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Profit Manager: A Systems Approach to Managing Risk

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  1. Profit Manager:A Systems Approach to Managing Risk Bradley J. HiltyInformation Management Specialist Penn State Dairy Alliancebhilty@psu.edu Sponsored in part by a grant from NECRME

  2. 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 Sponsored by Grant $ from NECRME

  3. 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 Sponsored by Grant $ from NECRME

  4. 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. Sponsored by Grant $ from NECRME

  5. 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 Sponsored by Grant $ from NECRME

  6. Profit Manager: Managing Risk Types of Risk • Financial Risk • Price Risk • Production Risk • Legal Risk • Environmental Risk • Human Error Risk • Others??? Sponsored by Grant $ from NECRME

  7. 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 Sponsored by Grant $ from NECRME

  8. 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 Sponsored by Grant $ from NECRME

  9. 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 Sponsored by Grant $ from NECRME

  10. Results of 2004 Penn State /Cornell Milk Check Survey Sponsored in part by a grant from NECRME

  11. Managing The PROFIT Equation Profit Manager Sponsored by Grant $ from NECRME

  12. Profit Manager“Control the Controllables” • What factors are controllable? • Volume • Expenses • Is price controllable? Sponsored by Grant $ from NECRME

  13. Milk Price Databy Geographic Location Sponsored by Grant $ from NECRME

  14. Milk Price Databy Volume Shipped Sponsored by Grant $ from NECRME

  15. Strategies for Managing Milk Production and Components Virginia Ishler Penn State Dairy Alliance Sponsored in part by a grant from NECRME

  16. 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 Sponsored by Grant $ from NECRME

  17. 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 Sponsored by Grant $ from NECRME

  18. 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 Sponsored by Grant $ from NECRME

  19. Analyzing Cost of Production Bradley J. Hilty Penn State Dairy Alliance bhilty@psu.edu Sponsored in part by a grant from NECRME

  20. Profit Manager Milk Price Trends (1987-2002) Sponsored by Grant $ from NECRME

  21. DairyCOP$ Profit ManagerHands-On: Sponsored in part by a grant from NECRME

  22. Cost of Production Data- DairyCOP$ Sponsored by Grant $ from NECRME

  23. Penn State Hedging Game by Downes-O’Neill Profit ManagerHands-On: Sponsored in part by a grant from NECRME

  24. 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. Sponsored by Grant $ from NECRME

  25. 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 Sponsored by Grant $ from NECRME

  26. 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. Sponsored by Grant $ from NECRME

  27. 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. Sponsored by Grant $ from NECRME

  28. Exercise Rules • What marketing strategy will you use? • Sell Futures • Buy Put Option • Sell Futures/Buy Call Option Sponsored by Grant $ from NECRME

  29. Sell Futures Lock in a specific price – zero price uncertainty! Sponsored by Grant $ from NECRME

  30. Buy Put Option Insurance against falling prices. Producer pays premium and receives floor price. Leaves upside open when prices rise. Sponsored by Grant $ from NECRME

  31. 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. Sponsored by Grant $ from NECRME

  32. 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. Sponsored by Grant $ from NECRME

  33. 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. Sponsored by Grant $ from NECRME

  34. January 4 Futures Quotes: October Class III 13.40 cwt. October Soymeal 148.60 MT The following table is the current Class III options quotes for today. Sponsored by Grant $ from NECRME

  35. 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. Sponsored by Grant $ from NECRME

  36. 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. Sponsored by Grant $ from NECRME

  37. March 15 Futures Quotes: October Class III 12.98 cwt. -0.42 October Soymeal 135.60 MT -13.00 The following table is the current Class III options quotes for today. Sponsored by Grant $ from NECRME

  38. 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. Sponsored by Grant $ from NECRME

  39. 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. Sponsored by Grant $ from NECRME

  40. June 18 Futures Quotes: October Class III 14.40 cwt. +0.85 October Soymeal 141.20 MT +9.80 The following table is the current Class III options quotes for today. Sponsored by Grant $ from NECRME

  41. 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. Sponsored by Grant $ from NECRME

  42. 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. Sponsored by Grant $ from NECRME

  43. August 13 Futures Quotes: October Class III 17.62 cwt. + 0.97 October Soy meal 136.50 MT + 4.40 Sponsored by Grant $ from NECRME

  44. Current August 13 Put Option Quotes Sponsored by Grant $ from NECRME

  45. Current August 13 Call Option Quotes Sponsored by Grant $ from NECRME

  46. 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. Sponsored by Grant $ from NECRME

  47. 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. Sponsored by Grant $ from NECRME

  48. September 2 Futures Quotes: October Class III 12.90 cwt. - 2.53 October Soymeal 146.30 MT +5.20 Sponsored by Grant $ from NECRME

  49. Current September 2 Put Option Quotes Sponsored by Grant $ from NECRME

  50. Current September 2 Call Option Quotes Sponsored by Grant $ from NECRME