Evaporating equity: The purchased heifer situation

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Heifer market prices have increased by about 100 percent in recent years. Although that's good for the dairies selling cattle, it poses some unique financial problems for buyers. Several years ago, banks were valuing cattle fairly close to their purchase price and then lending approximately 75 percent of that value. But banks have not kept up with current heifer prices in making their valuations; therefore, many farms lose $500 to $800 in equity with each purchased animal. This has serious effects for dairies that lease facilities, since cattle make up the bulk of their equity.

That lost equity makes it difficult for expanding dairies to meet the bank's minimum percent equity requirement. In this situation, the dairy must pay down debt and purchase cattle out of cash flow. This, in turn, slows down the dairy's expansion.

Banks, on the other hand, do not want to get into a position similar to the Land Bank situation of the 1970s and 1980s where they were lending money against rapidly appreciating land values. They point to the 20-year history of heifer prices, questioning whether the recent run-up in prices is merely an aberration.

Are current replacement prices similar to the land bust of the 1980s? I think not. Let's look at the driving forces that are creating the phenomenal heifer prices.

Supply and demand
A recent white paper compiled by dairy specialists at Monsanto Dairy Business, summarized the situation as follows:
n While no one knows exactly how many heifers are out there, the perception of a shortage exists.


  • During 2000-2001, cow numbers increased, while herd numbers fell. Shrinking herd numbers led to fewer heifers for sale.
  • Demand for heifers has been accelerated by herd expansions in recent years. In fact, expansion herds must purchase 1.7 heifers for each expansion animal over the first two years of the project.
  • USDA studies show that 10 percent of calves die during the first eight weeks of life. Another 5 percent to 10 percent never make it to the milking herd. So we only get about 34 to 36 mature heifers per 100 births. If the cull rate exceeds 36 percent, the current heifer supply would be depleted.

Not a short-term problem
This is not a short-term problem. Prices are being driven by forces that started more than 15 years ago when an over-supply of heifers masked some of the population shifts taking place in the dairy industry. However, banks still view this as a short-term problem - similar to the land deals of past decades.

The effect of discounted equity positions will have an effect on future expansion projects. Dairies with strong equity positions in land and facilities will have an advantage over dairies with a larger portion of their assets in cattle. Demand for heifers remained strong in 2000 when milk prices were low, and as well as this year with high milk prices. In the end, long-term heifer supply will depend on the rate at which dairy herds exit the market. There will become a point, given current culling and birth rates, where the remaining cows will not be able to supply the demand for heifers.

Bankers may have ultimate control over how much expansion takes place if they continue to discount the value of heifers in today's market.

Paul Johnson is a veterinarian and consultant in Enterprise, Ala.


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