Dairy producers say risk management takes time, planning, daily involvement

Producers share priorities, experiences during risk management conference

A panel of producers during the Center for Dairy Excellence Risk Management Conference last week agreed their top priority is stabilizing input costs, especially feed, is the first component to any dairy risk management strategy.

HARRISBURG, Pa. — How are dairy producers navigating the rapidly changing dairy markets? A panel of Pennsylvania producers shared during the 11th annual Center for Dairy Excellence Risk Management and Financial Conference, conducted ‘virtually’ by Zoom in September with an audience each day of over 100 people, most of them dairy lenders and consultants.

“Risk management is important, but it takes planning,” said Mike Hosterman of AgChoice Farm Credit, moderating the panel comprised of Mark Mosemann, who farms with his father and brother milking 450 cows at Misty Mountain Dairy, Fulton County; Glenn Kline, who farms with his two sons milking 600 cows at Y-Run Farms in Bradford County; and Rod Hissong, who farms with his brother milking 1600 cows at Mercer Vu Farms in Franklin County, Pa. and 1200 cows at their satellite dairy 65 miles south in Whitepost, Virginia.

Polling the audience, Hosterman revealed a low percentage of lenders see a risk management or marketing plan from clients.

All three producers put a big emphasis on the input side of the margin since 2012. Some common themes and priorities emerged.

Stabilize feed costs

The 2012 margin squeeze caught many producers by surprise as milk prices skyrocketed and feed prices went wild.

After that happened, all three panelists aimed to expand their land base through ownership and especially rented ground to produce all of their own forages and a portion of energy and protein.

They also increased inventory capacity to buy and store feed commodities and do risk management with local feed mills.

By stabilizing feed costs – the largest input cost on the dairy – they are positioned to operate the business, plan for the future and think about risk management opportunities on the milk side.

Hissong noted that their expansion with a satellite farm in Virginia was also a hedge on the future in terms of the next generation. The brothers will be able to downsize or upsize depending on how the future shapes up for sons, daughters, nieces and nephews because they invested in two sites, not expanding into one larger site.

Value of networking

“Don’t underestimate your networking capability,” said Mosemann, who described how this enabled his family to acquire rented ground and work with others in custom harvesting and feed inventory.

For Hissong, relationships on buying forage changed to relationships in acquiring ground. 

They also brought more pieces under their own management, now raising their own dairy replacements and hauling their own milk.

The satellite dairy allows the Hissongs to manage weather risk on the feed side and to set up their cow flows to gain labor efficiencies in operating the dairy. Baby calves are raised at the home farm and go to the Virginia site when bred. They stay there through gestation and calving and for milking through first, sometimes second, lactation.

Kline and Mosemann both purchase some inputs collectively with other farms, which is a risk management strategy more producers are using to stabilize costs today. They also work with other farms in custom harvesting and trucking.

Relationships with feed mills offer additional opportunities to manage risk, and relationships with the nutritionists, veterinarians, and financial advisors bring ideas to the farm.

Two ways to breakeven

All three producers use their farm accountants to do both a cost of production analysis as well as cash flow analysis to come up with a Class III price that meets their farm’s breakeven price in both scenarios, including the cost of the risk management.

That’s essential because producers can’t afford to pay for risk management that doesn’t secure breakeven or better.

“We take the COP analysis and come up with a gross milk price. We calculate our basis into that and look at the Class III price that is required for us to break even,” said Mosemann, explaining that a separate cash flow analysis, with net income offsets, calculates a final Class III price target. “That’s what we use to measure against when deciding what to buy, and our goal is to come out of it with a net price above the net breakeven.”

Even armed with this knowledge, relying on the Class III breakeven method has become a challenge today with the inverted basis from negative PPDs.

While the basis on milk in the East has declined rapidly along with the declining Class I milk utilization over the past decade, at least it has been relatively stable and could be plugged into a Class III breakeven strategy at an approximate level.

However, in the current market, a “Class III breakeven” is much more difficult to calculate because the basis is all over the place and mostly negative. Looking out at risk management for the next six to 12 months is frustrating even for those who have been doing this for a while.

Hissong observed that their strategy changes with conditions, but a key to making it work is to keep their variable costs “fairly flat” from one quarter to the next.

“We are not trying to ‘guess the market,’” he explained. “We are trying to gather information and make an educated decision. We are trying to protect the breakeven.”

Watching it daily allows him to adjust using other tools through the cooperative. Forward contracting through the cooperative means no margin calls, but Hissong noted that, “Once you take a position, you are locked into that position.”

Having both Class III and IV contracts helped because where they lost on Class III because it went higher, they gained on Class IV because it went lower.

Layered approach

All three producers use a layered approach. They don’t put all their milk in one basket and they don’t necessarily cover all of their milk.

They start by using the Dairy Margin Coverage (DMC) on the first 5 million pounds of annual production. 

Each farm on the panel also forward contracts with their respective cooperatives, and they use more than one tool offered by the cooperative. They have also used Dairy Revenue Protection (DRP) on a portion of their milk in a few quarters where it made sense.

Dedicated person

It is essential to have someone within the farm ownership core who manages the strategy and is looking at it every day, the panelists said. This is not something they do and then forget about, or hand off to someone else.

“You’ve got to be passionate about it. It takes a lot of time, and you’ve got to look at it every day. So that means someone has to have the time to do it, and enjoy doing it,” said Kline, who does the risk management at Y-Run.

For Mercer Vu, that person is Rod, and at Misty Mountain, it is Mark’s father.

Kline says he is able to do it because his two sons are doing the other things in the operation. “This gives me another perspective in the operation of the business to work on,” he explained.

“This is such an important part of our bottom line, so we believe we have to be more involved in it,” Hissong said. “The first thing to know is COP, so we know what price to protect. We have to know what is a profit. We do cash flows and budgets with Mike Hosterman and work with Acuity to do quarterly accrual-based accounting so we can calculate-back our breakeven through Class III and basis.”

“Risk management is not always successful,” Mosemann acknowledged. “But our strategy is to get base-hits, not a grand-slam homerun. If we can get on base and stabilize things, then we can plan. Risk management is now a cost of doing business for us to protect against the volatility we see.”

All three producers said they tap other resources for information in addition to those they work with on risk management.

Difficult environment

The current market environment is a difficult one in which to execute a risk management plan.

These producers do their homework, develop their strategies, layer their tools, know their breakevens, know their goals, watch the markets, work with their team — but still find it difficult to know over the next six to 12 months when to pull the trigger at what looks like a breakeven forward contract or price floor due to the unknown and negative basis relative to Class III.

Each producer said they would participate in more risk management right now, but it’s difficult to assess a breakeven level because the tools based on CME futures do not match up with how their farms could ultimately be paid for the milk in those future months. 

Without knowing how their cash price will perform in relation to the futures price, it’s hard to commit to a strategy that worked in the past, so new thinking is needed. The producer needs to have a handle on what to do about basis. Will the farm’s cash price move in the same direction as the futures, and by what margin of premium or discount will the cash price move? This is part of the decision making when working through a plan.

Using advisors

All three producers mentioned working with their farm and financial advisors as a key to risk management. They see lenders starting to require some level of risk management and foresee this being part of lending packages in the future.

A little bit of everything

From renting more ground and networking with others, to contracting feed, creating inventory, running cost of production, budget and cash flow analyses and using multiple tools from DMC and DRP to forward contracting, these dairy producers say a little bit of everything adds up to some base-hits to keep margins in a zone where they can operate the business and plan for the future.

“With the way the last four to five years have been, and seeing how politics and a global pandemic can turn everything on its head, if we are looking to purchase land or expand for the next generation, we better have risk management in place even if the lender doesn’t require it,” said Kline.

Hissong added that, “We continue to see our industry change. For those actively wanting to be in it and see a future in it, or if they have to work with someone to make a go of it, risk management will almost become mandatory.”

At the same time, he observed that the government CFAP payments and dairy product purchases add another ripple.

“The CFAP payments changed the balance sheet for us, and they were definitely needed from the perspective of our dairies coming out of a rough spot and scary time,” said Mosemann.

At the same time, noted Hissong, the government involvement has an effect on the market “when trying to figure out market signals and trying to figure out what to do in 2021.”

With milk class and component pricing relationships in turmoil from pandemic disruptions and government intervention, risk management is more difficult to do right now. 

Even so, these producers would encourage others to take this time to learn more about it, to work through their numbers and work through some scenarios to be prepared to implement risk management at some level in the future.

— By Sherry Bunting, Farmshine, Sept. 25, 2020

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