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Does Winter Backgrounding Present an Opportunity this Year?

18 November 2014

Strong cattle markets represent a risk for backgrounders this winter, according to two Kentucky cattle experts.

Cow-calf operators are currently enjoying the strongest fall calf market on record, write Dr. Greg Halich and Dr. Kenny Burdine, Agricultural Economists, University of Kentucky.

While calf prices typically decrease from summer to fall, that has not been the case this year. The combination of increasing spring 2015 live cattle futures and continual declines in corn prices have added fuel to a feeder cattle market that was already on fire.

Markets a Challenge For Backgrounders

While this strong calf market is music to the ears of cow-calf operators, it represents cost challenges for backgrounders interested in placing calves in winter programs for sale in the spring. In fact, some may be hesitant to place calves in this current market. This article examines potential returns to backgrounding programs this winter.

"Some additional effort should be applied to considering strategies to manage that downside risk"

At the time of this writing (October 20, 2014), spring 2015 feeder cattle futures were trading in the upper $220's. As winter backgrounders consider purchasing calves this fall, these spring futures prices provide market expectations for feeder cattle sale prices. 

Value of Cattle

A futures price in the upper 220's suggests a likely Kentucky price for 850 lb steers in the low $210's in the spring. As an example, with spring feeder cattle futures at $227, and a -$16 basis, an 850# feeder steer in Kentucky would be expected to bring around $1,794 (850# @ $2.11 per lb) in the spring of 2015. Of course actual basis is heavily impacted by local market conditions, lot size, cattle quality, location, and numerous other factors.

Basis for 850 steers next spring is likely to be impacted by larger price slides as futures prices are largely indicative of 750 lb feeder steers.

This basis will likely change compared to the last few years for two reasons. First, the overall market is much higher, which tends to widen price slides. Second, with corn much cheaper as a result of the large 2014 crop, prices slides are also likely to be larger due to the lowered winter feed costs.

The -$16 basis discussed previously is based on an expected basis for 750 lbs steers around $6 under the board and an additional $10 for price slide from 750 to 850 lbs. Regardless, producers considering winter backgrounding should make some estimate of spring sale price as they start to consider what can be paid for calves this fall. An excellent reference for predicting sale prices based on futures is AEC 2013-09, "Using the Futures Market to Predict Prices and Calculate Breakevens for Feeder Cattle" which can be found at the Agricultural Economics website.

The Kentucky Livestock and Grain Market Report for the week ending on October 17th reported a state average price for 500-550 lb steers of $247 and a state average price for 550-600 lb steers of $242. If this range is used as a starting point, one might expect to place 550 lb steer calves for around $245 per cwt or something close to $1,350 per head.

Larger groups of high quality calves would certainly sell for more than this, so individuals are encouraged to apply this process to the type of calves they typically buy. However, based on the calf prices described here and a -$16 basis estimate for 850 lb feeder steers this spring, the current market appears to be offering more than a $400 gross margin for 550 lb calves placed in winter programs now to be sold in the spring as heavy feeders.

Cost of Winter Feeding

From here, one must make some cost estimates on wintering those calves and selling them in the spring. While we provide an estimate for a specific winter program, costs will vary greatly based on local conditions and the specific backgrounding program. Feed is the major cost and producers should consider all potential feeding options including commodity feeds, corn, and corn silage.

For this scenario, we will consider a single program where calves are fed 1.5 per cent of their body weight per day of a 50 / 50 corn gluten / soy hull mix and another 1.5 per cent of their body weight per day of grass hay. While performance will vary, we will assume a rate of gain of approximately 2.3 lbs per day, which would put on 300 lbs in approximately 130 days.

In terms of costs, we will value the corn gluten / soyhulls at $200 per ton and value the grass hay at $80 per ton. Health costs are assumed to be $25 per head, commission is set a $51 per head, and transportation is set at $15 per head. An interest charge of 4 per cent is included and death loss is assumed to be 2 per cent . These costs will vary by location and operation, so readers are encouraged to come up with their own estimates.

Several of these cost estimates are worth careful consideration. For example, we have assumed commission of roughly $6 per head, plus 2.5 per cent of value.

However, many yards offer considerable commission savings on larger groups, as do other market methods. Vet and medicine costs are also important. We have assumed $25 per head, which is likely sufficient to include mass medication of all calves. However, this is a decision that the individual producer should make.

Finally, we would point out that our analysis largely assumes that calves are being purchased. If this was done for a cow-calf operator who was considering backgrounding his or her own calves, several costs would change.

First, it is likely that one might lower vet, medicine, and deathloss for raised calves. Secondly, transportation and commission would be paid on the calves if they were sold, so the relevant costs become the difference in commission and transportation paid on the heavy feeder versus the calves, rather than the total costs. With these caveats in mind, the following table shows expected returns to the program described above.

Calculating on Costs and Assumptions

As can be seen in Table 1, projected returns are $89 per head this winter, based on the assumptions discussed previously.

Producers are strongly encouraged to modify these assumptions for their individual programs to better reflect calf values and expected spring basis, as well as cost estimates and feed prices for their area. It is also worth noting that labor, depreciation, and interest on owned capital are also not included in the budget, so the return shown is a return to land, capital, and management. Producers should ask themselves if that return adequately compensates them for their time, capital investment, management, and risk.

The two key assumptions made in Table 1 include the cost of the calves being placed and the expected sale value in the spring.

Changes in calf placement costs will greatly impact winter backgrounding returns. For every $5 per cwt decrease in the purchase price of the calves, the return to land, capital, and management increases by $27.50 per head.

The second assumption, the sale price for the feeder calf won't be known with certainty until spring. Note that the assumed spring sale price in the analysis is $211 per cwt and the projected return is $89 per head. A $10 per cwt decrease in sale price would result in actual returns falling to $0.

Other assumptions can also have significant impacts on expected profitability. For example a decrease in commission from $51 to $13 if selling in large lots would bring the expected profit up to $127.

The commission on small lot sizes has increased dramatically in the last two years while the price for large lot sizes has remained the same, creating a major cost disadvantage for small operators trying to compete in this high priced market. A $25/ton decrease in price in corn-gluten/soyhulls would increase expected profit by $17 and vice versa.

Given the assumptions of the analysis in Table 1, returns are decent. As always, winter backgrounders are encouraged to explore opportunities to manage downside price risk through contracting, futures and options, LRP insurance, and other strategies.

Arriving at an Answer

While it does appear that the market is providing opportunities for winter backgrounding, it is also clear that price risk is high and producers will have a great deal of money invested in these programs.

Therefore, some additional effort should be applied to considering strategies to manage that downside risk. Winter backgrounders should carefully calculate their breakeven purchase prices for calves and be opportunistic as they approach this fall.

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