Benchmarks: percentage of owners’ equity, working capital per sow
I have been working with AgStar Financial Services ACA for 19 years, and when I started in 1997, I saw tremendous growth over a very short period of time. The achievement of 1998 quickly taught me a lesson in the hog industry, that whatever profits it brings in, it can quickly recoup.
After 1998, it took a few years for most homeowners to rebuild their balance sheets to respectable levels and by 2007 I thought I saw the healthiest balance sheets I had ever seen. It was until now!
Last week I had the privilege of speaking at the National Pork Board’s annual management conference on this topic. Without a doubt, I have never seen healthier balance sheets, working capital levels and the average production system in place today.
A few benchmarks that I like to look at are owner equity percentage and working capital per sow. From an equity standpoint, the average producer has over 70% equity in their operations today. Even more impressive is the working capital per sow.
For this number, we use the number of pigs marketed divided by a reasonable number of pigs that a sow would produce to arrive at an equivalent number of sows for each operation (X pigs marketed ÷ piglets produced per sow) = (sow basis). Then you just take your working capital and divide it by your sow base (Working capital ÷ sow base). As a target, we would like this target to be greater than $ 600 per sow. Today the average number we see is over $ 1,300 per sow. There is a huge amount of working capital today for most operations.
My recommendation to anyone looking to grow is to make sure you maintain a minimum working capital of $ 600 per sow after your expansion. Now is the time to structure your balance sheets to keep as much working capital as possible. Interest rates are low and balance sheets are very strong, giving you more leverage with your lender today. Looking back to 2008 and 2009, we all remember how quickly that can change.
At the Federal Reserve meeting last week, Fed Chairman Janet Yellen acknowledged that more signs of economic growth are needed before raising interest rates. What does this mean for your operation in the long term and in the short term? Even though the Fed did not raise rates at its June meeting, it is still committed to making some hikes in 2016. The next two meetings will take place at the end of July and September.
The decision was postponed at this meeting for several reasons. First of all, with an imminent British vote on the uncertainty of leaving the European Union weighed in the decision. If Britain decides to leave the EU, it will have unknown consequences for global financial markets and create possible economic concerns for other EU member countries and trading partners. If you remember, for the first time in nine years, the Fed raised the Fed Funds rate by 25 basis points last December. However, since then long-term rates have continued to fall in response to market conditions. Second, with a growth rate of slightly less than 2% (the Fed’s target), any increase could limit the maintenance of growth at target rates.
As to the best decision for your interest rate transaction, I think it depends on several variables. With rates close to historic lows, it is worth considering restructuring to lock in and mitigate interest rate risk. The first analysis I do when looking at a client’s current loan structure is to understand their cash flow needs. It is vital in the long run for all operations to have a reasonable and competitive payment structure per pig. Second, if your rates are reasonable and you aren’t growing your business, you might just want to keep your loan structure as it is.
For example, if you have a debt of $ 1,200 per sow with a fixed rate amortized over 10 years, a rate cut of 0.05% will only reduce your cost by $ 0.14 per pig assuming 26 pigs per sow. per year. However, if you are planning to expand your business and currently have an accelerated debt structure, consult your loan officer to determine your best payment structure to stay competitive in any economic environment.
Malakowsky has over 19 years of experience with AgStar Financial Services. For more information from Malakowsky and the AgStar Pig Team, including their weekly video Hog Blog, visit AgStar.com. If you want more information on AgStar’s margin management tool, see it on AgStar.com/MarginManager.