Enhance Profitability in Chaotic Times
Arbitrage and increased asset turnover ratio can be used to take advantage of market volatility.
by Troy Smith for Angus Productions Inc.
SAN ANTONIO, TEXAS (Jan. 27, 2010) — During recent years, beef producers have repeatedly heard market analysts advise careful attention to risk management. The reason cited is market volatility. However, volatility also creates opportunity to improve profitability when savvy producers apply some time-tested business tools.
At the 2010 Cattle Industry Annual Convention and NCBA Trade Show in San Antonio, Texas, Cattlemen’s College® attendees heard how the principle of arbitrage and increased asset turnover ratio can be used to take advantage of market volatility. According to session speakers Barry Dunn and Kim McCuistion of Texas A&M University’s King Ranch Institute for Ranch Management, commodity producers have profited from their use for more than 100 years.
Arbitrage, explained the speakers, is a high-falutin’ word for the simultaneous buying and selling of the same commodity in different markets in order to profit from price discrepancies. They defined asset turnover ratio as the amount of sales generated for every dollar’s worth of assets. It is calculated by dividing dollars of sales income by dollars of assets.
According to Dunn, the King Ranch marketing plan is a classic example of the use of arbitrage. The third-largest cow-calf operation in the U.S., the King Ranch calves approximately 25,000 mother cows in South Texas, but it also stocks up to 14,000 stocker cattle and maintains a 16,000-head-capacity feedlot.
Weaned, home-raised calves are sold, typically at a premium. At the same time, the ranch purchases stockers at discounted prices — cattle to which it can add value through the ranch management system. In addition, the feedlot is filled with feeder cattle that, for various reasons, can be purchased at discounted prices and eventually sold at prices on par with the finished market.
“And as a result of being in the marketplace multiple times each year,” Dunn said, “King Ranch also increases its asset turnover ratio.”
The advantages of arbitrage and increased asset turnover ratio explain why King Ranch and some other operations do not retain their home-raised calves all the way through the finishing period, despite the widespread promotion of retained ownership as a means of increasing profitability. The advantages became clear when a case study compared results of the King Ranch marketing plan, for eight years, with expected results of retaining ownership of ranch-raised calves for the same period.
“Results of these analyses show that for the last eight years, King Ranch had greater per head annual net income ($300 vs. $8) and cumulative net income ($2,400 vs. $62) using the production and marketing plan they have had in place, than if it had retained ownership of home-raised calves through the stocker and feedlot phases,” Dunn said. “On the King Ranch, retained ownership would remove opportunities for arbitrage and reduce asset turnover ratio.”
McCuistion said the King Ranch scenario was not presented as a recipe for profitability, but it is an example of the successful use of these business tools. She cited other examples, including a New Mexico producer who purchases small groups of “end lot” calves from other nearby ranchers to grow, repackage in larger lots and resell.
“He can buy calves at a $5 to $7 discount to the market, but it’s still more than the sellers might receive if they hauled the calves to a distant sale barn,” McCuistion explained. And after applying his good management, the calves are sold again, but at prices on par with the market.”
McCuistion advised producers to consider what production and market strengths or weaknesses are present in their localities and think about ways to apply arbitrage and increase asset turnover ratio.
“There are opportunities everywhere,” McCuistion added, “but you do have to be in tune with the market, be adaptable, be aggressive and reinvest your profits.”
Pfizer Animal Health sponsored the Cattlemen's College, now in its 17th year.
Editor’s Note: This article was written under contract or by staff of Angus Productions Inc. (API), which claims copyright to this article. It may not be published or distributed without the express permission of Angus Productions Inc. To request reprint permission and guidelines, contact Shauna Rose Hermel, editor, at (816) 383-5270.