CME: Summer 2008 - Best Time Ever or a Nightmare?

by 5m Editor
25 November 2008, at 10:14am

US - CME's Daily Livestock report for 24th November 2008.

Some recent hesitancy on the part of pork and beef packers to really push the numbers through can be easily understood if one considers the recent declines in packer margins. The graphs show computations of packers’ gross margins. They are comprised of the value of the carcass less the value of the animals purchased plus the value of by-products (also called the drop value). These figures would represent the gross profits for packers’ slaughter and carcass breaking operations only as far as primal cuts. Any further value-adding activities such as close trimming, boning, enhancing and further processing would be beyond the scope of these margin computations. Packers must sTill pay all non-livestock costs including labor, energy, packaging, transportation and facilities costs from these margins before a net margin can be calculated. Those values vary from plant to plant and are proprietary. Our thesis is that those costs are relatively stable and that gross margins are a good predictor of packers’ buying behavior

Pork packers will look back on the summer of 2008 as the greatest summer ever but they may look at the fall of 2008 as an absolute nightmare. The reduction in margins has been severe in recent weeks and helps explain packers’ reticence to pushing up slaughter numbers. With the number of hogs available clearly falling short of levels predicted by the September Hogs and Pigs Report, one might expect some tighter-than-expected margins due to hog prices. But these tight margins are NOT because packers have been aggressive. Product values have floundered and, perhaps more important, by-product values have plummeted (Figure 1) by over $7 per head since July. The price of virtually every drop value component has fallen during that time but the most dramatic drop has been in the value of fat or grease. Inedible choice white grease was selling for 51.21 cents per pound in mid-July. Last week it sold for 13.54 cents per pound — primarily because of the drop of corn prices. Inedible choice white is a feed energy substitute that was in high demand this past summer when corn prices soared. Lower grain prices have reduced the need for added energy. In addition, the stronger U.S. dollar has pushed by-product values lower as exports have cooled.

The stronger dollar and reduced by-products values have been HUGE factors for beef packer margins as well. Before a dramatic recovery driven by and $8.81/cwt. increase in cutout values the week of November 15 (the last for which complete data are available), beef margins had fallen by roughly $180/head from last summer’s high. Roughly $40 of that decline has come from lower by-product values which comprise a larger share of the beef packer margin due to the high value of the hide. The catch, of course, is that a very high percentage of hides are exports and the stronger dollar has caused their prices to rise significantly since September.

Note that packers of both species have spent several weeks “upside-down“ on meat margins this fall as well. We believe this is primarily due to slowing export demand and now some disruptions in the foodservice trade as the economy has slowed.