NEWS for North Dakotans
Agriculture Communication, North Dakota State University
7 Morrill Hall, Fargo, ND 58105-5665
July 22, 1999
Harlan Hughes, Extension Livestock Economist
NDSU Extension Service
Proper timing of heifer retention during a beef price cycle is critical to maximizing long-run beef cow profits. Management strategies that produce more calves in the early years of a beef price cycle and produce fewer calves in the late years of a beef price cycle tend to increase total profits over the complete cycle. This series of Market Advisors alerts readers that my analyses suggest that now is the time for herd expansion. In fact, we are almost past the optimum expansion time. My analysis suggests that the economic value of a bred heifer, entering a herd for the current 1996 to 2006 beef price cycle, peaks in the fall of 1999.
The economic value of a bred heifer today is the sum of that heifer's future annual net cash incomes, plus her final cull market value, discounted back to today's dollars. Sale barn price, more properly called the spot cash market price, tends to be highly correlated with current calf prices. Economic value is based on future prices while spot cash market price is based on current calf prices.
The beef cow industry tends to use the spot cash market price calf price increase in a beef price cycle as a signal for ranchers to hold back more heifer calves. The earliest this signal might come is with 1999 calves. The timing of this increased price signal and the resulting biological lag of when these new heifers finally produce added calves will cause these new heifers to produce their calves on the downward side of the beef price cycle. Instead of increasing long-run cash flows, the traditional wait-for-the-signal-and-then-expand strategy limits and can even lower long-run cash flows.
A more optimum long-run strategy would be to sell (not hold back) the most calves when calf prices are at the top of the beef price cycle and to hold back the most calves at the bottom of the beef price cycle. I am proposing, then, that a better signal for optimum long-run heifer retention strategies is the economic value of bred heifers rather than the spot cash market price for heifers.
So how does one calculate the economic value of a bred heifer? For this example, I will assume that a bred heifer is a 1998 spring-born calf bred in 1999. She is to have seven consecutive calves starting with her first calf in year 2000. There are six recommended steps in this economic calculation. The first five steps will be presented in this Market Advisor, and the sixth step will be covered in my next Market Advisor.
Step I--Preparing a set of planning prices. Due to the cyclical nature of calf prices, today's spot cash market prices are poor proxies for long-run planning prices. I annually publish a set of long-run planning prices for North Dakota that corresponds to the cattle cycle forecasts released by the University of Missouri and Iowa State University's Food and Agricultural Policy Research Institute (FAPRI). Readers are encouraged to use these cyclical planning prices as a starting point for developing their own set of planning prices tailored to their cattle type, location in the country and personal expectations for the cattle industry. These are the long-run prices used in this analysis.
Step 2--Preparing a cash-flow budget for example herd. This example herd includes 166 crossbred cows on a North Dakota diversified crop and livestock farm. In 1998 this herd had an 87 percent calf crop and weaned 489 pounds per female exposed. Steers weighing 565 pounds were sold at weaning in 1998 for $76 per hundredweight (cwt.). Heifer calves sold for a $5 per cwt. price discount to the steer calves. Gross cash income generated was $379 per cow, and cash production expenses were $316 per cow before family living draw. Given this family's $90-per-cow family living draw, net cash income was a negative $27 per cow. The negative net cash flow after family living draw for this herd is typical of what I found in my Integrated Resource Management (IRM) analyses of 1998 beef cow herds. Net cash flow before family living, however, is used to determine the economic value of a bred heifer. In this case, net cash flow before family living draw in 1998 was $63 per cow.
Net cash flow before family living draw is used to calculate the economic value of a bred heifer. Seven net cash flow budgets were prepared for this herd using my long-run calf prices for years 2000 through 2006. Production costs were held constant over this period. Net cash flow after family living is projected to be $106 per cow in year 2000, increase to $136 per cow in 2002 and turn downward to $54 per cow in 2006.
Step 3--Projecting cull salvage value after seven calves. FAPRI also provides long-run projections of cull cow prices, and these long-run prices were used in this analysis. Cull cow prices during the current beef price cycle are projected to run from a low of $30 per cwt. in 1996, to a high of $43 in year 2002, and back down to $36 in 2006. These long-run prices suggest that a 1,200 pound cull cow will sell for $360 in 1996, $516 in 2002 and $432 in 2006.
Step 4--Determining an appropriate discount rate. This herd manager has money borrowed for pasture land at 9 percent annual interest rate. If he did not invest in additional heifers, he could apply that money toward the 9 percent pasture land note. The appropriate discount rate should be this 9 percent interest rate adjusted for after tax. I elected to use an 8 percent discount factor in this analysis.
Step 5--Calculating the net present value of a bred heifer. A simple spreadsheet was constructed to calculate the economic value of a bred heifer. The net income column presents the net cash flows before family living generated in the seven annual budgets for the beef cow profit center. The middle column calculated the appropriate annual discount rate for each year. The right-hand column presents the annual discounted net cash flows before family living. The cull cow salvage value is added at the end of the investment time period and discounted back to today's dollars.
Nominal net cash income is projected to total $1,143 per heifer spread over the seven years. When the appropriate 8 percent discount rate is applied to each year's annual net income, the calculated net present value of a bred heifer is $783. This net present value is the calculated economic value of a bred heifer.
What does the $783 economic value tell us? It suggests that if this beef cow producer paid $783 for this bred heifer at pregnancy check in the fall of 1999, the $783 investment in a bred heifer is projected to earn an 8 percent return on that investment. If this beef cow producer pays more than $783 for this bred heifer, he is projected to earn less than 8 percent return on his investment. If he pays less than $783 for this bred heifer, he is projected to earn more than an 8 percent return on his investment.
In summary, the economic value of a bred heifer today is all of her future annual net cash incomes, including her cull value, discounted back to today's dollars. The economic value of a bred heifer is highly influenced by where in the beef price cycle that heifer starts producing calves. Heifers born during the beef price cycle's low-price phase tend to produce calves during the high-price phase, and heifers born during the high-price phase tend to produce calves during the low-price phase. Given this fact, the spot cash market price for bred heifers is not a good signal for triggering increased heifer retention. Economic value, based on projected future values, is the preferred signal for expansion. My analysis says now is the time.
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Source: Harlan Hughes (701) 231-7380
Editor: Dean Hulse (701) 231-6136
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