The Bottom Line - MARGINSMART
Published on Fri, 12/21/2012 - 4:18pm
We all live in a world of volatility and uncertainty. Whether you view this statement as profound, debatable, or the understatement of the year, I think you would agree that the level of commodity price fluctuations, and their impact on your dairy’s bottom line profitability, has heightened in recent years (we will discuss some facts on this later). Individual dairy producers’ views and opinions on how they manage the volatility can result in a wide spectrum of emotions; ranging from fear and confusion to an adrenaline rush. For further proof of this, simply recall the last four to five years. Heck, just look back at 2012 alone.
So with the fact that price and profitability volatility in the dairy industry are now the “new norm,” you may wonder what you can do about it. You may feel pretty confident in understanding rations, sire traits and veterinary protocols, as well as the importance of maximizing feed intake and proper milking protocols, but what exactly do all those price risk management terms really mean?
MARGINSMART was developed specifically to help dairymen with all of these areas and more. It was designed to create a product which is easy to use and understand, yet handles all of the complex areas and calculations with speed, accuracy and timeliness. MARGINSMART identifies all the critical information needed to truly zero in on your dairy farm’s bottom line profitability. Since it is web-based, users can log in from anywhere they have an internet connection and all information is kept current and real-time so there is no worry about lost data or computer crashes. Most importantly MARGINSMART is extremely easy to use and is customized for every user. It is simply the most comprehensive price risk management and profitability tool in the dairy industry today.
Understanding Price Risk
The roller coaster ride of milk prices is well documented, so I won’t spend much time on that. While the milk price gets the majority of discussion amongst producers, the prices of corn, alfalfa and forage sources, soybeans and related proteins are just as critical. A simple view of Chart 1 shows the price of Class III Milk and Cash Corn (across the United States) for the past 6 years. Just as milk fluctuated, corn did as well, but not necessarily in the same correlation or direction during the same months. In addition, in many instances milk may move in the opposite direction of corn and soybean meal during a given day, week or month which results in opportunities which are sometimes very brief periods of time. These are all opportunities for dairy producers to “lock in” profits when they are available. Opportunities are just that – if you don’t execute when they are available they become lost opportunities.
Chart 2 shows the volatility over the last six years as the Class III Milk and Cash Corn prices have moved on average20% each over a 6 month window. That means that on average for the past 6 years, Class III Milk and Cash Corn prices have been 20% higher or lower than they were just 6 months prior. In addition you will see that sometimes they both move in the same direction, but at other times they do not.
The number one concept for you to consider is that of overall profitability and how these all really affect your business. Aside from the occasional braggart whose agenda is to simply broadcast that he received the top price for milk (despite the fact that he may not mention that he also paid the top price for grain or protein), I think the vast majority of dairy producers are really ultimately most concerned about the bottom line profitability. And while that seems like such a simple concept, market forces outside of your control can add complexity to this.
So that brings me back to the earlier discussion on what you should concentrate on. If you truly want to impact your overall bottom line profitability you must consider all components that contribute to that result. In its basic form, it is all your revenue minus all your expenses. Obviously the largest revenue item for nearly all dairy producers is milk revenue and the largest expense item is feed, followed by a number of other operating expenses. Nearly all of those other expenses, such as labor, utilities, veterinary and medicine are relatively stable unless your herd size is changing. Therefore, in most cases those expenses can be estimated with a relatively high degree of certainty, which leaves milk and feed prices as the most volatile. But most of you already know that. The main point here is that if you only concentrate on milk prices, and completely ignore your feed costs, you very likely may miss out on maximizing your overall goal of bottom line profit. Likewise, if you only concentrate on feed costs and ignore milk prices, the same thing could happen. These two areas work together and when you concentrate on both simultaneously, whether you realize it or not, you are executing price risk management.
We need only to look back to 2009 for some real life examples. For most dairy producers 2009 was a terrible year which resulted in major losses, significant deterioration of equity and the corresponding stress that comes with that. Would it surprise you that some dairy producers actually had a very good 2009? Please see Chart 3 for an overview of the Class III Milk prices that were available for hedging 2009 production, along with the final actual Class III Milk price for each month of 2009. This shows that on average for the year, there was an opportunity to lock in milk prices at $8.53 per cwt. above the final actual Class III Milk. Producers that had properly managed their price risk and entered into hedges to lock in their milk margins for 2009 during 2008 realized significantly higher milk margins for the entire year than those who did nothing. The majority of this was from higher milk prices offset by slightly higher corn prices that would have also been prevalent at that time, as those decreased slightly from 2008 to 2009. Chart 4 shows an estimate of the lost margin opportunity for various sized dairies.
Long Term View
Dairy farming is a long term occupation. It is not something you expect to do for 6 months or 1 year. There are many facets of the industry that incorporate a long term view; including building design and construction, site plans, permits, family succession planning, herd genetic advancement and the corresponding financing to make it all happen. These are important components to ensure that dairymen have the proper infrastructure to continue in the industry. With so much at stake with these long term commitments, taking an active role in ensuring the viability of the dairy’s financial health through active price risk management may seem logical; especially with the volatility discussed above. While some dairymen have implemented an active price risk management strategy, others have been on the sidelines for various reasons. In discussions with those dairymen the leading reasons are: 1) they do not have the proper information and systems to implement a price risk management system, 2) they either do not understand the various parts of price risk management or get overwhelmed by discussions with industry financial experts and/or 3) they do not have access to an easy to use program which can provide them the appropriate information in an accurate, reliable manner to make decisions in a timely fashion. My discussions with many of these dairymen indicated they would participate more actively if these areas could be addressed.
Development of the MARGINSMART Solution
Lake Breeze Dairy is a 3,000 cow family owned dairy in Malone, Wisconsin and one of my customers. As I discussed price risk management strategies with Brian Gerrits, financial manager for Lake Breeze, he told me they struggled with having the proper systems in place to do this. In the past they had hired various commodity brokerage firms, reviewed the LGM templates created by the University of Wisconsin and investigated other various programs offered by different companies in the industry, but never really found anything that did exactly what they needed, much less did it specifically for them with their exact set of circumstances. He also told me that Lake Breeze wanted to get involved in price risk management because they had adopted a long term view of their participation in the dairy industry. Brian also stated that he had heard a lot of industry professionals talking about income over feed cost, milk margin and these topics, but no one had a product that fit his needs to actually do anything about it.
That was all I needed to hear! I simply said, it if doesn’t exist today we will design it and make it happen. My roots grow deep in dairy and agriculture. I grew up on a dairy farm in Wisconsin and have always been driven by the pursuit of innovation and a challenge. When I graduated from high school and our main farm wasn’t large enough to include me because my older brother was already in partnership with my father, I asked if I could start my own dairy herd in our second barn where the heifers were housed. So, starting with 10 cows and working up to 35 head, I spent my college career waking up at 2:30am, milking cows for a neighbor, milking and feeding my herd (in buckets – no pipeline), commuting an hour to college and then reversing everything in the afternoon and night. While this meant very little sleep, it did allow me to gain a first-hand understanding of financial management (especially since I purchased 100% of my feed and endured the high feed costs of the 1988 drought) and allowed me to graduate from college without the benefit of any grants or student loans. My dairy farming career also included a real eye opening experience. While my dairy was small I still received visits from nutritionists from several local feed mills inquiring about my business. At one point I completely caught every one of them off guard when I asked them to give me fixed prices on my protein and mineral mix for a six month period. I had simply taken my rations, and based on my expected cows and milk production, I had already calculated my needs in quantity for that six month period. I heard “We have never heard of, nor done that before.” from every one of them. I didn’t let that deter me, so I simply explained that that is what it would take to get my business and I got it done with one of them. While I can’t say that was the first fixed price protein mix contract in the United States dairy industry, it certainly was in that part of Wisconsin. Now around 20 years later these contracts are so commonplace that it is hard to remember what it was like without them.
With a poor dairy outlook, no room for me on our home farm and an accounting degree in hand, I ventured out to a career continually tied to dairy and agriculture. I spent 6 years working for a large commercial bank in the agricultural lending world. This experience taught me that dairy is only a part of the overall agricultural landscape in the United States. I worked with companies in over 35 states across the country with the majority of them being large scale producers or processors. Since I was in charge of risk management of a loan portfolio in excess of $1 billion, I needed to very quickly understand the price risk management strategies employed in all these industries which, in addition to dairy farms, encompassed grain elevators and merchandisers, some of the largest beef feedlots and hog producers in the country, beef processing plants and rice processors to name a few. Since my passion has always been in agriculture I learned more during this period of time in my career than all my years at college combined. I gained an understanding of how each agricultural industry affects the other, and in addition to mastering price risk management concepts, I also saw it from the perspective of a lender to add to my view as a dairy producer.
One day out of the clear blue I received a call from Packerland Packing Company, a beef processing company based in Green Bay, Wisconsin with 4 plants across the United States and a borrower of my bank offering me a position in their management. At the time it was privately owned (eventually it became Smithfield Beef Group) and I accepted the position to be able to work in private business again and make a direct impact on a company’s bottom line profitability. During my seven plus years I continued to receive promotions and take on increased responsibility which culminated with me being the Executive Vice President of this company which had annual revenues of over $3 billion. My main responsibility was making strategic decisions to make the company profitable in an industry that in my opinion is subject to more price risk than the dairy industry. We consistently were the most profitable large beef packer (on a per head processed basis) in the United States during my tenure there. With the need to source over 7,000 cattle each day in all parts of the United States with prices changing by the minute and then having to also process those cattle into various cuts and sell into markets (without any guaranteed outlet) where the prices also change by the minute it made for some very interesting price risk management decisions. I also oversaw all business development which included the acquisition of a 50% interest in the largest cattle feeding company in the world. At one point Smithfield had financial price risk on over 700,000 head of cattle, and I had responsibility for the price risk management decisions on feed and cattle prices.
When Smithfield sold its beef division, I decided to start my own certified public accounting practice to concentrate on serving customers ranging from production agriculture to grain elevators and processors. For the past four years I have worked closely with companies in these areas to create meaningful business solutions to increase their profitability which includes managing price risk.
So when Brian Gerrits asked about a way to manage price risk for Lake Breeze all of my prior experience led me to tell him - no problem we will build it! So we collectively designed and developed a program for Lake Breeze and quickly realized that this was something the entire industry could use. But we agreed we would only do so if we could provide it in an independent format that could work for operations of all sizes. That led us to form Dairy Analyzer, LLC and contract with a professional software development company to create MARGINSMART.
The program is completely customizable for each and every user. It has four different user permission levels so a dairy owner can choose what everyone will see. (See Top Exclusive Features of MARGINSMART on page 21) Multiple users can be in MARGINSMART at the same time which enhances conference calls to discuss your dairy’s information and results. It incorporates the exact feed ingredients for every ration fed to the herd along with the corresponding headcounts and milk production per day. Users have the ability to include any fixed price and futures contracts, along with all home grown feed and all operating costs. But, it adds specific touches to account for shrink, dry matter percentages, valuing grown feed at cost or market and allows every user the ability to enter their exact basis for milk, corn, soybeans and soybean meal. All milk, corn, soybeans and soybean meal prices from the CBOT and CME are continually updated throughout the day and immediately update all margins and bottom line results so users have timely information to make decisions. As described in the Top Exclusive Features on page 21, it has a robust target and text feature along with a comprehensive financial reporting system to provide users all the key information they need to manage their business.
Now Brian Gerrits states “We have implemented MARGINSMART on our dairy and it has made an immediate impact. We now know at any time during the day what our milk margins and general profitability opportunities are. MARGINSMART is now the most important tool we have in managing our price risk and profitability. It has exceeded my expectations.”
We think you will agree. Ryan Studnicka, MARGINSMART’s Director of Marketing and Business Development and a former member of AttenBabler’s margin management team says “The flexibility, customization, ease of use and overall comprehensive features of MARGINSMART are truly unique and unmatched in the dairy industry!”
Contact us at 877-474-7589 or firstname.lastname@example.org for a free demo to see just how MARGINSMART can work for your dairy.
Mark Linzmeier is a Certified Public Accountant (CPA). Linzmeier was raised on a 75 cow dairy in Northeast Wisconsin. He received his Bachelors of Science degree in Managerial Accounting from the University of Wisconsin – Green Bay. He earned his Certified Public Accountant designation in 1992 and just recently completed his 20th year as a CPA. Linzmeier has a unique perspective on price risk management and its application to the dairy industry as he has spent 5 years owning and managing his own dairy operation. During his professional career he spent 6 years in large scale agricultural lending for FBS Ag Credit, Inc. (also known as US Bancorp Ag Credit, Inc.) which had production and processing borrowers in dairy, grain merchandising, beef feeding and processing and various other agricultural industries in over 35 states across the country with loans up to $250 million. Linzmeier was Executive Vice President and spent over 7 years in executive management of the Smithfield Beef Group which had annual revenues of over $3 billion and was the fifth largest beef processor in the USA and the largest cattle feeder in the world. His main responsibilities included the projection and attainment of day to day profitability in a highly volatile commodity industry, all mergers and acquisitions, all cattle carcass yield determinations and measurement and price risk management of the cattle feeding operation.
Currently he owns Linzmeier Business Solutions, LLC, a certified public accounting firm in Green Bay, Wisconsin that specializes in working with dairy producers and related agricultural companies across the United States. He provides audit, tax and business valuation services, as well as overall strategic business advice on improving profitability and processes. In 2012 he co-founded Dairy Analyzer, LLC and was the innovative force behind the development of the MARGINSMART program which is the leading comprehensive price risk management program in the dairy industry. He has also managed his grain farming operations for over 15 years.
Linzmeier can be contacted at either 920-819-0703 or 920-264-9139, or via email at email@example.com or firstname.lastname@example.org.
Dairy Farmers Basic Guide to Price Risk Management Terms
While most can be defined in much greater detail, the following is intended to present a simple definition for various terms.
Milk Margin - What is left from the milk check after you pay all the feed bills and the cost to grow crops fed to your herd.
Income Over Feed Costs – Another name for milk margin so basically the same as above.
Hedging – An action taken to reduce risk.
Speculation – An assumption of risk.
Fixed Price Contracts – Any contract you enter into which identifies the commodity (milk, corn, corn silage, protein mix, etc.), the price and the delivery period and location. You can enter into these on your own behalf and do not need a broker.
Futures Contracts – These lock in a price for a specific future delivery period with exact specifications. Examples include milk contracts on the Chicago Mercantile Exchange (CME) and corn and soybean meal contracts on the Chicago Board of Trade (CBOT). These must be executed through a licensed broker.
Unrealized Gain Or Loss On Open Contracts – The difference between the committed contract price and the current market price for the same commodity with the same delivery date and location. These can relate to either fixed price or futures contracts. An open contract is a contract, or portion of a contract, that has not been delivered.
Margin Calls – Amounts required to be sent to the brokerage firm if the price of your futures contract goes against you (the result of a realized or unrealized loss).
Realized Gains and Losses on Closed Futures Contracts – The difference between the total value paid for a futures contact and the total value received when it was sold.
Price Risk Management – Generally anything that you do to protect the price of milk or any feed inputs.
Basis – the difference between a standardized reported price and the price specific to your farm. For example, if March 2013 corn on the CBOT is quoted at $7.50 per bushel, but based on your farms physical location you have to pay $8.50 per bushel to get corn delivered to your dairy, your basis is +$1.00.
Top Exclusive Features of MARGINSMART
MARGINSMART allows users complete flexibility as it relates to managing their farm data. Multiple individuals can have access to each farm. The program allows four different levels which allow the dairy owner to provide acccess to the individuals with the appropriate safeguards and protocols:
Basic – can only enter basic information, cannot see financial results
Analyst – can enter any information throughout the program but limited report viewing
Nutritionist – can enter and view ingredients, rations, and basic info but can only see feed related reports and not overall farm financial reports
Manager – full access to everything
Target and Text Features
As we developed MARGINSMART, we realized that we needed to provide users with great access to information; especially since we also know that they have farming and other things going on and can’t always be “in front of a computer or tablet”. Therefore, we put the SMART in MARGINSMART so it watches things for you.
The exclusive target feature allows a user to set a target for any electronically traded Class III Milk, corn, soybean or soybean meal commodity contract on either the CME or CBOT. The program has a complete Target tab where the user simply enters the commodity, the month and the percentage of either milk produced or grain or meal needed and MARGINSMART does the rest. It will send a text alert when the commodity hits your desired target, along with the volume of the commodity based on the percentage that you desired. Want to enter multiple targets for the same commodity for the same month at different price levels – no problem – MARGINSMART will also calculate the cumulative average price and volume information for all targets.
The target feature also allows the user to set targets for milk margin and profitability. In the same manner as above the user can identify the month, year, percentage and type of target that they want to hit. MARGINSMART constantly updates all information, including the CME and CBOT market prices to constantly determine your farm’s metrics. When a target is hit, MARGINSMART sends you a text so that you can take the appropriate action under your plan. Under both of these exclusive features MARGINSMART watches things for you 24/7/365!
Text on Demand.
MARGINSMART also realizes that you may want to know what your margins may be at any time, whether a target is met or not, even when you don’t have direct internet access or the time to connect. Therefore it offers several easy to text requests whereby you text MARGINSMART a simple message and it immediately sends your real time margin information to you. This is invaluable for you to keep up with your operation.
Daily Automatic Texts.
Lastly MARGINSMART also knows that dairy farming is very busy. So, we have built in automatic texts that can be received every morning and afternoon which give you real time margin information to keep you apprised of your operation twice a day.
And, if you have multiple farms, you will have each of the above features for each of your farms with a designator that identifies each farm so you can keep everything identified.
MARGINSMART has several special features which allow you to know the following (all on a monthly basis):
Projected milk production by ration and overall
Projected blended milk price after all contracts, hedges and market positions are considered
Projected overall feed usage for all ingredients
Projected price risk covered for milk, grain and soybean meal
Volumes of milk, grain and soybean meal either unpriced or overpriced
Overall milk margins based on all projected milk produced and feed consumed – both in dollars and per cwt.
Overall pre-tax net income – both in dollars and per cwt.