Introduction to Margin Management. Commodity & Ingredient Hedging, LLC

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1 Introduction to Margin Management Commodity & Ingredient Hedging, LLC

2 What is a Margin? The concept of a profit margin is not new. Revenues minus expenses equal the profit margin of a business. Revenue Expenses Profit Margin Copyright 2009 Commodity & Ingredient Hedging, LLC 2

3 How to Calculate the Margin? The profit margin calculation is different for every pork, beef, crop, and milk producer. But each type has a few elements in common. Hog Operations Cattle Feedlots Dairies Crop Producers Copyright 2009 Commodity & Ingredient Hedging, LLC 3

4 Hog Operation Margin In a hog operation lean hog sales are on the revenue side of the equation The expense side of the ledger is divided into feed and nonfeed costs. Feed Costs Corn Meal DDGS etc Hog Sales Non-Feed Costs Utilities Staff Vet etc Profit Margin Copyright 2009 Commodity & Ingredient Hedging, LLC 4

5 Cattle Feedlot Margin Live cattle sales are on the revenue side of the feedlot equation The expense side of the ledger is divided into feeders, feed and non-feed costs. Live Cattle Sales Feed Costs Corn DDGS etc Non-Feed Costs Feeders Utilities Staff Vet etc Profit Margin Copyright 2009 Commodity & Ingredient Hedging, LLC 5

6 Dairy Margin Milk sales are on revenue side of the dairy equation The expense side of the ledger is also divided into feed and non-feed costs. Feed Costs Silage Haylage Meal Corn DDGS etc Milk Sales Non-Feed Costs Utilities Staff Vet etc Profit Margin Copyright 2009 Commodity & Ingredient Hedging, LLC 6

7 Crop Production Margin Crop sales are on the revenue side of the equation Land, fuel, seed and fertilizer expenses are some of the costs. Corn, Wheat, or Soybean Sales Fuel Land Fertilizer Seed Production Cost Staff Storage Drying etc Profit Margin Copyright 2009 Commodity & Ingredient Hedging, LLC 7

8 Protecting Profit Margins for the Future Copyright 2009 Commodity & Ingredient Hedging, LLC 8

9 Why Protect Future Profit Margins? Help your business through the inevitable lean times that are part of any cyclical industry Significantly improve profitability Assist with planning, budgeting, borrowing discussions with lenders Copyright 2009 Commodity & Ingredient Hedging, LLC 9

10 Ways to Protect Future Profit Margins Using the commodities futures market, businesses can trade contracts to help secure revenue for deferred periods They can also trade contracts to help control costs on the expense side, including: corn, soybean meal and fuel Copyright 2009 Commodity & Ingredient Hedging, LLC 10

11 How Can the Futures Market Protect Profits? Futures prices correlate to local cash prices Futures contracts can be used as substitute purchases and sales for the physical commodities in deferred periods Futures Price Local Cash Price Copyright 2009 Commodity & Ingredient Hedging, LLC 11

12 How Can the Futures Market Protect Profits? Holding other expenses constant and ignoring basis for a moment, if you sell futures against your projected sales and simultaneously buy futures against your projected feed purchases, you have effectively locked in a profit margin for your operation. Sell Futures against Sales Buy Futures against Feed Purchases Locked-in Future Profit Margin Copyright 2009 Commodity & Ingredient Hedging, LLC 12

13 Protecting a Forward Profit Margin The futures market allows a producer to contract around a combination of values for input costs as well as output sales that projects a profit. Today Spot Sales Spot Purchases Spot Margin = loss Next Year Projected Sales Projected Purchases Projected Margin = profit Copyright 2009 Commodity & Ingredient Hedging, LLC 13

14 Protecting a Forward Profit Margin Spot sales are current transactions The futures market taking place allows in the a cash producer market between to contract around a combination you and the packer, of values processor, for input elevator costs as or other buyer for immediate delivery. well as outputs sales that projects a profit. Today Spot Sales Spot Purchases Spot Margin = loss Next Year Spot purchases are transactions taking place in the cash market for immediate delivery Projected between Sales you and the feed company or input supplier. Projected Purchases Both spot purchases and sales are based upon the price of the corresponding futures contract with the closest expiration. Projected Margin = profit Copyright 2009 Commodity & Ingredient Hedging, LLC 14

15 Protecting a Hog Operation Margin The futures market allows a hog producer to contract around a combination of values for corn & meal as well as lean hogs that projects a profit. Today Spot Prices Nearby Lean Hogs $65/cwt Next Year Futures Prices Deferred Lean Hogs $75/cwt Nearby Corn $4/bu Nearby Meal $302/ton Other Current Costs Deferred Corn $3/bu Deferred Meal $278/ton Other Projected Costs Spot Margin = loss Projected Margin = profit Copyright 2009 Commodity & Ingredient Hedging, LLC 15

16 Protecting a Cattle Feedlot Margin The futures market allows a feedlot to contract around a combination of values for feeder cattle and corn as well as live cattle that projects a profit. Today Spot Prices Nearby Live Cattle $83/cwt Next Year Futures Prices Deferred Live Cattle $91/cwt Nearby Corn $4/bu Nearby Feeders $96/cwt Other Current Costs Deferred Corn $3/bu Deferred Feeders $88/cwt Other Projected Costs Spot Margin = loss Projected Margin = profit Copyright 2009 Commodity & Ingredient Hedging, LLC 16

17 Protecting a Dairy Margin The futures market allows a dairy to contract around a combination of feed-equivalent values for corn & meal as well as class III milk to project a profit. Today Spot Prices Nearby Class III Milk $13.5/cwt Next Year Futures Prices Deferred Class III Milk $15/cwt Nearby Corn $4/bu Nearby Soybean Meal $302/ton Other Current Costs Deferred Corn $3/bu Deferred Meal $278/ton Other Projected Costs Spot Margin = loss Projected Margin = profit Copyright 2009 Commodity & Ingredient Hedging, LLC 17

18 Protecting a Crop Production Margin The futures market allows a farmer to contract a price for their crops around the costs of producing that crop to lock in a projected profit. Today Spot Prices Nearby Soybeans $9/bu Next Year Futures Prices New-Crop Soybeans $11/bu Current Production Cost Current Land Cost Projected Production Cost Projected Land Cost Spot Margin = loss Projected Margin = profit Copyright 2009 Commodity & Ingredient Hedging, LLC 18

19 Realizing Profit Margins Copyright 2009 Commodity & Ingredient Hedging, LLC 19

20 Realizing a Deferred Profit Margin Now, let s step forward to next year Last Year Next Year Copyright 2009 Commodity & Ingredient Hedging, LLC 20

21 Realizing a Deferred Profit Margin When the actual production period approaches and the cash market transactions for corn, meal, livestock or milk take place, the futures market position is offset and gains or losses are tallied to calculate a net, realized margin. Last Year Now Futures Market Positions with Projected Profits Local Cash Market Transactions Offsetting + Futures Market = Positions Realized Net Margin Copyright 2009 Commodity & Ingredient Hedging, LLC 21

22 Realizing a Deferred Profit Margin Last Year Futures Market Positions with Projected Profits Local Cash Market Transactions Now Offsetting Realized + Futures Market = Net Margin Transactions Sell Hogs Buy Feed Actual Margin -$10/cwt Loss Hog prices have declined and feed costs have increased so today s actual margin is now a loss, versus what was projected last year. Copyright 2009 Commodity & Ingredient Hedging, LLC 22

23 Realizing a Deferred Profit Margin Last Year Futures Market Positions with Projected Profits Local Cash Market Transactions Now Offsetting Realized + Futures Market = Net Margin Transactions Sold Hog Futures Buy Back Sell Hogs $ Hog Futures $72.50/cwt $65/cwt $65/cwt $7.50/cwt Hog prices have declined so the futures sold last year are offset today with a gain. Copyright 2009 Commodity & Ingredient Hedging, LLC 23

24 Realizing a Deferred Profit Margin Last Year Futures Market Positions with Projected Profits Corn and meal prices have increased, so the futures bought last year at lower prices are also offset today with a gain. Local Cash Market Transactions Now Offsetting Futures Market Transactions Realized = Net Margin Sold Hog Futures Sell Hogs Buy Back Hog Futures $ Bought Corn & Meal Futures Sell Back Corn & Buy Feed $ Meal Futures $3/bu $270/ton $4/bu $350/ton $4/bu $350/ton $1/bu gain $80/ton gain The prices and calculations above for illustrative purposes only. Copyright 2009 Commodity & Ingredient Hedging, LLC 24

25 Realizing a Deferred Profit Margin Last Year Futures Market Positions with Projected Profits Local Cash Market Transactions Now Offsetting Realized + Futures Market = Net Margin Transactions Buy Back Sold Hog Futures Sell Hogs $ Hog Futures Bought Corn & Meal Futures Sell Back Corn & Buy Feed $ Meal Futures $7.50/cwt The $1 per bushel corn gain combined with the $80 per ton meal gain is roughly equal to a $7.50/cwt gain in hogs. 25

26 Realizing a Deferred Profit Margin Last Year Futures Market Positions with Projected Profits Local Cash Market Transactions Now Offsetting Realized + Futures Market = Net Margin Transactions Sold Hog Futures Sell Hogs Buy Back Hog Futures $ Bought Corn & Meal Futures Buy Feed Sell Back Corn & Meal Futures $ The balance of all offsetting transactions produces a gain. Position Offset $15/cwt Gain Copyright 2009 Commodity & Ingredient Hedging, LLC 26

27 Realizing a Deferred Profit Margin Last year s projected margin becomes a reality: Last Year Now Futures Market Positions with Projected Profits Local Cash Market Transactions Offsetting Futures Market Transactions Realized Net Margin Buy Back Sold Hog Futures Sell Hogs $ Hog Futures Bought Corn & Meal Futures Sell Back Corn & Buy Feed $ Meal Futures Projected Margin $5/cwt Profit Actual Margin -$10/cwt Loss + = Position Offset $15/cwt Gain $5/cwt Profit Copyright 2009 Commodity & Ingredient Hedging, LLC 27

28 Conclusion The profit margin in your hog, cattle, crop or dairy operation is always the revenue minus the cost of production. Identifying the forward margin in your operation is the first step toward protecting profits for production periods in the future. Establishing protection around the unrealized forward margin is essential for sustained profitability and business growth. Copyright 2009 Commodity & Ingredient Hedging, LLC 28

29 END Commodity & Ingredient Hedging, LLC

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