Market Outlook

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There's a little patch of middle ground in the beef business today that has bankers taking notice. Cattlemen call it a "grow yard." Lenders call it an "economic entry point" to the industry. Thomas Allen calls it a path home to Texas.

With five years of experience working in the feedyard industry, Allen started Kabil Cattle Co. in April 2018. Based in the Dalhart area, the custom grow yard sells most of the feeders it raises to Five Rivers or Cactus feedyards. Allen says the year-round operation runs between 6,500 and 7,500 head at a time with a 10,000-head capacity.

Kabil doesn't own cattle. Most of the animals it grows out come from a partnership of area farmers and ranchers. Calves come from sale barns all across the country, as far north as South Dakota, west to New Mexico and east to Florida and South Carolina.

"It's based on where cattle are pricing right for us," Allen explains. "Usually, we are looking for calves as light as 450, normally nothing over 600 pounds. We like to put 250 to 300 pounds on them, and from there, the feedyards will finish them."

The nearby Allen family farm produces row crops including wheat, corn and hay. These go into feed Kabil uses, and the manure from the grow yard is used on the fields. Calves typically start their time at the yard on a high-roughage diet.

"Maybe we use a little flake corn, but mostly it's high silage, high wheat straw. We may use an earlage product as opposed to the flake. It depends on what we have available. Our goal is to take advantage of our capital assets. Sometimes, that means grazing them on some grass corners and wheat pastures," Allen says. Overall, the goal is about 2.5 pounds of daily gain for 60 to 70 days. Once feeders get to the weights buyers are looking for, Allen makes a call.

"They take a look and make a bid. That's how we handle this. Relationships are important in this business," he says. "We have the benefit of being in a good region. Summers and winters are relatively mild. There are a lot of finisher feedyards and kill plants in the area, so we have a good market."

MORE EFFICIENT, NOT CHEAPER

Don Close believes grow yards such as Kabil are going to be a key segment in the U.S. cattle industry in the years to come. The senior animal protein analyst for Rabo AgriFinance says while these operations aren't entirely new, they are evolving and becoming a means for feedyards to create more reliable cattle supply chains.

"Grow yards are more efficient, not necessarily because they are a cheaper way for the industry to handle cattle but because they can better identify rate of gain, cost of gain and predict when cattle will leave and be placed in a feedyard," Close says. "That higher predictability is key, and it's feasible because you are removing some environmental variables."

He adds, grow yard operators can buy a broader range of weights and types of cattle, building a reserve for future placements. They provide a central collection point for cattle, essentially a preconditioning arena to get calves to desired weights and states of readiness. Generally, this is going to be a 750-to-900-pound window for most feedyards.

Grow yards can help feedyards implement better risk management and commit earlier to packers, because there are simply fewer unknowns when buying their cattle. Close adds that expanding the weight class of purchases can ease feedyard competition common at certain times of the year.

OFFSET TO LABOR PROBLEMS

With his background working for feedyards, Allen says operations like his also help with labor issues, a constant and growing challenge.

"Feedyards have trouble getting good qualified staff," he says. "The hours are long, and the pay is hard because there are such slim margins. That's one reason it's harder for them to take a chance on high-risk cattle. Those animals just require so much more labor."

Grow yards, he notes, "can work the bugs out of those calves and get them to the point where you can put the pounds on them. Then, they go to that big feedyard for finisher feed. It's a good system that allows us to do what we do best, which is manage these higher-risk calves, and then lets the feedyards benefit and put on those final pounds."

Allen adds they've recently hired a nutritionist, who also works with one of the feedyards to which they sell. This will help them better align feeding strategies with those of the feedyard, reducing stress on calves as they transition from one place to the other.

EXTENSIVE QUALITY BOOSTS

While the overall success of grow yards as a sector won't be known for some time, another shift in the industry that began nearly a decade ago is paying dividends. Beef quality has hit its stride largely because of genetic influence.

Stewart Bauck, vice president of Neogen Agrigenomics, has been on the beef genetics ride since it started. He's not surprised at the meat-quality improvements the industry has seen.

"We've seen a change in mind-set with regards to genetic testing," he notes. "There's more female testing, and that has led us to the point where the industry is identifying superior females. That is a large part of what's driving this acceleration in beef quality."

Mark McCully, vice president of Certified Angus Beef (CAB), reported on the improved quality in the beef industry recently, specifically marbling.

"We have made incredible strides in the quality of our end product," he says concerning U.S. cattle.

"Go back to 1996, and look at percent Choice and Prime on U.S. cattle. For years, we were at a 55% level. We weren't making much progress. It was not a bad product, but we weren't making it any better. In late 2008 and 2009, however, we started to see trends in a new direction."

He says an intentional focus on improved marbling genetics, along with a period of rebuilding the cow herd with consumer preferences in mind, made the difference.

For comparison, he notes that in 2010, 13 million pounds of Prime beef carcasses were processed in an average week in the U.S. In 2018, that number was at 33.5 million pounds -- a 20-million-pound (plus-158%) increase. Massive improvements were also seen in premium Choice beef, going from 51.1 million pounds weekly in 2010 to 95.6 million pounds in 2018.

"We've gone from a commodity-minded business to producing with the consumer in mind. This is the result of an intentional focus by cattlemen to produce a better quality end product and having the tools to do it successfully."

A TASTE FOR BEEF

Much of this top-quality beef is being sold to high-end restaurants and into the export markets. Despite some disappointments on the trade front, beef's overall export numbers have continued to climb. Now is a critical time to build on that success, says CoBank's Will Sawyer, lead economist, animal protein.

He stresses U.S. beef's quality foundation has to stay solid moving forward to build on exports, as per-capita protein consumption domestically reaches all-time highs and likely plateaus. Based on USDA reports, total per-capita consumption for red meat and poultry are forecast to hit 222.4 pounds this year. For beef, the number is 58.3 pounds. These numbers are part of a steady increase in per-capita consumption after a downward trend that began in 2007. For beef, growth in consumption started to show in 2016, when the per-capita number went up nearly 3% in one year.

MARKET PRESSURES

CoBank is forecasting a significant step up in mergers and acquisitions consolidating cattle feeding in a move to offset pressure on profit margins. Sawyer adds short- and medium-term free-trade agreements will start to play out this year, a pivotal point in defining how competitive U.S. beef will be on the world stage.

At the same time, animal protein and dairy sectors will continue to expand production in 2019. The dairy, pork and poultry sectors are all projected to increase processing capacity, likely resulting in lower margins. CoBank's outlook report notes that "of the three major animal-protein species, beef appears to be weathering the ... oversupply situation the best, with favorable fed cattle prices and historically high packer margins."

Sawyer notes trade-related issues must be resolved to restore normalcy to ag markets. It will be important to see ratification of the United States-Mexico-Canada Agreement (USMCA), removal of steel and aluminum retaliatory tariffs, and improved trade relations with China.

Beef exports have been consistently strong, with values increasing from $7.3 billion in 2017 to $8.3 billion in 2018. Top buyers in 2018 included Canada, Hong Kong, Japan, Mexico and South Korea. Continuing these strong relationships and building on those export numbers is the No. 1 priority for U.S. beef producers, says Florida beef specialist Chris Prevatt.

"If we can get to the point where the USMCA is ratified, and there is an agreement of some type with China, I think we are going to see a positive impact on the beef market—even with the possibility of seeing per-capita domestic consumption plateau. Without a strong export outlook, though, we could face some serious challenges ahead."

Those challenges, Prevatt believes, include a risk of recession in the U.S. for the next two to three years.

"We don't have to be in an economic panic to see an impact. The GDP [gross domestic product] is projected at 2.5% for all of 2019. And, that's a moving target.

There is a real risk that we won't see that much growth. I think what we're seeing is part of the cycle of a healthy economy. The purpose is to remove some waste. But, it could impact how consumers spend money, and that will potentially reach into beef producers' pockets."

Another impact factor will be interest rates. As they climb, Prevatt notes, they have an effect that goes from one end of the beef industry to the other.

"If feedlots are using borrowed money, for example, their cost of production is higher, and that puts pressure on the feeder market. This could add to contraction in the economy, so we need to watch any increase in rates very closely. Those most at risk in this scenario are stockers and feeders, especially those without good risk-management programs."

WHAT IT MEANS FOR PRICES

Pressure on prices and increased production will mean a dip in numbers for cattle producers this year. That doesn't mean there won't be any pricing opportunities, but rather that this is a good time to consider the use of tools like options and futures to help manage risks.

Kabil's Allen says his predominant strategy is built around selling futures. He's not as comfortable working with options.

"I'm bad at anticipating the market," Allen laughs. "If I do an option, that's when the market will tank. I like working with futures better because I know my costs, and I feel I'm making informed decisions because of that."

If he sees an opportunity to make money, he locks it in. His biggest risk rides on the production side, and part of that is just being new to the business.

"One of the downsides to being new is that we don't have decades of data. So, getting our data and finding our identity are important right now. But, if we can walk away and know we broke even or show a little to the upside, I feel good about that.

"What I believe you try to do is avoid the big disaster. Take calculated risks and maybe leave some room to play to the upside," he continues.

Derrell Peel says those are good strategies no matter where you sit in the beef industry.

The Oklahoma State University beef economist believes expansion of the U.S. beef herd may be mostly complete but says there is no sign of any type of liquidation ahead for 2019. That means a mostly level price environment for producers. He even hints at a tiny bit of expansion left in the industry.

"The number of beef replacement heifers is large enough to support a minimal level of additional herd expansion in 2019 if it all breaks right," he says.

The Jan. 1, 2019, inventory of cattle and calves in the U.S. increased to 94.76 million head, a 0.5% bump over 2018 levels. Beef cow numbers were at 31.77 million head, a 1% increase over year-earlier levels. Replacement heifer inventory decreased 3%, to 5.93 million head. As a percent of the beef cow herd, they are 18.7%.

"This ratio is down from 19.4%, where it was one year ago," Peel notes. He explains that moves the industry closer to levels consistent with "zero herd growth."

Florida's Prevatt says based on analysis out of the USDA and the Food and Agricultural Policy Research Institute (FAPRI), he expects Southeast feeder calf prices to be lower than in 2018 on an annual average basis about $13 per cwt lower.

"We are still in a downward price transition of the current cycle," he says. "So, be aware that for cow/calf producers, when we look at annual price averages, we have not bottomed out yet. The bottom is still ahead of us. We have limited upside potential for the next two to three years. Now is the time to focus on how you adjust. Is it possible to position yourself to be able to take advantage of lower prices? In other words, can you prepare now to benefit from the upward transition that happens after we bottom out?"

Prevatt says forecasts indicate this upward transition starts around 2021 or 2022, and continues five to seven years.

"Are we going to be in position to capture those potential future profits by expanding when everyone else is contracting? This is when you expand. This is where the potential is."

Asked if niche and specialty markets are a good path to growth, Prevatt says they are just one tool. As long as they exist, and a producer can be profitable in those arenas, he should ride them.

"But, always have an escape route, a Plan B to move forward if that dries up," Prevatt adds. He notes that many of today's niche markets are ultimately competing with organic beef, and as the price differential narrows, he thinks more consumers will opt for organic over natural or grass-fed.

The locally finished beef niche, however, should continue to be strong, especially where sales go straight to consumers and local restaurants.

"Those sales are built on relationships, and once those relationships are established, they can withstand some price challenges."

(BAS/SK)

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