Don’t Underestimate Inflation in Your Forecast Model
A lot of variables go into calculating cost of production. Besides your standard list of inputs, have you also included the cost of inflation? Inflation is running over 8% year-to-date. Interest costs are increasing, and there’s uncertainty around basis levels with feed input costs. Now, more than ever, it’s important to look at revising your forecast, at least quarterly, or when there is a major change with your input costs.
With the September Hogs and Pigs Report recently published, there was nothing that should be a major surprise to producers. Actual numbers were lower in all categories and close to the bottom end of the range of estimates, except for September. through November farrowings. The outlook for 2023 will closely resemble 2022. There should be steady profits in 2023, if you are willing to take advantage of opportunities when available. If the USDA reports are any indication, expansion most definitely is not underway. There are some farms being built in the U.S., but most of those are through attrition of existing farms.
Probably the most debilitating factor to expansion are current costs of new farms. It was only a few years ago, we routinely saw costs for a sow unit at $2,500 to$2,800 per sow. Today, we’re seeing $3,500 to $4,000 per sow space, depending on whether it’s an open pen gestation or Prop 12 farm compliant. Then, couple that with increased interest costs, which have risen by 3 to 4%. The capital necessary as a down payment is slowing any desire for expansion.
For example, if you had a farm that cost $2,800 per sow and you capitalized it at 25%, you would borrow $2,100 per sow. A year ago, the interest rate was in the 3.75% range. At that level of capitalization, the principal and interest payment per pig would be $6.55. That would mean with an extra $300 per sow capital for a farm that costs $4,000 per sow space in today’s environment. With current interest rates at 7.50%, the principal and interest payment would be $12.10 per head, or $5.55 more per pig at 28 pigs per sow per year (PSY). That doesn’t include any return on your additional $300 per sow space in extra capital investment. The result is little motivation for producers to expand in the swine industry today.
Looking at risk management plans in the past, most cost of production numbers were set annually, if not just carried over from year to year with a modest increase. The risk management forecast model would determine what your margin looked like monthly. Unfortunately, that method will no longer work for making marketing decisions until we find some stability in the U.S. economy.
The impact of higher labor and energy costs alone should encourage a cost structure review. Considering basis, what is your corn and soybean meal basis going to look like during the summer of 2023? I understand most of this is an educated guess, but these are the numbers to look at when revising your forecast models. The difficult decision to make is – what targeted price levels should you sell hogs for in July 2023 when looking at inflation? If your model doesn’t consider an inflation-adjusted cost, you might be missing your profitability targets. I strongly recommend reviewing targets and models to make sure all costs of your operation are included to make the best marketing decision possible.
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