Dairy analysts look at what's in store for this year

Issue Date: March 26, 2008

By Ching Lee
Assistant Editor

California dairies continue to set production records year after year as herds have gotten larger and cows are producing more milk per animal.

After enjoying some of the highest milk prices they had seen in years in 2007, many California dairy farmers are wondering what the current year holds for them as they continue to grapple with escalating feed costs, a volatile market and other economic uncertainties.

To help them sort through some of the finer points of dairy financial management that could improve their bottom line, a panel of financial experts from Genske, Mulder & Co., which specializes in providing consulting services to the dairy sector, spoke to producers about market challenges, profit projections and other issues that could affect the decisions they make about their operations. The presentation was given in February at the 2008 World Ag Expo in Tulare.

Gary Genske, managing partner of the firm, said California dairy producers will continue to face difficult challenges marketing their milk due to the imbalance of supply and demand. The nation's milk production--nearly 190 billion pounds today--continues to expand every year and is expected to climb another 2.5 percent this year.

There are more cows in production today, and production per cow is growing by about 1 percent every year, he said. At the same time, national consumption of milk is about half of what it used to be 20 to 25 years ago, a trend that spells trouble for a sector that sees consistent growth in production.

Ultra-pasteurization, which more than triples the shelf life of milk, is already having a major impact on consumption, he said, noting that more dairy cooperatives are now considering producing more of this milk due to growing demand.

"How can we expect consumption to go up if the shelf life lasts that much longer?" Genske asked.

The overseas market, which has been a tremendous boon for dairy producers, provided some relief. In 2007, dairy exports jumped 62 percent from 2006, a hike that Genske said is an anomaly. The weak dollar has largely been responsible for the export growth, he said. Shrinking European production and droughts in Australia and New Zealand, the world's largest milk-exporting region, also helped. .000

But Genske said he doubts foreign market sales will continue in their current momentum. As the dollar becomes stronger, American milk products will be less competitive and harder to sell internationally, he said.

"So the question is, do we make long-term marketing plans to build more plants to be able to meet this current export market when in a few years that export market will be gone?" he asked.

California, the nation's No. 1 dairy state, is currently dealing with a lack of processing plant capacity when milk production shows no signs of slowing down, especially after a year of favorable milk prices. The concern with building more processing plants is that it would promote more milk production and lead to a surplus, which would drive down prices. Genske noted that just a 2-percent national surplus would drop milk prices by 30 percent, and farmers are "very close to a break-even in 2008."

While some would argue that milk prices usually rebound when the least profitable dairies drop out and milk supply stabilizes, Genske said this marketing strategy does not work because farmers never quite make back in good times what they lost when times were bad.

About the only thing they have control over is the national cow population, which is currently about 9,220,000 cows, some 100,000 higher than last year, Genske said. He added that producers should continue to support the farmer-funded CWT (Cooperatives Working Together) program, which has helped to stabilize milk production and supplies by keeping the nation's cow population down through its voluntary herd retirement program.

In the past, adding more cows to the herd was one way dairies could boost their profits, said Albert Nunes, who specializes in financial analysis and cash flow projections. But lack of plant capacity, environmental issues with water and air and the implementation of production quotas have stripped California dairy farmers of that option, he said.

Rather than looking to grow the dairy in terms of herd size, producers need to look more at what's inside their dairies and at the individual parts of their operations, Nunes said.

"You've got to go back to looking at which cows are profitable, which ones aren't," he added.

To do this, producers need to know their cost of production so they can determine which costs are variable and which ones are fixed. Then they can analyze which cows can stay and which ones need to go.

While many producers may be reluctant to eliminate some of their heifers, Nunes said the rise in cost of feed means they might need to at least consider that option. They will need to know the cost of raising the heifer to determine if it makes sense for them to keep it.

"If I have extra heifers, there's a possibility of selling them today," he said. "They're still worth a lot of money today; they might not be a year from now."

With the implementation of production quotas, more producers will be looking to reduce their milk supply. But Nunes said they don't necessarily have to sell their cows.

The first thing to consider is that producers are not paid per pound of milk produced but rather per pound of butter, fat and solids sold. Therefore, if producers could lower their production to stay within the production quota but get their milk components up, their returns would stay relatively unchanged and they would not have to reduce their herds, he said.

Producers who are considering moving their dairies to another state to be more profitable should first do their homework, said Joel Eigenbrood, who specializes in financial forecasting.

According to the firm's analysis, milk prices and operating costs are pretty consistent in dairies throughout the nation. During the first nine months of 2007, milk prices averaged $18 per hundredweight across all dairies nationwide, with operating costs ranging from $16 to $17 per hundredweight, leaving a net profit of $2 to $3 per hundredweight.

"These are actually fantastic profits this year," said Paul Mulder, who specializes in dairy income. "This shows that it doesn't really matter where you put a dairy because as long as you have a really good operation, good management and have some equity, you'll do well in any state."

However, there are some states that have a bigger milk surplus problem than others, with California being one of the most over-produced states. The others are Idaho, Wisconsin, New Mexico and Minnesota. The milk-deficit states are generally in the South and East Coast.

Despite the milk surplus in some states, there are actually fewer dairies in the nation today producing that milk. The number of U.S. dairies has been decreasing drastically over the years--from almost 220,000 in 1988 to about 70,000 in 2007. That's a two-thirds drop in less than 20 years.

At the same time, the nation's herds have gotten bigger. In 1998, about 50 percent of the milk in the country was produced by herds with fewer than 200 cows. In 2007, only about 30 percent of U.S. milk was produced by herds with fewer than 200 cows, Eigenbrood noted.

Looking to the future, Wayne Cunningham, who specializes in financial analysis, said farmers could expect to see higher feed costs and lower milk prices in 2008.

"We see tremendous growth in ethanol and the strain on demand for feed that's going to our dairy cows," he said.

He predicts corn prices will hit $4.25 to $4.75 a bushel this year. That's a huge jump from the $1.76 a bushel farmers were paying in 2001 and the $3.51 a bushel in 2007.

Ethanol plants will likely consume more corn this year--pushing the national corn use from 5 million bushels last year to an estimated 9 million bushels this year.

Meanwhile, producers could expect other cost increases in feed: 15 percent for hay, silage and other forages, and 20 percent for grains.

Other operating expenses also are expected to go up, including 3 percent for labor, 25 percent for environmental costs, 5 percent for repairs and utilities, and 20 percent for fuel.

There are two areas where producers could see some decreases in cost: rent rates by 10 percent, thanks to federal banking issues, and rBST by 50 percent due to removal of the product from the market because of pressures from cooperatives and consumers.

The higher production costs will mean a slimmer profit margin for producers this year as milk prices are not expected to be as robust as 2007. Cunningham projects the average milk price this year will be around $16.91 per hundredweight, a 5-percent decrease from 2007.

Using a 1,912-cow dairy as an example, he said that dairy could expect to make 37 cents in profit per hundredweight compared to the nearly $3 return per hundredweight that producers enjoyed in 2007.

"So we're pretty skinny there on the bottom line for 2008," Cunningham said.

(Ching Lee is a reporter for Ag Alert. She may be contacted at clee@cfbf.com.)

Permission for use is granted, however, credit must be made to the California Farm Bureau Federation when reprinting this item. Top