaughter in the U.S. typically averages 130,000-135,000 head per day.  Thus, if a packing plant were very profitable and wanted to operate close to its maximum capacity, it could conceivably be able to process about that many head on Saturdays.  Note that in Figure 2, Saturday slaughter averaged less than 20,000 head last December, and eventually declined to 5,000 by the last Saturday of January.

The over capacity in the beef packing industry might be both a short-run blessing and a long-run curse for cattle feeders.  In the short run, it will prompt packers to bid aggressively for market-ready cattle.  We’ve already seen that this past month and at other times in the last year, and probably will in the months to come as well.  In the long run, though, continued losses at the packing level will likely cause one or more plant closures somewhere in the country, leaving cattle feeders with more transportation costs and possibly one less buyer.

The information in this report is believed to be reliable and correct.  However, no guarantee or warranty is provided for its accuracy or completeness.  This information is provided exclusively for educational purposes and any action or inaction or decisions made as the result of reading this material is solely the responsibility of readers.  The author and South Dakota State University disclaim any responsibility for loss associated with the use of this information.  There is substantial risk of loss in trading commodity futures contracts and traders should consult their brokers for a full disclosure of these risks to determine whether such trading is suitable for them in light of their circumstances and financial resources.