August 24, 2017

Non-Feed Costs Cutting into Margins

 |  By: Fran Howard

Even though recent income-over-feed calculations portray a dairy farm sector rife with profits, non-feed costs have been rising. And that means some dairy producers, especially those who rely heavily on hired labor, might not be enjoying hefty profits.

“Sharply intensifying non-feed costs at the farm level are not limited to labor,” says Sara Dorland, analyst with the Daily Dairy Report and managing partner at Ceres Dairy Risk Management. “Interest costs, access to credit, and environmental regulation and compliance are also on the rise. Thus, while the ratio between milk prices and feed costs remains positive, increasing non-feed costs are starting to impact profitability at the farm level.”

Feed costs, the largest expenditure on a dairy, remain well below the average milk price. According to the feed-cost formula used in the Margin Protection Program (MPP) calculation, dairy producers spent an average of $7.97 for feed in June to produce 100 lbs. of milk, leaving June’s income-over-feed margin at $9.33/cwt.—a good number by any standards. Or is it?

“Milk-over-feed ratios are an indication of on-farm profitability, but returns might not be as lucrative as they appear at first glance,” Dorland says. “After feed, labor is one of the largest expenditure for dairies, and rising labor costs appear to be affecting dairy operations.”

According to the California Department of Food and Agriculture (CDFA), in 2016, labor costs in California were $1.74/cwt. of milk, up 2.4% from 2015 and 11.5% higher than in 2014. On top of that, between 2007 and 2014, labor costs on California dairies increased 2.6%.

“Labor costs for California dairies could ramp up even faster beginning this year because the market for labor is becoming increasingly competitive and laws passed in 2016 related to minimum wage and overtime have recently gone into effect,” Dorland notes. Other states have also seen increases in the minimum wage.

Beginning in 2017, California’s minimum wage increased by 50 cents per hour to $10.50 for businesses with more than 25 workers. Starting in 2018, the same increase will go into effect for businesses with fewer than 25 employees.

The immigrant worker pool has also tightened due to fewer border crossings and competition from other industries, she adds. Producers will likely have to pay more to find new workers.

As non-feed costs rise and cut into profit margins, producers have some choices, says Dorland. For example, they can consider large-scale investments to reduce labor costs, such as installing robotic milkers and/or they can prepare for the future by retrofitting lagoons to comply with environmental regulations.

“While these investments could mitigate cost increases in certain categories going forward, they still require access to capital and they incur interest costs—two things that could prove challenging for some farms,” she says. Of course, producers could also choose to do nothing and just absorb rising costs.

“Regardless of what producers decide to do, more money is now headed to interest, labor, and regulatory and environmental compliance, and that means less is going to the bottom line,” says Dorland. “As a result, the appetite for expansion could moderate going forward relative to the past few years.”

If that proves true, the long-term expansionary mode the U.S. dairy industry has been experiencing could slow.