A Conversation with Hog Margin Consultants, David Ward and Gavin McPherson

This interview was conducted by Brendan Dorais, Vice President of Business Development, CIH.

Q: You’ve helped hog producers manage profit margins for over ten years. Tell me how you’ve seen the role of the producer’s lender change.

A: The role of the lender has changed as the risk to the producer has changed. 10-15 years ago packers were offering cost plus or window contracts. For most producers, this was a large part of their risk management plan. As those contracts went away more risk management fell on the producers shoulders. Over the last 5 years hog production has become increasingly capital intensive. Building and operational costs have increased, with the drought in 2012 feed prices have increased and only recently have come down, and with PED there is added human resource and transportation costs to keep the inventory you have to market. All of this has led to needing more capital to run and build a business and relying more on a good lender to understand and fund it.

Q: Given the critical role of the lender in a margin management plan, at what point in the planning process do you recommend producers involve their lender?

A: One of our first activities with a client is to help them identify how much price risk they are exposed to in corn, soybean meal, distillers and hogs. We then work with our clients to build a margin management policy. Generally, the policy consists of profit margin levels that trigger coverage using pre-approved contracting methods and strategies that can go out as far as 18 months into the future. Once the client has reached this point with CIH, it is time to describe that plan to the lender. We work closely with the client to help the lender understand the plan and provide the lender with regular updates. We strongly encourage regular reviews of the margin management plan with the lender. Many times we find that the more informed the lender is kept on a regular basis on how the client is protecting strong forwards margins the more comfort they have on supporting not only the margining of that position but also the growth initiatives the client has in their operation.

Q: To what extent does the lender stay involved in your relationship with the producer?

A: As much as the producer would like. CIH understands the importance of the “team concept” and has invested heavily in building tools that were specifically designed to foster this collaboration…to make things transparent…to facilitate communication. In some cases, clients have asked to create a view only login for lenders to the client’s website so they can keep a very close track of what is going on. In most cases, however, it will be a quarterly or annual meeting with the lender to specifically address current and forward positions and goals for risk management into the future.

CIH understands the importance of the “team concept” and has invested heavily in building tools that were specifically designed to foster this collaboration…to make things transparent…to facilitate communication.

Q: Give me an example of a helpful tool created by CIH.

A: One powerful tool is the Capital Monitor. It monitors a producer’s capital outlay of exchange-traded positions, which you can stress-test with hypothetical changes in the market. For example, given my current position what if feed came down 10% while hog went up 10%, what would my capital requirement be? Also what if I added 15% to my position and then that happened. It allows both the client and lender to test what if scenarios so everyone is informed on potential increases or decreases in markets and how that may affect an operation’s margins and their capital requirements. These are all tools that work towards keeping everyone informed.

Q: Tell us about a recent success story regarding a new margin management client and their lender?

A: This summer we had a relatively new client protecting a small percentage of their operation’s margin and wanted to add more margin protection. They didn’t believe their lender would support a larger loan for them because of hedge losses on existing positions due to the strong cash markets we were experiencing. Our first step was to have a meeting with the client and their lender to review the margin management plan and show the lender the coverage the client would like at add at the current, very attractive margins. To the client’s surprise, the lender was quite pleased to see the forward opportunities and encouraged the client to continue adding coverage as planned.

Q: What do lenders expect of margin management clients and CIH?

A: They want their clients and CIH to: A) Maintain a margin management approach; keep feed coverage in balance with hog coverage. B) Work to develop a plan that ideally, and incrementally, increases coverage as margins improve. C.) Remain objective, follow through with the plan, and make the planned adjustments as needed. Over time, lenders want to see their clients and CIH stay true to the margin management plan.