The 'cause and effect' of processor margins

The 'cause and effect' of processor margins

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Processor margins can be an important indicator of where cattle prices might be headed.

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The profit (or losses) incurred by meat processors can be an important indicator of where cattle prices might head in the future.

Processor margins remained at extremely profitable levels in June with meatworks enjoying the benefits of a falling Australian dollar and robust beef export prices, coupled with solid supply as destocking continues in dry areas. These factors helped to spread meatworks' costs across greater slaughter numbers, while demand and prices for most categories of beef co-products improved.

The Mecardo/AMPC processor margin model* eased slightly during June to see a $274 margin recorded per head of cattle processed, compared to $285 for May 2019. This places the annual average margin for 2019 at $205, which is significantly higher than the annual average of $36 achieved during the 2018 season (Figure 1).

The last time processor margins were this strong was during 2014. This is somewhat ironic as this also coincided with the end of a particularly dry period that resulted in a significant herd liquidation.

In comparing these two seasons, we can see that the half-yearly average margins aren't too dissimilar. Indeed, the January to June average margin in 2014 was a profit of $202, only $3 off the January to June margin for 2019.

Figure 1: Processor margin model. Source: MLA, Steiner, USDA, ABS, Trade, AMPC, Mecardo.

Figure 1: Processor margin model. Source: MLA, Steiner, USDA, ABS, Trade, AMPC, Mecardo.

Interestingly, the big gains in processor margins during the 2014 period came in the second half of the year, with the monthly margin peaking just shy of $400 during November of 2014. The major driver for this margin level was very strong demand from the US. The ongoing dry conditions locally meant that supply was able to keep up with this increased demand.

The usual pattern for processor margins is for a tightening during the May to September period, based on the 10-year average. The trend has started to narrow this month, but we will have to wait and see what transpires as we head toward September this season.

*Note: The Mecardo/AMPC processor margin model is designed to reflect the general trend in meatworks profitability and should be viewed as a reflection of an average industry participant.

Slaughter numbers remain strong

Meat and Livestock Australia (MLA) is forecasting annual cattle slaughter to reach 7.7 million head during 2019. With the annual female slaughter ratio currently at 55.9 per cent, this equates to around 4.3 million female cattle slated to be sent to the abattoirs this season.

A reasonably strong correlation exists between annual female slaughter volumes and the annual processor margin. Although, if we use the annual female slaughter figure of 4.3 million head, the processor margins currently being achieved are higher than what the normal relationship would suggest for 2019 (Figure 2).

However, over the coming months, the female slaughter ratio is likely to ease and probably finish the 2019 season at around the 54pc average level for the year. If this eventuates, the annual cull of female cattle would be closer to 4.1 million head come the end of the year. Based on this scenario the annual average processor margin for 2019 is likely to be $130-$150 per head of beast processed.

Figure 2: Female slaughter vs processor margin. Source: USDA, Steiner, MLA, AMPC, ABS, Mecardo, Trade.

Figure 2: Female slaughter vs processor margin. Source: USDA, Steiner, MLA, AMPC, ABS, Mecardo, Trade.

Tough times ahead

Processors need to "make hay-while-this-sun-shines"; these conditions don't last forever. The recent dry spell has caused a high proportion of female cattle to flow through the meatworks, as producers respond to feed and water shortages. As per normal in these circumstances, meatworks become very profitable. This has been further supported by the strong and rising price (demand) for export beef. The 90CL price is a good product to gauge the value to be extracted from cows slaughtered (Figure 3).

The future though is almost a mirror opposite. Using previous drought recoveries as a guide, cattle producers will reduce their sale of cows and heifers, some dramatically. A typical producer who has been grappling with a tough season will respond by holding back an extra age group of cows when the season permits.

Instead of cashing in 75pc of heifers to adjust the stocking rate, they could decide to keep 95pc of heifers when feed is available to rebuild drought depleted herds.

Figure 3: 90CL vs EYCI. Source: MLA, Steiner

Figure 3: 90CL vs EYCI. Source: MLA, Steiner

Increased demand

During the past two years, we have seen severely restricted competition from restockers for females. There has been too much cattle country without rain and without feed. This has run the herd down right across the country. When we do eventually see conditions improve, the response will be for not only fewer females offered into the market, but increased demand from those beef producers who find they are understocked. If this coincides with a strong market for finished stock, then the incentive to adjust breeding numbers back to optimum levels will be solid.

The drought has also played into the hands of those with "finished" slaughter-ready stock. The improving export demand has pushed beef prices steadily higher, and this has been reflected in saleyard and OTH prices for slaughter ready cattle.

The expected increased demand for females will also spin-off into other related markets. For instance, the supermarkets have had ready access to heifers which are ideal to go onto 60 to 90-day grain finishing programs. During the drought, they have had limited competition from breeders and restockers. This ready source of relatively cheap supply will have a strong and committed competitor when restockers re-emerge. They may even be further emboldened if the value of prime stock continues to rally.

Not everyone is a winner (or a loser)

While processors are currently in a very good position regarding margins for cattle, they are well aware of the storm clouds on the horizon. Producers, including backgrounders and feeders, can look forward to improving market circumstances when the season improves. Supply of females to slaughter will contract, perhaps dramatically. This will inevitably push up prices of females, certainly for restockers but also beneficially for sellers, including those producers who have prime cattle for sale.

  • Sources: MLA, Steiner, USDA, ABS, AMPC, Trade, Mecardo

The story The 'cause and effect' of processor margins first appeared on Farm Online.

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