A
contract should make provisions for 1) handling and feeding, 2) division of
profit or loss, and 3) marketing of the livestock. When livestock are being
financed for feeding, the lender may want to be included in the written contract.
The contract should state the approximate delivery date and deadline for delivery.
Shrink may need to be mentioned, especially if rate of gain is the system
for paying for the feeding program. Statements about general management practices
or expectations of management should be stated. If livestock are not cared
for properly, provisions should be made for their repossession.
Generally,
the feeder is responsible for the proper manure handling, storage and associated
liability. In unique situations, the contract may need to state which party
gets the hides.
The
agreement should include the type and weight of cattle to be fed. The owner
and feeder should agree on the grade to which cattle are to be fed and the
approximate time of marketing. A clause should be included for low performing
cattle and allow for their early departure.
When
feeding cattle under contract, the owner retains title on the cattle. The
death loss is usually borne by the owner, except for those caused by negligence
of the feeder. Another option is share loss above a certain percentage of
deads. Both parties need to determine whose insurance company will cover
losses due to catastrophe
- Some
feedlots will finance the feed bill for customers, and some will finance
the cattle. However, is not uncommon for the feedlot operator to require
a deposit upon delivery. The deposit will be applied to overall expenses.
Interest rates vary and are usually based off the prime rate.
Partnerships
or Joint Ventures
Another
option to custom feeding is a partnership or a joint venture. This offers
opportunities for cow-calf producers, stockers, feeders and perhaps even the
lender to take advantage of a favorable market situation, and yet spread risk
among more individuals. It is an opportunity for other ag-businesses to increase
their customer base. It is also a viable alternative when lending institutions
are not familiar with cattle feeding or are hesitant about being the sole
institution involved.
A
joint venture may occur when the producer wants to retain part ownership in
the cattle and obtain the management and marketing expertise of another key
partner. If you are a cow-calf operator considering retained ownership, yet
need cash flow, consider selling a portion of your calves to the feed yard
and feeding the rest. The groundwork necessary for undertaking a successful
joint venture would include:
- A
document explicitly stating the terms of ownership
- A
statement of understanding concerning management control
- Guidelines
for responding to changes in the cattle market (?)
- An
adequate pool of capital
- An
analysis of tax consequences for all parties.
- Specifications
for a pre-conditioning program.
Evaluating
a Potential Feedlot Partner
It
is important that the bills received from the feeder provide sufficient detail
concerning what was fed, when it was fed and how the animal was managed.
But correct documentation can only achieve so much. It is also important
to work with a reputable feeder. Visit with neighbors, feed suppliers and
the local sale barn about the cattle feeder. Check out the financial condition
of the feeder. Legal and financial entanglements with a feeder that declares
bankruptcy will often derail any potential profit. You might have your
lender talk to the cattle feeder’s lender. Ask what kind of cattle work best
under their management system. Some feedlots handle mostly yearlings while
others specialize in weaned calves and still others are set up to care for
long-hauled, weaned cattle. It is also a good idea to visit several operations
instead of just one.
Visiting
a Feedlot
Visiting
a lot while cattle are being fed or after bad weather can often reveal much
about a feeder’s ability to manage cattle during key time windows that critically
affect cattle performance. A good lot should be fairly clean and well drained.
Ask how often the pens are cleaned. The water and feed should be clean, fresh
and available at all times. There should be adequate shelter and bunk space
for all cattle in the pen. An astute feeder will put locks on gates and loading
chutes when feeding cattle for other people. Beware if you observe a large
flock of birds or spilled grain; these are classic indicators of inefficient
feed management and increased feed costs. Cattle from different owners should
be kept separate for accurate billing sheets. The sick pen should be kept
dry and well ventilated.
How
to Choose a Feedlot
Cattle
producers are, by and large, a reputable group with well-managed operations;
hence ruling out an occasional substandard operator will not be that difficult.
The more difficult question may be how do I choose among them? Several key
feedlot factors should be considered when making this decision including the
feedlot’s cost of gain, method of selling cattle, payment arrangements and
financing options. Each factor is considered in greater detail below.
Cost of Gain
Since
feed costs often dominate potential profitability, a good place to start is
to compare expected cost of gain. When you talk about cost of gain, it is
important to know how it is calculated. To start with, you need to know if
it is figured on pay weights or in-weights. The pay weight is how much the
cattle weighted when they got on the truck for the trip to the feeder. An
in-weight is what the animals weigh when they arrive at the feedlot. Since
cattle shrink due to transport (see Table 1 for examples), in-weights are
less than the pay weight. By the end of the feeding period, cost of gain
based on the in-weights usually looks more favorable than those based on the
pay weight. In-weights are often used because a feedlot may not know what
the pay weights are.
Feed
yards can estimate the cost of gain on your cattle, but normally cannot
guarantee a cost of gain. From a feeder perspective it is not encouraged because
of the many factors beyond the feedlot operator’s control affect gain (e.g.
weather). This may be the only option where facilities for weighing feed are
not available. Another option under this system is to have a sliding scale
in the cost of gain for various weights of cattle.
Table
1. Time in Transit and Cattle Shrink
|
Hours in a Moving
truck
|
%Shrink
|
Days required
to Recover Pay weight
|
|
1
2-8
8-16
16-24
24-32
|
2
4-6
6-8
8-10
10-12
|
0
4-8
8-16
16-24
24-30
|
A main driver of shrink is
fat composition, which, in turn, is driven by the animal’s age, sex, and type-condition.
In short, fatter animals suffer less shrink because fat contains less water
than muscle. Generally, older cattle have more fat than younger animals,
heifers have more fat than steers of the same age, and larger frame cattle
have less fat than medium frame cattle of the same age.
Feed efficiency is another factor that affects the cost
of gain. Feed efficiency is the amount of feed an animal requires to gain
one pound of body weight. Knowing the cost per ton of the complete rations
is only a starting point for calculating cost of gain because a higher priced
ration may improve feed efficiency and provide a cheaper cost of gain. Therefore,
cost of gain is the more economically important factor to ascertain than the
cost of feed.
Ration costs can be compared three ways:
1.
Expected cost of gain (including
all costs)
2.
Expected cost of gain on a dry
matter basis
3.
Expected cost of gain on a net
energy basis
For evaluating the rations provided by different feeders,
it is best to compare diets on a dry matter basis and on a cost-per pound
of net-energy basis. To calculate these figures using either method, you
must know the ration ingredients and the percent moisture of the ration.
The following example is an illustration of comparing rations on a dry matter
basis:
Feedlot # 1 Ration cost as fed =
$65/ton
Ration dry matter
= $50%
Ration cost, dry matter
= $130 (65/.5)
Feedlot # 2 Ration cost as fed = $75/ton
Ration dry matter
= $60%
Ration cost, dry matter
= $125 (65/.5)
Selling
Cattle for Harvest
At
the start of the feeding period, a market date should be projected. It is
important for the cattle owner to be involved in this crucial marketing decision.
Allowing the feeder to make all the decision regarding marketing may classify
you as a passive investor for tax purposes.
The
cattle or loads of cattle can be sold in different ways. The cattle can be
sold on a live weight basis through an auction barn or direct to the packer.
Selling direct to a packer could involve selling cattle on a live basis, based
on carcass weight/USDA quality grade/-USDA yield grade (e.g. formula/grid
pricing) or by a forward contract agreement. When making this decision inquire
about shrink and who will incur the trucking charges and possible condemned
carcasses. Typically when selling cattle on a live weight basis, the packer
will apply a pencil shrink to the live weight and assume trucking charges
and condemned carcasses. Pencil shrink accounts for the weight loss that
occurs during shipment from the feedlot to the packing plant. Cattle may
remain in the yard for a few days after they are sold. The buyer of your
cattle can pick them up any time. The cattle may remain your responsibility
and not the buyer’s until they leave the yard or until they are officially
“transferred.” Therefore, you will pay for the feed and incur any losses
due to weight loss or death until that time.
You
may feel that you have the type of cattle that can take advantage of actual
carcass value prices. Within this option you may sell on a carcass/dressed
weight basis (in the beef) or on a carcass/dressed weight and grade (grade
and yield) basis. If you decide to sell cattle on a dressed weight or dressed
weight and grade basis, the cattle owner typically pays the trucking charges
and stands the risk of any condemned carcasses but pencil shrink is not a
factor in the agreement. The packer assumes the grading risk if the cattle
are sold on a carcass/dressed basis. You assume the risk/benefit of carcass
grades when cattle are sold on a “grade and yield” basis. Grade and yield
marketing are major factors when selling on a “grid” or formula pricing system.
Carcass weight in critical when selling to a packer.
Payment
Your
receipt of payment can occur in several ways. If you finance everything through
a lender, the packer’s check can go directly to your lender to pay off any
outstanding debt on the loan and then the lender pays you the balance.
The
packer may write two checks: one to the feedlot for their feed and service
and a second check to the cattle owner. If the cattle owner has been paying
a feedlot bill, the check should come directly to the cattle owner.
At
the end of the feeding period, after the cattle are sold, you get a final
“close-out” report from the feedlot. It serves as a bill plus a summary of
the itemization of costs and performance.
Loan
Requirement for Retained Ownership
The search for loan money is not the sole responsibility
of the cattle owner. The custom feeder should be able to direct the cattle
owner to financial institutions that are familiar with cattle feeding. Loan
policies can vary. Some financial institutions will loan up to 70 percent
of the appraised value of the cattle and 75 percent of the feed bill. Cattle
may be appraised when they arrive at the feedlot. A large line of credit
will call for a current financial statement. In order to protect its investment
in the cattle the financial institution may require the cattle owner to engage
in some sort of price protection such as hedging or an option contract. If
this is the first time you have custom fed cattle, the financial institution
may want to send someone to visit the operation during the feeding period.
The feedlot operator may carry peril insurance against
fire, lightning, tornadoes, theft, etc. Full mortality insurance sometimes
is available, but is quite expensive.
A
lender may request some of the following:
Of
an Individual Cattle Owner
- Current
financial statement
- Historical
earnings statements
- Loan
Application
- Trust
agreements (if applicable)
Of
a Partnership:
- Current
financial statement (for each partner and the partnership)
- Historical
earnings statements (for each partner and the partnership)
- Partnership
loan applications
- Partnership
agreement (if available)
Of
a Corporation (LLC/others)
- Current
financial statement (corporation and each shareholder)
- Historical
earnings statements (corporation and each shareholder)
- Corporate
loan application
- Articles
of Incorporation or Organization
- Bylaws
The
feedlot may send all bills directly to the financial institution for payment.
The owner will receive a copy of the bill payment. A computer-generated economic
and animal performance predictor model can be use to illustrate how the cattle
should perform during the feeding period. This service is available through
OSU Extension Animal Science.
Some Precautions
Custom feeding and joint venture projects are viable
tools that should be considered.
Although
retaining ownership and having cattle custom fed offers an opportunity for
increased profits, the practice is not for everyone. You may end up marketing
two calf crops in one year (e.g., a set of finished cattle and the next weaned
calf crop), which can have significant tax implications for those using cash-basis
accounting for tax purposes. You should work closely with your tax professional
in order to evaluate opportunities for income averaging before placing cattle
on feed. The first time you retain ownership the flow of cash back to your
operation can be delayed six to eight months until cattle are harvested.
Discuss your equity position with your lender and see if it matches the opportunity
to retain ownership of cattle.
Feedlot Budget for 600 lb steer
Example Price Your Price
|
1.
Purchase cattle price ($85/cwt)a
|
$510 (85 x 6)
|
|
|
2.
Feedlot sale weight
|
1200 lbs
|
|
|
3.
Estimated days to market
|
200 days
|
|
|
4.
Interest for cattle @ 10%
for 200 days
|
$27.94
($480
x .1/365 x 200)
|
|
|
5.
Death loss at 1%b
|
$5.10
($510 x .01)
|
|
|
6.
Veterinary and processing
|
$10.00
|
|
|
7.
Estimated feed cost
600 pounds of feed at
a feed to gain of 6:1 DMbasis
(600 x 6
= 3600 lbs DM basis)
Feed cost quote:
$5.00-6.00/cwt
DM basis
|
$180.00-$216
(3600 x $.05)
to
(3600 x $.06)
|
*Experiment with different
feed
efficiency numbers and notice its importance.
|
|
8.
Cost of Futures contract at $70
per contract
(40,000
pounds/1200 lb steers = approximately 34 head)
|
$2.05 commissionc
($70/34 hd)
|
|
|
9.
Yardage cost
|
$50
(200 days x $.25/hd)
|
|
|
10.
Interest on operating capital
$140 + $10 + $2.05 + $50 = 202.05
|
$5.54
202.05
x .5d x (.1/365) x 200
|
|
|
11.
Total Cost
|
$790.63-$826.63
+
$1(beef checkoff)
|
|
|
Breakeven
|
$66-$69e
($791.63/1200)
to
($827.63/1200)
|
|
aValue of the calf plus freight charges
b
This value can vary thus you need
to consider feed charges while alive
cYou may want to put a cost for estimated margin calls.
This can vary but generally ranges from $1-2/head.
d Interest on operating capital (at least feed) in this
case is part of the monthly/bi-monthy bill from the feed yard. A rule of
thumb is that we can divide the interest bill in half since the previously
mentioned billings interest will only accrue on a portion of the bill.
eOther cost could be freight to packing plant, carcass
data collection, etc.
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