Advice from One Humbled Rancher

During our last RFP Bookshelf Discussion (our monthly book club for alumni) an old copy of a ProfitTips article written by Wally Olson fell out of my Knowledge Rich Ranching book by Allan Nation. Wally Olson is a rancher and Ranching for Profit  alumnus from Vinita, Oklahoma. He also teaches Bud Williams livestock marketing principles. It had obviously been almost ten years since I last read Knowledge Rich Ranching because the ProfitTips was from July 21, 2015. The title was “The Perfect Storm is Here in the Cow Business.” As I reread it, the advice is still absolutely true! I sent it to Wally for permission to run it again with current market prices and a few edits. So here you go:

The Perfect Storm is Here in the Cow Business #2

Wally Olson

I don’t think anyone will argue with me about how high the cattle market is right now, and it seems to keep rising. The current market has caused the relationship of heifer calves to bred cows to cull cows, to move so much that the cow is now the overvalued female. With this change in relationship, it may be time to reallocate capital in different classes of animals by going out into your pastures and inventorying your cow herd. You can then identify the animals that have the most risk of dropping in value (depreciation) over the next few years, and replace them with animals that have the greatest potential to increase in value (appreciation).

Example: A 6-year-old cow-calf pair today has a $3,500 value. In two or three years that same cow could have a value of $1,400 at cull cow price, which is $2,100 of real depreciation ($3500 – $1400 = $2100). If you carried her for three more years, and had three more calves, each calf would carry $700 in depreciation costs ($2100 / 3 = $700). Assume it takes $2 per day to run a cow for a year, that would be $730 cost to carry. When you add the depreciation value lost, and the cost to carry, that is $1430 per cow/calf unit in cost. If a 500-pound calf is worth $3.00 that is $1,500 in value produced, so we are only netting $70 ($1500 – $1430 = $70) per calf in a record high calf market. And that doesn’t even include death loss or open cows that don’t wean a calf.

Here is a visual representation of the cow bell curve calculated in the example above:

Notice the cow bell curve shows the drastic appreciation and depreciation happening within your cow herd depending on their age. In today’s markets, the bell curve suggests selling middle aged cows and keeping more heifers. In some markets the curve is flatter than others, so it is on you to understand your cattle inventory ages and values, and all of your ranch costs.

It is important to know your inventories, as the six year old cows could experience a lot of depreciation. If the three, four, and five year-old cows will maintain their value to next year, their cost would only be the cost to carry at $2 per day. Now you have a calf that is worth $1,500 less the cost to carry of $730 equals $770 net. Once again ignoring deaths and opens.

I believe depreciation is the most misunderstood part of the cow business because ranchers don’t actually write a check for it to be able to feel the value leaving the business. Understanding it can have a huge impact on your ranch sales and inventory values. Cow depreciation is not a straight line calculation and it is not tax depreciation (do not confuse this with tax depreciation!), we are just looking at value changes. The cow depreciation actually shows up in “absorbing” the calf check away. Those are the calves from 6-,7-,8- and 9-year-old cows in today’s market. Eventually, a cow depreciates until she reaches cull price and if you keep raising calves with her, there is no depreciation – only the cost to carry her. Once again, you must know your inventory and your cost to put this principle into practice.

As we look at these high cattle prices and look at all other commodities, there has been a 50% rollback or more in corn and oil. So, when we project a possible rollback of 50% in cattle prices, this $3,500 cow now is really scary. If you roll the cull cow price back by 50%, we are selling $700 cull cows. Now we are talking about $2,800 depreciation. No matter what we do, our inventory value is going to drop as the market moves lower. To mitigate the effects of the drop in the market, you can turnover different female classes to maintain head counts and build some cash in the meantime.

Example: Suppose we were to sell some of the older pairs (by older I mean 6- year-old cows) and keep a heifer calf this fall. By doing this we’ve sold a $3,500 cow and calf and replaced her with a $1,500 heifer calf this fall. Now we have a weaned heifer calf and $2,000 cash. Then we calculate bringing that heifer calf up to equal the cow and calf we’ve sold. It will be 600 days from the day she is weaned until she has her first calf. If it costs $1.50 per day to carry a heifer until she calves, she’ll cost a total of $900. The end result is we gave up a 6-year-old cow, but replaced her with a two-year-old cow and put $1,100 cash in our pocket.

We do not know what the market will do in the future. We do know the relationships between the different classes of cattle we have in inventory on today’s market. As these relationships change, sell what is overvalued and keep what is undervalued, all while building cash and managing our feed inventory. The last thing to note is a little thing called inflation. I am not talking about politics or bad inflation, just the general increase in prices over time. What were your ranch costs in 2015 compared to what they will be in 2025? I bet the difference might give you a heart attack. If we were to compare “record” market prices then and now, what would profit be in the two comparisons?

—

If you’d like to see what Wally is up to and learn more about sell-buy marketing head over to www.ranching.fyi, you can join him Monday mornings for a weekly market pulse.

We would also love to see you in our winter Ranching for Profit Schools. Our schools are a chance for you to connect with a whole group of ranchers and farmers working on their businesses to improve their lives and the bottom lines of their operations.