Analysis: Processor margins – simple supply and demand, or price gouging?

Jon Condon, 07/06/2013


There’s no doubt that Australian beef processors are making handsome profit margins on slaughter cattle under the current climate of heavy livestock over-supply, brought on by drought.

But does their current pricing represent gouging or exploitation of beef producers who have their backs to the wall in the current market?

It’s an accusation that has been levelled from a small, but vocal body of disillusioned and frustrated producers as the current livestock price cycle has descended to historic lows.

From highs above 415c at the start of last year, the Eastern Young Cattle Indicator recently fell to 278c – a 33pc decline in value in 15 months. Slaughter cattle rates have typically fallen 20-30pc for some categories over the same period.

Similar accusations of price exploitation have recently been levelled at some lotfeeders providing custom-feeding services. A recent ring-around showed finished ration prices in southeast Queensland feedlots providing custom-feeding services ranging from $300/tonne to $380/tonne for finished ration.

Are those more expensive ration quotes taking advantage of producers desperate to place cattle under the current seasonal conditions? That’s a discussion-point for another day, but for today’s purposes, let’s look at processing.

It’s widely known that processors are unwilling to share their financial information with the production sector on profit in processing cattle. The primary reason, while they are making a profit, is that it can be used against them in price negotiation, when producers know there is ‘fat in the system.’

That becomes irrelevant during times like this, however, when processors are killing all-time record numbers because of extreme supply pressure.

But here’s some actual margin figures taken directly from an export processor source last week. Keep in mind that production costs and efficiencies vary significantly from plant to plant, region to region, and other variables, however.


$130/head margin on cows 

“There’s no question that processors at the moment are making money, and plenty of it,” a trusted processor source told Beef Central.

In his company’s case, last week it was writing a margin of around $100 a head on grassfed ox, and as much as $130 a head on cows, where prices have fallen relatively further due to supply pressure.

The big reason: This week’s grid prices for kills in major southeast Queensland plants quoted to Beef Central on Monday included four-tooth grassfed ox 285-290c/kg, milk and two teeth ox 295-300c, and best cow 235-250c/kg. Keep in mind the cow quote is for heavy cows hitting the grid ‘sweet spot’, and many cows under current conditions are making much less than that. Around 220c is probably more representative on cows.

“But does that represent price gouging? I don’t think it’s the case,” our processor source said.

“Despite the current strong margin performance, by no means have we recovered the huge losses processors have incurred in operations over the last two or three years.”

“Those same cow grids were +300c for long periods last year and the year before, but in reality, those cows were worth perhaps 260c/kg to us at the time. Forty cents a kilo loss on a 260kg cow is the wrong side of $100, but no producers were offering us a discount on price at that time.”

“We might be $100 black on heavy steers at present, but I can remember plenty of times over the past three years when we were $100 red on the same cattle.”

“It’s easy to forget the big, big losses that processors were writing, both grainfed and grassfed as well. It’s got to come both ways,” he said.

The last time that processors were ‘consistently’ back in the back was around 2008, but even then, bullocks were 300c and cows 260c.

“We might be slightly below that now, but not by that much. Yes, we’re on a falling market and the A$ might be starting to put a few more dollars back into processors’ pockets, but it is very unjust to call current prices gouging,” Beef Central’s source said.

“The way I’d describe it is that what processors were giving away for the past few years, they are only starting to peg back a little this year.”

“I can sympathise with producers for the position they are in, but they can’t expect processors not to make money at some point. Yes, it’s back in processors’ favour at the moment, but I don’t subscribe to any theory that it is exploiting the position of producers. It’s simply the principles of supply and demand in action.”

On grainfed ox, processor profits are nowhere near as attractive at present, and would be in the red, in many plants, our source said. That’s because grained ox currently are costing around 375c-380c (bought forward four months ago), but in this plant’s case, are worth around 355c/kg today. That still represents a loss of $80 to $90.

That’s partly because a lot of the ‘commodity’ cuts coming out of a 100-day carcase suffer, because of what happens at the grassfed end: as grassfed gets cheaper due to over-supply, it tends to drag down 100-day commodity cuts prices as well.

Another consideration in terms of earlier processor losses is the number of ‘dark days’ logged over the last three years – normal weekday shifts skipped because cattle prices did not make a kill viable.

Statistically, it appears processors have had more voluntary ‘dark days’ over the past three years than they did over the entire previous decade.

‘Dark days’ cost processors big, big money, but sometimes there is no alternative.    

The old formula on how to calculate the impact of a lost day: basically, the processing contribution should offset the plant’s indirect costs: management (but not processing) staff, repair and maintenance etc. In some plants that might come in at $60-$70 a head. If that plant can’t make that in processing, then the option is not to kill – and there were plenty of occasions over the past couple of years when that in fact happened, across eastern Australia.

The profit margins currently being logged by processors, while heavily driven by livestock purchase price, also in part reflect the solid gains being seen for some by-products and offals. MLA’s recent first quarter co-products report compiled by Ben Thomas suggests that potential co-product value from a heavy steer increased 11pc in the March quarter, compared with the same period last year, to $203 a head.


US comparisons  

At this point, it’s worth looking at margins in the US processing industry, which tend to be much more transparent than those in Australia. A recent graph produced by analysts, Steiner Consulting, illustrated that historically, US packer margins tend to be solidly positive, or solidly negative. They tend to spend relatively little time around breakeven.

JBS’s USA Beef division recently reported a big loss for its first quarter. Tyson Foods earlier reported a $26M operating loss in beef in the quarter, confirming that the quarter was negative for US fed beef processors.

In JBS’s operations, margins might have been better in Australia than the US or Canada, as drought forced more Australian slaughter cattle to market towards the end of the quarter and cattle prices began to decline, one US analyst said.

“Right now, US processor margins are extremely positive, but they come against a negative first quarter – particularly for January and into February – as results from Tyson Foods and JBS USA Beef reveal,” Cattle Buyers Weekly’s Steve Kay told Beef Central.

“Margins were positive in March and April and have improved dramatically in May, thanks to the surge in boxed beef prices and the decline in live cattle prices,” Mr Kay said.

He stressed that ‘margins’ in US language were for fed-cattle only, and did not encompass no-fed cattle like cows.

US margins a fortnight ago were positive by just over $67/head, and $85/head last week, according to analyst The big driver has been the fact that US packers paid no more to secure their cattle requirements, while the price of US beef has soared to all-time record levels.

But rather than being unusual, those sort of swings were ‘quite the norm’ in the US packer sector, Mr Kay said.

“Hedger’s suggests that in all the first quarters since 1991 (21 years), US packers have only made money in ten of those years,” he said.     

Several research companies and equities analysts perform packer margin assessments on a daily or weekly basis in the US, but there is no similar function in Australia, to Beef Central’s knowledge – at least none with any credibility.

Additionally, the Packers and Stockyards program of the Grain Inspection, Packers and Stockyards Administration of the USDA puts out an annual report discussing industry wide margins for the entire meat industry.

Unlike Australia, where no large packers divulge quarterly results (JBS Australia’s results are ‘shandied’ in with those from the company’s US and Canadian business), actual results for companies like Tyson, National Beef and JBS US (more obscure) does provide some good indicators of recent packer margins, Mr Kay said.

“US analysts like Andy Gottschalk at Hedger’s have a reputation for being pretty spot-on with the numbers,” he said.

“But it’s still very difficult to determine exactly how much money packers are making, because there are so many value-added products being sold. There are enough speciality programs where they are perhaps making twice as much money as on their commodity beef, per head.”

Asked whether there was any evidence of big profits among US packers specialising in cows and other non-fed cattle since the country’s drought started in late 2010, Mr Kay said the past two years, with the enforced movement of US cows to slaughter, those beef packers had made ‘very good’ returns.

“That applied especially last year, in the aftermath of the Lean Finely Textured Beef furore, when there was a huge gap in supply in lean manufacturing beef,” he said.

It pushed the price of 90CL, in US$ terms, up to record high levels.   

US cow slaughter is up again this year, and there have been 11-straight weeks where cow-kills have been above year ago levels.


Canada is a precedent

Mr Kay said there had been episodes in the past of packers in several countries being accused of ‘gouging or exploitation’ in livestock prices, when circumstances went against producers.

“It was clearly evident in the example of Canada, after the discovery of BSE in 2003-04,” he said.

“Fed cattle prices collapsed, because Canada could not export beef to any of it’s traditional markets. It was like Australia, selling around 70pc of its beef into export at the time. Packers were accused then of exploiting the situation, reducing prices further than they needed to.”

“But what else were packers going to do: be altruistic, and pay more for cattle than they needed to, at a time when they could not find homes for beef?”

“If one believes in a free and open market, with no controls, as the best way to discover price, then you have to let the supply and demand market conditions prevail, regardless of the circumstances.”



US reader, Dennis McGivern, Vice President of Informa Economics, Inc, said he read Beef Central’s original article, published above, with great interest.

“Following the 2003 BSE incident in Canada and consequent border disruptions, the packers in Canada made a lot of money,” Mr McGivern said.

Jeff Church of the University of Calgary was commissioned to look into the behaviour of packers before and after the incident, and report on packers’ use of market power.

“I talked to Jeff about the time he was releasing his work (access link here),” Mr McGivern said.

Jeff Church’s report summary said the results indicated that during the time that the US border was open to UTM beef from Canada, but closed to live cattle, the packers could have exercised market power but did not do so to any significant level.

“The level of market power did increase slightly but the researchers believed that the range of margins was reasonable during that time period. Prices were not consistent with the coordinated exercise of market power and indicated that the actual behaviour by the Alberta packing industry was more competitive than might have been expected,” Mr Church’s report said.

Dennis McGivern said there was plenty of talk and some efforts by producer groups at the time to start up new packing plants to handle the excess cattle in Canada and make the industry ‘more competitive’. 

One group did finally get a new plant built in the Calgary region (Ranchers Beef).  It closed in August 2007, just over a year from its June 2006 opening (see this news report).







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