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HUNTIN' DAYLIGHT -- COMMODITY BUSINESS CONTINUES TO SHIFT

by: Wes Ishmael

Don't be fooled by the historic alignment of supply and demand fundamentals that have helped launch cattle and beef to new trading levels. Fact is, the shift away from commodity beef production toward value-added continues, even though drought and bovine spongiform encephalopathy have conspired to slow the pace by tightening supplies further than they would have otherwise.

For instance, speaking at the recent Visions Symposium hosted by the North American Limousin Foundation, Randy Blach, Cattle-Fax executive vice president explained, his organization expects 70 percent of fed cattle will sell by some means other than spot-market cash transactions within the next 5-6 years. Keep in mind the percentage of cattle trading by means other than cash actually declined last year, and is expected to for 2004.

The fact that non-cash trade remains above 40 percent even during historically tight supplies speaks to a number of factors.

First, consolidation and concentration continue. The top 10 retailers currently control 55.1 percent of food sales, according to Blach. Within the next five to seven years he expects the top five to seven retailers to control 65-70 percent of the market.

Next in line, the five largest packers today harvest 84-85 percent of the annual fed cattle supply. The players may change along the way, but so few harvesting so many is expected to continue.

Currently, 25 cattle feeding organizations feed 40 percent of the annual fed cattle supply. Blach expects that percentage to grow to 45-50 percent within the next couple of years, due to more consolidation spurred on by the investment required to operate in the current and expected cattle feeding business environment.

Unsurprisingly, the number of cow-calf producers continues to dwindle as well; about 785,000 beef cattle operations, according to the last Census of Agriculture.

Rather than resulting from some grand Run-‘em-out conspiracy, Blach points out these structural changes are simply industry response to economic signals that consumers are sending. And those consumers are sending more.

On a per capita basis, Blach explains consumer demand—the industry's willingness to listen and respond to customers—has increased consumer spending $70 higher than a decade ago.

Sure, consumers are eating more beef in general. However, when you consider the fact that average quality grade has remained constant during the past decade, while average yield grade for fed cattle has declined, it's not commodity product leading the charge—it's the kind of value-added products consumers purchase by brand name.

Although Blach says less than 10 percent of beef is traded under a non-store brand label today, he believes marketing products with the promise of a brand holds giant opportunity for the industry.

Snubbed up with a shorter rope, these trends mean that producers in each segment who know more precisely what they're producing, relative to consumer needs, can exploit more market opportunity. Blach points out, that especially during the past three years, price spreads have grown for same-class, same-weight cattle selling in the same geographic region a the same time. He expects these spreads to continue to grow wider.

Identified Opportunity

Speaking of which, a growing number of producers now have the opportunity to ID their cattle in compliance with the nascent National Animal Identification System (NAIS).

You'll recall the goal of this program—so far voluntary—is the ability to track any head of cattle back to all previous locations of residence within 48 hours, all for the purposes of animal disease surveillance and monitoring.

According to Neil Hammerschmidt, USDA's NAIS Coordinator, more than 40 states are either already registering premises for the system or are in the process of doing so. Premises registration is the foundation of NAIS and will be followed by individual animal identification and reporting of animal movement.

What had been frustrating producers who wanted to begin tagging cattle in accordance with NAIS was that for the better part of a year USDA offered no direction. Finally, in November the Animal Health and Plant Inspection Service (APHIS) published an interim rule in the Federal Register (effective November 8), which amends regulations to recognize NAIS's 15-character animal identification number, 13-character group/lot identification number and 7-character premises identification number. With the interim rule in place, producers who want to begin using the NAIS-compliant numbering scheme will be able to do so.

USDA emphasizes the interim rule doesn't change requirements defining which animals must be officially identified, nor does it require that producers use the new numbering systems. Instead, according to APHIS, the rule ensures the new NAIS numbering systems are recognized as official, allowing those who want to use such systems to do so. The system will apply to interstate commerce and cooperative disease control and eradication programs for animals.

Moreover, Hammeschmidt explains the interim rule also means that producers currently using tags with the unique numbers of the U.S. Animal Numbering System or those using electronic ear tags conforming to standards set by the International Committee on Animal Recording will be able to grandfather these numbers into NAIS. That's contingent upon the operation already having a premises registration number.

Growing Potential Tomorrow and Beyond

Currently, it may be tougher for buyers to apply discounts based on the lack of identity because of historically tight supplies. Even though the tightest cattle supplies are behind us, Blach says they'll remain snug.

Bottom line, Blach expects calves (basis 500-550 lb.) to trade in the range of $90-$1.25/cwt. for the remainder of the decade.

If demand holds together, fed cattle should also continue to trade along the higher plane established the past couple of years. Blach says fed cattle prices will wind up averaging $84.50/cwt. this year. If the industry had to trade cattle into a market with the same consumer demand as in 1998 (when industry fortunes finally began to change) Blach says fed cattle this year would have averaged $62.51.

Finally, as herd expansion begins, and it has, Blach cautions producers to keep in mind the closed Canadian border and the cattle inventory up there mean that when trading resumes, the U.S. will actually be further along in the expansion phase that some may be banking on currently. He expects Canadian trade to resume in the first quarter of 2005.

Of course, if U.S. beef exports to Japan resume, all bets may be off on ID-based discounts. The current negotiations have the Japanese ready to accept U.S. beef as long as it is from animal 20 months old or younger. Whether or not that comes to pass is yet to be seen. However, if it does, the safe money says that records verifying birth will be required for eligibility. The same money also says that this export market is too valuable for any of the major packers to ignore supplying it.

ID aside, what's the market want? Basically, the same thing it has wanted for at least the last decade: carcasses that will quality grade no worse than Select, yield grade no worse than 3, with a hanging weight that doesn't incur discount, from cattle that consume enough to gain enough, efficiently enough to make them worth owning.

Arguably, the crux of everything mentioned here is that vertical cooperation will continue to grow within the industry because economics dictate that it must. In an effort to differentiate themselves retailers will continue to focus on the beef case. But, with Wal-Mart already having won the price battle, the rest are left to differentiate themselves on other beef characteristics. In short, they will continue to want more branded beef products with the consistency and promise they can back up to customers. That means they will continue to work more closely with packers who can ensure them a consistent supply of products that consistently comply with narrower specifications. In turn, these packers will continue to work more closely with feedlots that can ensure them a steady supply of cattle, which allow them to hit the narrower specs. These feedlots will work more closely with cow-calf and stocker operators who can provide them the cattle that fit the narrower window of customer demand.

More than just have the potential to meet these narrower specs, each segment will expect more documentation from suppliers verifying the genetic, production and management that will allow cattle and beef to fulfill the potential. That begins with identification that can be tied to such verification.

The good news in all of this is that what used to be only a commodity business can also be a thriving one based on increased value.

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