Sponsored in part by a grant from NECRME Profit Manager: A Systems Approach to Managing Risk Bradley J. Hilty Information Management Specialist Penn State

Sponsored in part by a grant from NECRME

Profit Manager:A Systems Approach to Managing Risk

Bradley J. Hilty Information Management Specialist Penn State Dairy Alliance [email protected]

mailto:[email protected]

Sponsored by Grant $ from NECRME

Profit Manager:Program Overview

Many programs offered on RM Topics Most focused on a single form of risk Business managers - manage Profit Margins Multiple forms of risk impact Profit Margins Develop an integrated approach to RM Focused on managing risk associated w/

Feeding and Nutrition Milk Price


Profit Manager:Program Objectives

Increase Producers’ awareness of and develop their skills in the use of BMP’s in: Managing Milk Price Risk Managing Feed Expense Risk Hedging Strategies to Manage Profit Margins Nutrition and Feed Management Strategies Labor Management practices


Profit Manager:Program Objectives

Provide a systematic approach to manage the multiple forms of risk that impact profit margins.

Encourage the use of a planning & budgeting tool in implementing risk management strategies.


Profit Manager:Program Collaborators

Lisa Holden – Dairy & Animal Science Virginia Ishler – Dairy Alliance Rich Stup – Dairy Alliance Ken Bailey – Dept of Ag Econ & Rural Soc Downes-O’Neill Brokerage Firm

Jeff DeGrand / Mike Downes


Profit Manager: Managing Risk Types of Risk

Financial Risk Price Risk Production Risk Legal Risk Environmental Risk Human Error Risk Others???


Profit Manager: Managing Risk Two Focus Area

Focused on the Nutrition and Feeding Program Production Risk Price Risk

Milk Feed

Human Risk Milk Price Hedging


Profit Manager:Workshop Topics

Milk Price Comparison Controlling Risk in Nutrition

and Feeding Calculating Production

Costs Hedging Tools Managing Labor Risks Penn State Hedging Game Profit Manager Planning tool


Profit Manager:Workshop Methods

Combination of class room and hands-on sessions in: Comparing Milk Prices Evaluating Nutrition

Programs Calculating Costs of

Production Implementing Hedging

Strategies Planning and Budgeting


Results of 2004 Penn State /Cornell Milk Check Survey


Managing The PROFIT Equation

PRICE XM arke tin g

W h o, W h en , W h ereH ow , H ow M u ch , Q C

VOLUM EM an ag em en t

G en etics , N u trit ion , F QR ep ro , D isease

EXPENSESV ariab le o r F ixed

P rod u c tiveN on -P rod u c tive

PROFIT

Profit Manager


Profit Manager“Control the Controllables”

What factors are controllable? Volume Expenses

Is price controllable?


Milk Price Databy Geographic Location

All Central NC/NE SC SE Other

Gross Milk $ 14.24 14.29 13.96 14.39 13.46 13.64

Risk Mngt $ (0.25) (0.14) (0.10) (0.55) (0.17) (0.46)

PPD (0.44) (0.26) (0.54) (0.38) (0.41) (0.83)

Milk Mark $ 0.87 1.01 0.89 0.77 0.85 0.84

Net Milk $ 13.12 13.14 12.98 13.07 13.44 12.34

Net – Min 11.35 12.41 11.91 11.59 12.42 11.35

Net - Max 14.30 13.87 14.30 14.17 14.09 12.98


Milk Price Databy Volume Shipped

All > 1.5 M 1-1.5M .5-1 M 100 K-.5M

< 100 K

Gross Milk $ 14.24 14.99 14.39 14.67 13.94 13.99

Risk Mngt $ (0.25) (0.30) (0.49) (0.79) (0.05) 0.00

PPD (0.44) (0.10) (0.39) (0.36) (0.49) (0.63)

Milk Mark $ 0.87 1.01 0.80 0.83 0.81 1.04

Net Milk $ 13.12 13.69 13.11 13.05 13.08 12.95

Net – Min 11.35 12.94 12.42 11.59 11.91 11.35

Net – Max 14.30 14.09 13.92 14.17 14.04 14.30


Strategies for Managing Milk Production and Components

Virginia Ishler Penn State Dairy Alliance


What are your objectives?

Improve profit Improved milk production? Improved milk components? Decreased feed costs? …………….

Manage risk How?

Home grown feeds Purchased feeds Monitor performance information


What are my objectives

Not to make you nutritionists! Manage the feed consultant

Take control of the situation Managers need to take

responsibility when programs fail Change is not bad


Key Performance Indicators

Why Feeding is the single largest

controllable expense on the dairy Largest impact on health and

production Examples of KPI

DMI Production (volume and components) IOFC


Analyzing Cost of Production

Bradley J. Hilty Penn State Dairy Alliance [email protected]


Profit Manager

Milk Price Trends (1987-2002)Milk Price Trends (1987-2002)

$12.00

$12.50

$13.00

$13.50

$14.00

$14.50

$15.00

$15.50

$16.00

$16.50

$17.00

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002


Profit ManagerHands-On:


Cost of Production Data- DairyCOP$

0

1

2

3

4

5

6

# H

erd

s

< $ 12.00 $12-$13 $13-$14 $14-$15 $15-$16 $16-$17 > $17.00

$/Cwt

Milk Production Costs/ CWT



Penn State Hedging Game by Downes-O’Neill


Trading Simulation

The goal of this trading exercise is to lock-in optimal profit margins as market conditions change over the course of a marketing year.

A “snapshot” of nine trading days will be given with futures and options prices and a market conditions update on each date.


Exercise Rules Producers paired All teams assume a fictitious 1,000,000

lb. per month dairy operation that uses 500 MT of soymeal per month.

Producers can lock-in 100 percent of their milk production in 200,000 lb. increments using the October Class III futures and options

Producers can lock-in 100 percent of their input costs in 100 MT increments using the October soy meal futures contracts


Exercise Rules

Upon viewing the current Class III and soymeal prices, teams will have five minutes to make their marketing decisions.

Teams are allowed to initiate, as well as liquidate, hedge positions, prior to contract expiration on November 5.

All team are responsible for tracking any liquidated (realized) profits or losses throughout the exercise

All liquidated futures reconcile to the oldest initiated position.

Brokerage commissions will be calculated but margins requirements will not.


Exercise Rules Producers will be allowed to use the

following strategies to initiate hedges: Sell Class III futures Buy Class III put option Sell Class III futures and Buy Class III call

option Buy Soymeal future

Teams can liquidate any positions at current market prices but cannot be long a call option without having a corresponding short futures position.


Exercise Rules

What marketing strategy will you use? Sell Futures Buy Put Option Sell Futures/Buy Call Option


Sell Futures

Lock in a specific price – zero price uncertainty!


Buy Put Option

Insurance against falling prices. Producer pays premium and receives floor price. Leaves upside open when

prices rise.


Sell Futures/Buy Call Option

A call option may be purchased in conjunction with a short futures position which allows a producer to “participate” on upward price moves even when locked-in with a futures contract.

A call option is essentially paying a premium to insure the futures position in the event of upward milk price movements.

Call options don’t need to be purchased simultaneously with futures. Calls can be purchased at later date to match with existing futures positions.

Call options may not be purchased prior to sale of futures contract.


January 4October Class III: 13.40

It’s the start of a new milk marketing year and the futures market is offering producers a well-above average Class III price for the October contract. Milk prices finished strong the previous year so traders are still leaning toward higher prices as we enter the New Year.


January 4 (cont.)

On the other hand, milk production and cow numbers are rapidly increasing in response to the high milk prices. Most analysts are projecting a 2 ½ to 3 percent increase in milk production for the month.


January 4 Futures Quotes:October Class III 13.40cwt.October Soymeal 148.60 MT

The following table is the current Class III options quotes for today.

Put/Call Strike Premium Change

Put 13.00 0.60 -

Call 14.25 0.47 -


March 15October Class III: 12.98

What a difference two months make! Cheese and butter stocks have grown significantly since the beginning of the year and analysts are projecting February milk production to be up 4 percent or more on the USDA report released later this afternoon. Retail prices are slow to reflect the decline in farm-level prices as the drop is not being passed along to consumers.


March 15 (cont.)

The Chicago Mercantile Exchange(CME) spot cheese market has dropped sharply since the beginning of the year, now at its current level of $1.33/lb. Ideal weather on the West Coast has some traders wondering if an early flush will leave production tight at the start of the summer grilling and ice cream season. Lower milk prices have also slightly increased the cull rate.


March 15 Futures Quotes:

October Class III 12.98cwt. -0.42October Soymeal 135.60 MT -13.00



Put 13.00 0.60 -0.02

Put 12.50 0.43 -

Call 14.25 0.25 -0.22

Call 13.50 0.42 -


June 18October Class III: 14.40

Cheese prices have unexpectedly climbed almost $0.20 lb. over the past month to $1.43/lb. Traders question whether the current production and demand fundamentals support the current uptick in cheese. Buyers watched cheese prices climb sharply higher the previous year and are nervously accumulating product on the current run-up.


June 18

Milk production continues to surge seasonally with the May production data released this week up 3.5 percent versus the previous year. American cheese production for April was up a whopping 10.6 percent versus last year. Although dairy product consumption is above average, trader question whether the current cheese price will hold these levels.


June 18 Futures Quotes:October Class III 14.40cwt. +0.85October Soymeal 141.20 MT +9.80



Put 14.00 0.46 -

Put 13.00 0.21 -0.05

Put 12.50 0.14 -0.01

Call 14.50 0.48 -

Call 14.25 0.58 +0.28

Call 13.75 0.90 +0.46

Call 13.50 1.08 +0.55


August 13October Class III: 17.62

There appears to be no end in sight for the upward surge in Class III futures. September and October contracts have smashed through the $17.00 level and appear to be headed higher. The CME spot block cheese market is trading at $1.9325 lb. and many sources say $2.00 to $2.10 lb. is possible. However, the deferred futures contracts are starting to sell-off, suggesting traders think the up-move’s sustainability will be short-lived.


August 13 (cont.)

Despite the hoopla surrounding record milk prices, milk production has remained strong. The USDA July milk production report, to be released next week, is still expected to show milk production 3 ½ to 4 percent above year ago levels. The weather out West has moderated and California production is expected to be 12 percent over last year. More good news for producers is that feed costs have backed-off.


August 13 Futures Quotes:October Class III 17.62 cwt.

+ 0.97October Soy meal 136.50 MT +

4.40


Current August 13 Put Option Quotes


Put 16.00 0.25 -

Put 15.25 0.12 -0.11

Put 14.00 0.04 -0.03

Put 13.75 0.03 -0.03

Put 13.00 0.01 -0.02

Put 12.50 0.01 0.00


Current August 13 Call Option Quotes

Call 18.00 0.55 -

Call 17.00 0.92 +0.32

Call 14.75 3.01 +1.03

Call 14.50 3.24 +1.04

Call 14.25 3.48 +1.06

Call 14.00 3.72 +1.07

Call 13.75 3.96 +1.07

Call 13.50 4.20 +1.00


September 2October Class III: 12.90

Class III futures continue their collapse in the wake of last month’s cold storage report revision. Despite the futures market freefall, the CME spot block cheese market still remains at $1.70 lb. This would calculate out to a $15.00+ Class III price even though October futures are sitting over $2.00 cwt. beneath that level. CME cheese prices will start calculating toward the October Class III in three weeks.


September 2 (cont.)

With milk production still running strong and increasing cow numbers, traders don’t look for much upside price recovery. Furthermore, retail grocery prices still remain strong ruling out much in the way of dairy product features in the near-term. However, the market is approaching price levels where commercial buyers may re-enter the futures arena, supporting prices.


September 2 Futures Quotes:October Class III 12.90 cwt. -

2.53October Soymeal 146.30 MT

+5.20


Current September 2 Put Option Quotes


Put 16.00 3.20 +2.15

Put 15.25 2.37 +1.68

Put 14.50 1.86 +1.45

Put 14.00 1.34 +1.06

Put 13.75 1.26 +1.03

Put 13.00 0.84 +0.72

Put 12.50 0.61 +0.54

Put 12.00 0.42 -


Current September 2 Call Option Quotes

Call 18.00 0.01 -0.03

Call 17.00 0.01 -0.09

Call 16.00 0.03 -0.37

Call 14.75 0.12 -0.91

Call 14.50 0.15 -1.05

Call 14.25 0.18 -1.20

Call 14.00 0.23 -1.24

Call 13.75 0.30 -1.46

Call 13.50 0.40 -1.56


November 5USDA Class Price Announcements

October Class III Price $11.49 cwtOctober Soy meal Settle $154.10 MT


Final Option Settlement Values

Put Call16.00 4.51 18.00 0.00

15.25 3.76 17.00 0.00

14.50 3.01 16.00 0.00

14.00 2.51 14.75 0.00

13.75 2.26 14.50 0.00

13.00 1.51 14.25 0.00

12.50 1.01 14.00 0.00

12.00 0.51 13.75 0.00

13.50 0.00

12.50 0.00


Account Reconciliation

Reconcile all outstanding futures and options positions to the announced Class price and soymeal settlement price.

Account for all realized profits and losses that were liquidated during the exercise.

Deduct any call option premium that expired with no value from ending P/L.

Deduct original put option premium cost from hedge profit.

Calculate net hedge profit on a cents per hundredweight basis.

Multiply total transactions by $40.00 for brokerage commission total.



Profit Manager Budgeting & Planning Tool

PROFIT MANAGER Planning & Budgeting

Tool


Profit Manager Tool

Excel Spreadsheet which: Allows producers to calculate basis Calculate feed needs Project Expenses

With feed price hedging Project Milk Income

With milk price hedging Examine Impact of Strategies on Profit

Margin Develop monthly Cash flow Budget


Results – 3 workshops

32 Participants 21 producers 8 Industry Professionals 3 PSU Students

Knowledge Level – Pre & Post Test Pre-Test Score 57.9 % SD - 17.8 Post-Test 77.9 % SD - 10.6


Results:(6 month follow up survey)

52% of Producer Participants Responded 100 % implemented at least 1 management

change 83 % implemented over 4 management changes 91.7 % experienced at least 1 positive impact 50 % experienced 3 or more positive impacts


Thank You!

?? Questions ??

Documents

Sponsored in part by a grant from NECRME Profit Manager: A Systems Approach to Managing Risk Bradley J. Hilty Information Management Specialist Penn State