Rebuild CautiouslyWritten by John Ritten
By John Ritten, UW Extension Economist
The rebuilding of the national cowherd has begun. With this development, we are seeing an increase in the price of breeding stock.
I am concerned that some of these animals may not be a wise investment. I tend to think that waiting a few years to rebuild may be a smarter choice. While I understand the desire to not waste good grass, I’d rather leave some grass in the pasture than deplete my equity.
One of the reasons I am concerned with rebuilding this year is the high cost of breeding stock. While calf prices will help offset some of those costs, the size of the initial investment requires a rather long payback period.
Even assuming current prices hold, the value of money over time needs to be accounted for when making investments such as purchasing breeding stock. Your investment needs to, at the very least, provide a return large enough to offset any operating interest.
When accounting for the time value of money, the revenues associated with future calf sales aren’t worth as much in today’s money.
How long will it take to payback a cow? I will assume it will cost $1,000 per head per year to carry a cow. This figure includes breeding costs, feed costs and the cost of grass. I will also assume you will wean a 550-pound calf worth $280 per hundredweight each year, starting next year.
So, if we buy bred cows or heifers this summer, I am charging half of an annual carrying cost per bred animal purchased. In following years, we are charged $1,000 and receive $1,540 in revenues, for an annual net return of $540.
If we ignore the time value of money, it appears as though every year we will generate $540. However when charging ourselves five percent, next year’s return is only worth $514 today, and the following year’s return is worth even less today at $490.
I have calculated both the nominal and real, or discounted, returns for this scenario over the next nine years in the table below.
The table shows the annual return as well as the net return by year, or the sum of all returns through each year. The table also shows both the nominal or non-discounted returns in the top half and the real or present value returns in the bottom half.
In any given year, the net returns show how much value has been generated by a cow that will produce that many calves, ignoring both her purchase cost and cull value.
It is important to note that when considering the time value of money, the farther in the future a benefit occurs, the less it is worth in current dollars.
So, what’s a bred cow worth? It will depend on a lot of factors, but using our simple model we can determine how long it will take her to pay herself off.
If she costs $2,500, and we get $1,400 when we cull her, it appears as though we only need three calves before we see a positive return, but when we account for the time value of money we need four calves to break even.
If a bred cow costs $3,000, she appears to pencil out at four calves, but when accounting for the time value of money, we really need her to produce six calves before we break even. I’m not convinced I will get that number of calves from any cow. There will surely be some cows with that kind of longevity, but we need this number of calves from the average cow in order to break even on this investment.
These numbers get even more worrisome if we see any increase in annual costs or decrease in calf prices over the life of the cow. If we see a $50 per year increase in annual cow costs, it takes five calves to pay for a $2,500 cow and 10 calves to pay for a $3,000 cow.
If we keep the original $1,000 per year cow cost, but see calf prices drop by $10 per hundredweight each year from $280 in 2016 to $200 in 2024, it takes six calves to pay for a $2,500 cow and 10 calves to pay for a $3,000 cow.
I am just not confident that we will see a period without either drought, which will increase annual costs, or decreased prices to be confident the current situation will hold for long. I am also not comfortable that the average cow purchased this year will produce at least six calves before she is culled.
I understand there are other factors driving the rebuilding decision – tax management for example. However, it seems to me to be a better investment decision to delay rebuilding until breeding stock prices are more inline with the discounted value of the revenues they are likely to produce.
If rebuilding is currently occurring by retaining heifers, the costs of breeding stock are relevant as you could sell those animals this year, both increasing current year revenues and delaying the costs of breeding stock until prices abate somewhat.
While I think rebuilding the national herd is important and needs to happen, I would personally continue to take advantage of current prices by selling animals now, rather than investing in expensive breeding stock, whether by purchasing cows or retaining additional heifers, to produce calves in the future, when prices are almost certainly going to be lower than they currently are.