Marketer: Highway 21 Feeders, Carbon, Alberta

Overview of the Business

Highway 21 Feeders is a 20,000-head beef feedlot owned by the Miller family, located approximately 100 kilometers northeast of Calgary, near Carbon, Alberta. The feedlot was established in 1979 by Ed and Linda Miller who added the feeding enterprise to an already established cow-calf operation. Since that time, it has grown steadily and is currently one of the top 20 feedlots in Alberta. The operation now includes the next generation of family members listed as follows: Lee Miller, Production Manager; Lyle Miller, Marketing and Sales Manager; and Shannon Miller, Manager of Animal Health.

The operation itself is a combined ‘owned’ and ‘custom’ feedlot which feeds cattle owned by the Millers as well as providing ‘cattle feeding’ services to a range of customers. In this regard it charges a ‘per-head per-day’ fee to house and feed cattle from the time they enter the feedlot until they are marketed. The proportions of cattle that are custom owned versus owned by the Millers will vary depending on such factors as customer demand, market conditions etc.

  The business of feeding cattle comprises the following fundamental elements:

• The provision of feeding facilities – typically the feedlot consists of a receiving area for incoming cattle; a series cattle pens and feeding alleys; feeding bunks; and a feed preparation and storage area.
• The purchase of calves and/or feeders from cattle producers, auction markets or agents (brokers and cattle buyers).
• The feeding of cattle to desired market weights – these weights will vary depending upon the strategy of the individual feedlot. Some feedlots will finish all cattle to final-market weights direct to packing plants. Other feedlots will market some or all cattle at weights below market (also known as background cattle) to other feedlots that in turn finish these cattle to final market weights.
• The marketing of cattle. The actual marketing strategy will also vary based on the previous point.

The objective of the feedlot is simply this: to sell cattle at prices that exceed the purchase price of the cattle, feeding costs, handling and other operational costs. However straightforward this may appear, the reality is much more complex. At any one time, a host of variables are at play including fluctuating daily cash price; futures prices; feed grain prices; currency risks to the extent that the Canadian price and market for cattle is U.S based and basis risk – namely the difference between local prices and prices at other locations. Note: basis risk is discussed in more detail in the following section.

It should also be noted that the Alberta beef feedlot sector has undergone profound change over the past 20years. Structurally, the industry has experienced massive consolidation at both production and processing sectors. For example, two large packers (Tyson Foods and Cargill Foods) dominate the market – each company operates world scale plants located in the southern part of the province. These two companies account for more than 70% of all the processing capacity in Canada.

Within the feedlot sector, less than 20 feedlots account for over 50 % of market cattle. Generally speaking, the feedlot has several marketing options. It can sell to the packers located in Alberta; or it can sell to one of five major packers located in the U.S. Every week, large numbers of live cattle move to be slaughtered in the U.S. depending upon the prices being offered in each market.

Marketing Strategy

The Miller’s marketing strategy can be described as sophisticated and is based on experience, insight and extensive market knowledge. First and foremost, the Miller’s state without equivocation that marketing is key to the success of their operation. Their approach is guided by two key principles:

1. A commitment to determining where the margin within the cattle business is being made and buying/selling accordingly. Note: the ‘location’ of this margin opportunity is constantly subject to variation.
2. The basis[1] risk is greater than actual price risk. This means that the difference in the prices paid locally and what is being offered in the U.S. market is greater than the risks associated with actual price variations. This is known as the basis and accordingly, the variation is known as the basis risk.

To appreciate these principles, it is necessary to have a fuller understanding of the complexities of the North American beef market. Firstly, it must be noted that the market for beef (and therefore cattle) within Canada is hugely influenced by U.S. market conditions because Canada is a major supplier to this market. Secondly, several simultaneous factors are constantly occurring – namely price of local feed grains which impact the profitability of feeding cattle; consumer demand; seasonal price cycles; to name just some of these variables. Finally it must be understood that the prices being offered by the major packers within Alberta are often lower than the relative net cash price that could be received from a U.S. based packer (net is defined as selling price less cost of shipping and handling). This variation can, at times, be significant and most often occurs seasonally depending upon packer buying patterns. That being said, U.S. packers are well aware of the differences between the prices being offered in Canada vs. prices being offered to U.S. based feedlots. Consequently, they may offer bids for Canadian cattle that will result in a slightly higher net cash price compared to the local price, but these may not be as high as what is being offered in their local U.S. market. The aggressiveness of the U.S. bids depends on the availability of local supplies.

In other words, it is imperative to understand the flows of cattle within the system, the differing conditions and where the best opportunities may lie to earn a positive margin between ‘the buy’ and ‘the sell’. Thus, Highway 21 Feeders is not locked into one system of buying cattle at one weight and simply selling finished cattle at market weight. Rather, they constantly monitor the market conditions for differing weights of cattle and will buy or sell any weight depending upon the opportunity.

Marketing History

Highway 21 Feeders marketing history is rooted in experience and the product of overcoming numerous challenges. It began with Ed Miller’s start as a cow-calf operation in the early 1970s when times were optimistic and rapid expansion was the norm. However, within a very short period of time, prices fell more than 50% (from a high of 80 cents per pound to 35 cents per pound). The result: a hard lesson in financial management and the need to develop a much greater understanding of the industry.

Significantly this experience has changed how the Miller’s have run their business ever since. Ed Miller acknowledged that during the 1970’s, he knew little about the beef market and was not aware of something as basic as the ‘cattle cycle’ – the 10 year period during which the cattle numbers expand and contract before the cycle begins to repeat itself. As a result of this experience, Ed committed to learning everything he could about cattle markets, cycles, margins, basis, and price discovery. His key insights include:

• An understanding of the basic 10-year cattle cycle – as a consequence, he bought cows and expanded his herd when prices where low and sold them when they were high. The Millers have executed this strategy twice over the past 20 years having just recently exited the cow-calf sector completely.

• The identification of a yearly price cycle for market cattle – an intense study of pricing trends illustrates that within a set number of weeks, prices typically rise whereas during another set of weeks, prices generally decline. This guides the buying and selling patterns for both feeders (incoming) and market-weight cattle (outgoing).

• The realization that government support programs typically distort markets and thereby create opportunities – For example, under the National Tripartite Stabilization program in the early 1990s, Ed observed that the prices offered by packers during the latter two weeks of the month were substantially lower than during the first two weeks of the month. Thus, he began to buy market-weight cattle at prices that were higher than what was being offered by the packer, contracting these cattle for sale into the U.S. for delivery in 1 to 3 weeks. At the same time, once a contract was established, he would establish a hedge contract thereby protecting him from any change in prices.

• The observation that competitive bidding on the part of U.S.-based packers offers better pricing than what is being offered locally. This has led the Millers to be part of a new group of beef producers known as the North West Consolidated Beef Producers[2] – a marketing organization dedicated to the establishment of improved price discovery processes in the North American beef industry.

Consequently, Highway 21 Feeders is constantly buying and selling cattle in response to opportunity. In fact, incoming cattle may vary anywhere from 200 to 1,400 pounds in weight depending upon the buying opportunity. To quote:

“ When the pen is empty, this is an opportunity to fill when the price is right.”

Perhaps, the abiding philosophy at Highway 21 Feeders is best epitomized by the followed statement:

“ When the opportunity is nowhere, we see the opportunity is now, here!”

This means studying the market, evaluating cash and futures prices, calculating the basis and establishing a “basis contract”[3] if the basis contract being offered is deemed favourable compared to the estimated seasonal cash to cash basis. These decisions enable Highway 21 Feeders to buy cattle at prices where a target margin is assured upon sale. Thus the role of the Marketing and Sales Manager is to constantly monitor several variables including:

• Yearly cash price trends;
• Futures prices and price trends;
• Basis between U.S. and southern Alberta markets;
• Local feeder prices;
• Price of feed grains;
• Exchange rates;
• Freight rates;
• Estimated yields and grades;
• Grading premiums or discounts; and
• Proportions of cattle receiving premiums or discounts.

The above combination of variables is used to calculate the equivalent Canadian rail price and in turn the calculated Canadian basis cost. This close monitoring involves a constant review of how futures prices are moving relative to cash prices. Strategies will vary – sometimes Highway 21 Feeders will establish future basis contracts if futures prices look favourable relative to cash prices. Other times they will sell only on the cash market if futures prices look less favourable than cash prices. In summary, Highway 21 Feeders uses several tools but their fundamental strategies are based on market information, analysis and experience.

Key Information Sources/Influences

The Millers use a variety of information sources including the Chicago Board of Trade, beef industry sources such as Cattlefax and Canfax, commodity brokers, auctions, packers etc. However, they have also had a long-standing relationship with a futures broker who they work with to take positions in the futures markets. Highway 21 Feeders is in fact committed to using professionals. To quote:

“We hire experts who can take us to the next level.”

In addition to brokers, the feedlot hires veterinarians for animal health expertise; nutritionists to oversee the feeding programs; agronomists for field-crop management.

Key Challenges

The challenges facing Highway 21 Feeders comprise a mix of micro factors as well as several major macro factors that are industry wide. On the micro front, the biggest challenge is keeping current on prices, basis, local conditions, etc. This requires discipline and constant contact with key sources of information including brokers, packers and other industry information sources such as Cattlefax and Canfax.

The bigger challenges facing Highway 21 Feeders are in fact industry challenges. A major issue facing the beef industry is competitive pricing and competitive price discovery. As pointed out earlier, the beef industry is characterized by many sellers and few buyers. This is particularly the case in Canada where two major buyers in effect dominate the market. This creates a situation of market imbalance and a continued tension between the sellers and the buyers since market knowledge and transparency are not equally shared. This has led to the formation of the Consolidated Beef Producers in the U.S. with the objective to create a critical mass of producers in the supply of cattle in a more competitive trading environment. The Canadian wing is known as the North West Consolidated Beef Producers with the primary purpose to extend the philosophy and the capabilities north of the border. Currently approximately 3,000 head per week are being assembled by this group – cattle are being marketed in the U.S. and Canada on an ‘ask’ basis. In other words, Consolidated Beef sets a price and then seeks buyers at that price.

The Millers made a very important point:

“Our competitor is not our neighbour. If we get a better price, that is not our objective. Our real competitor is the lack of competitive buying for our finished cattle in Canada compared to Canadian cattle that are finished in U.S. yards. If we don’t overcome this challenge for ourselves and our neighbour, our whole industry is affected and we risk the loss of business activity such as cattle feeding, processing and value-added product development in Alberta and Western Canada.”

Lessons Learned

The Highway 21 Feeders case provides a cursory insight into the complexities, opportunities and challenges of the beef commodity market with North America. The case offers numerous lessons that can be directly or indirectly applied to commodity producers operating in a variety of sectors. The lessons are listed as follows:

1. Know your market – this point can not be stated strongly enough. Clearly, Highway 21 Feeders success is the result of experience and most importantly a commitment to knowing the intricacies of the beef market in every way. They observe that many producers seem reluctant to learn when the opposite should be the case.
2. Understanding price and costs – a key lesson learned from this case, is the complexity of pricing and the options that producers may in fact have before them. In other words, the local price being offered is never the only option or the actual price that can be realized. This requires contact with other markets and the ability to seek out more options than may be apparent. This is particularly the case should the difference between local prices and prices offered at other locations be excessive. At the same time, it essential to fully understand your costs and have an effective cost accounting system. This is critical to knowing what price you need to achieve to earn a positive margin.
3. Understanding basis – Highway 21 Feeders is an excellent example of the importance of understanding ‘basis’ and ‘basis risk’. This builds from the previous point and speaks to the abiding principle guiding this operation, namely the recognition that basis risk is greater than market risk.
4. Studying margin opportunities – two factors are key to success in the commodity market: (1) volume; and (2) margin. In the case of cattle, margins opportunities are always shifting – these may vary from buying calves; selling calves; buying feeders; selling feeders; buying market-weight cattle; selling market-weight cattle; selling/buying in Canada; selling/buying in the U.S. In other words, the opportunities are always shifting but they are always there. The challenge for the operator is to find them and to take advantage of them.
5. The Opportunity is now, here – perhaps the biggest lesson to be learned from the Highway 21 Feeders case can be summarized by this statement: “The opportunity is now, here.” But to find the opportunity takes commitment, information, analysis and courage.
6. Using experts – the Millers recognize the importance of learning and using experts who are current in their respective fields. In this regard they use brokers, nutritionists and agronomists. Clearly they have developed relationships with these professionals and trust their recommendations and judgment.

Advice to Other Producers

The Millers offer several points of advice to other producers:

1. Study your markets – there is no substitute to knowing your markets in great detail.
2. Work hard – further to the previous point, studying takes commitment and hard work. But there is no other way. And you can never know too much.
3. Learn where the margin is being made – this determination provides the basis for the buying and selling opportunities. And it needs to be done on a constant basis since it always changes.
4. Out-hustle the hustlers – thriving in a commodity market is all about out hustling the hustlers. This is not a market for the timid. You have two choices: (1) be a passive price taker; or (2) seeking out the best opportunities. The latter choice makes for a much more interesting and profitable business.

Final note to the reader

The concept of managing basis risk using futures contracts is not easily grasped nor is it commonly employed by Canadian farmers. A course in futures trading, hedging and working with experienced personnel (other producers, brokers, consultants) is highly recommended. Furthermore, do not hesitate to ask questions. If you do not understand what is being said, ask for an explanation. Do not proceed until you understand what is being said and the underlying strategy behind the proposed trade.

[1] The ‘basis’ is defined as the price difference between two different locations. This can be a cash basis or a futures basis based on future prices quoted on the Chicago Mercantile Exchange (CME).

[2] The mission of NWCBP is to optimize value by enhancing beef production and marketing. It comprises several feedlots that ‘pool’ market-weight cattle each week and offered to a number of packers on an ask basis. An ask type system (as opposed to a bid) enables the seller to become a price maker instead of a price taker. The intent is to develop critical mass and bring balance to the buy-sell relationship.

[3] A basis contract is known as a “fixed price later” contract. The seller offers a fixed price for delivery on a set future date at a price based on the futures price less a basis.