CattleFax sees red flags moving forward for cattle industry

Looking at profit and loss positions, CattleFax Analyst Lance Zimmerman noted that 2017 has been stronger than at any point in 2016 for people who sell feeder cattle and calves.

“Overall, psychology of the market has been better, and prices have been better, as well,” he said during an Aug. 30 Trends+ webinar, presented by CattleFax and sponsored by Elanco Animal Health.

Profitability

Zimmerman noted that feeder profitability is the primary factor for price stability.

“Even on a conservative basis, we can say that most feedyards through the spring period probably saw cash-to-cash profits of around $300 a head,” he said.

During that time, feeder cattle prices also made year-over-year gains, seeing increases as much as 10 percent, which was a sharp contrast to 2016, where extreme losses were seen.

“We basically saw the cattle feeding segment go through 24 months of consecutive losses,” Zimmerman continued. “It took a toll on feeder cattle prices.”

For people selling calves, losses in the growing segment have impacted producers.

“We saw a similar situation here,” he said. “Big price declines came in a period of big losses for those folks in the backgrounding and growing businesses, and we transitioned to sharp and very consistent profitability – in many cases around $200 a head – for the better part of this year.”

As a result, calf sellers were rewarded, and folks wanted to bring more cattle in. As cattle feeders moved more cattle through the system and gained currentness, stocker operators and backgrounders moved their cattle into the feeding segment more quickly, and calves were moved more quickly through the system, as well.

“Our concern as we talk about this market going into 2018 is we’re already seeing the telltale signs that profitability’s going to be fading for each of these segments,” Zimmerman said. “As we transition to fall, more of those break-evens are going to transition fully to losses.”

At that point, buyers tend to “sit on their hands” rather than purchase cattle, especially as they know that more cattle are about to hit the market.

“As we think about the challenge for demand next year, we need to start preparing ourselves for a year that’s going to be a little bit tougher to get a good bid for our cattle in 2018,” Zimmerman said. “As we look at 2017, we’re probably going to see some negative activity seasonally as we work into October, but the big red flags come as we transition to the new year, in our opinion.”

Market phase

“One of the ‘ifs’ that we look at as we transition to this market is the idea that producers recognize what phase of the cattle cycle we’re in,” Zimmerman said, noting that CattleFax frequently discuss the cattle cycle and trends. “As a result of that, producers have done a much better job in the last 12 months of selling early – either hedging cattle by selling futures, participating in video auction markets or some other form of forward contract sale.”

Looking at the Cattle on Feed report from USDA, Zimmerman said that producers can look at the report compared to how many short position the Chicago Mercantile Exchange shows.

“Looking at that, we have roughly 40 percent of the cattle on feed today protected by a short position,” he said. “As we look at that, it’s very possible we’ve protected ourselves from some of the cash-to-cash losses from the cattle feeding segment, and the same trend is true to a certain degree among feeder cattle sellers, as well.

Zimmerman emphasized, “The better protected we are on this downside, the better we may be able to prop up these markets, specifically for calves. If things seem to be performing better than expected, better price protection is one of the reasons we can point to.”

Cattle inventory

However, Zimmerman cautioned producers that the cattle inventory continues to grow, and USDA’s latest numbers from July 1 of this year estimated the 2017 calf crop at 36.3 million head, an increase of 1.2 million head over a year ago.

“That was bigger than CattleFax estimates and bigger than most trade estimates,” he said. “This is the biggest year-over-year estimate from a percentage standpoint going back to the 1980s.”

More concerning, he said, is what these numbers mean as we approach 2020.

“There are going to be a lot of calves to move through the system. This increase is big, and we see one more really big year-over-year increase for 2018,” Zimmerman explained. “I think we’ve made good progress this year and done a better job selling cattle early. The effects of next year, knowing that we’re going to be knocking on the door of 38 million going into the fall run, should at least put up a caution flag to all of us.”

Moving into the future, Zimmerman noted that cattle numbers will continue to be a challenge.

“The feeding capacity, packing capacity and shelf capacity at retail is much more limited in its desire to grow right now,” he said.

“We have to recognize what the profit structure looks like, what inventory looks like and what the futures market tells us about the value of the product we’re trying to sell,” Zimmerman explained.

Shape of the industry

“Another thing to keep in mind as we look forward is the shape of our industry,” Zimmerman said. “The industry has an hourglass shape. We have a smaller number of producers selling into a more restricted packing segment. As we get north of the packer, we sell to a greater number of retailers, restaurants and ultimately consumers – both domestic and international.”

In the short-term, industry structure creates a big challenge, he said, which is echoed in other protein markets, as well.

“We’ve been able to grow the factory – our production systems – far faster than the processing segments above them,” he said. “This looms huge for cow/calf and stocker operators going forward.”

As numbers increase, the cattle feeder will gain confidence that he can bid less for feeder cattle, and stocker operators are likely to do the same when he buys calves, said Zimmerman, which will influence the remainder of the industry.

“That’s part of the reality of the cattle cycle as we get to the contractionary phase,” Zimmerman said. “It’s important to understand the magnitude of this risk. As we think long-term, this should weigh on the back of our minds that the leverage shift is going to be extreme.”

The Trends+ webinar was sponsored by Elanco Animal Health.

Saige Albert is managing editor of the Wyoming Livestock Roundup. Send comments on this article to saige@wylr.net.