Date September 2016
Approximate Net Recovery on Cost
CME cheese prices
- After low prices during the first half of 2016, cheese inventories reached a 30-year high in the U.S. But prices have risen 35 percent since May, eclipsing their highest price since November 2014. Stronger domestic demand and lower production have been credited for the shift
- After dipping during the second quarter, milk prices rose through July. In August, the United States Department of Agriculture (“USDA”) forecasted that the price of milk will strengthen through the fourth quarter to an annualized price of $16.25/cwt, 5 percent lower than in 2015. However, the strong dollar, slowed growth in China, and higher milk production are among the factors limiting price growth
Butter and cheese prices anchored to Chicago Mercantile Exchange (“CME”): Typically, the selling price for butter and cheese (with some exceptions, such as new cheeses including feta and blue) are based on the CME price plus a negotiated “overage” amount, which is a fixed dollar amount that is added to the CME price. The overage amount varies by customer and by product. These rates are typically negotiated annually. There are other exceptions; for example, organic cheeses are based on market prices and not a derivative of the CME. Thus, fluctuations in that contract price have a direct impact on inventory valuations and are crucial to monitor.
Cheese inventories are at 30-year high: During the last 12 months, prices of 40# blocks traded on the CME traded under $1.50 per pound for half of that time. In May, they hit their lowest level in nearly 10 years. These low prices, combined with a weak export market (down 12 percent for cheese in June) and steady production, have resulted in an extraordinary surplus. The situation is so extreme that the federal government stepped in to purchase 11 million pounds of cheese in August for $20 million to combat the problem. While that won’t do much to dent the surplus (the current surplus is estimated at $1.2 billion), it is illustrative of the extraordinary nature of the situation.
In a normal market, most cheese put into storage is contractually obligated to someone, which typically makes it dependable collateral for lenders. However, current market conditions have created uneasiness in this business norm. If a liquidation of even one rail car of this cheese came to market, it could have a disruptive effect on prices because it so rarely comes to spot. This is why Gordon Brothers typically values cheese assuming a six- to nine-month liquidation period. It’s necessary to structure the wind down to smooth the release of inventory to the market or it will disrupt the pricing. Lenders should also remain aware of any third-party liens on product stored in warehouses.
Milk prices a crucial benchmark: While its limited shelf life makes some lenders averse to lending on fluid milk, it’s crucial to understand nonetheless because of the fundamental role it plays in the production of other dairy products. Cheese, butter, and nonfat dairy milk powder (“NFDMP”) are some of the products derived from it. After bottoming out in May, milk prices have been rising, surpassing $16/cwt in July. Higher cheese prices and some improvement in dry whey prices are credited for contributing to the increase. Despite that, prices year-to-date remain below 2015 levels.
If milk is an asset you do lend against, pay close attention to how the appraiser modifies the exit strategy to accommodate its perishability. Depending on the product, there may be a couple of weeks or possibly just days to sell it. Also beware of the strict regulations governing the sale and production of milk.
Butter may warrant special analysis: Butter is a seasonal product. Prices almost always go up in the fall and winter, related to holiday cooking and baking. While sales volumes may be moderately impacted, rising market prices for butter can more greatly impact sales dollars. A lot of creameries will start building supply in anticipation of fall demand. Discuss with your appraiser whether a high-low analysis to account for seasonality makes sense for companies in this sector.
Export markets for dry products is weak: There are a variety of dry milk products available including dry buttermilk, dry whey, nonfat dry milk, dry whole milk, and NFDMP. These dry products are mostly used as ingredients in other food products. While used both domestically and abroad, much is exported because it is shelf stable and can be easily shipped in bags or bulk totes. Similar to dairy products on the whole, exports for many of these products have seen declines this year. Dr. Bob Crop, Professor Emeritus at the University of Wisconsin, stated in the Cheese Reporter, “Compared to June a year ago exports were lower by 9% for nonfat dry milk/skim milk powder, 33% lower for butterfat, 12% lower for cheese and 2% lower for dry whey. However, whey protein concentrate exports increased 52% as China bought a record volume and increased exports to Southeast Asia.” He does not expect a major export recovery until later in 2017.
Privately labeled products may warrant modifications to exit strategies: Many dairy products are privately labeled. Lenders should be aware that manufacturers may not be permitted to sell privately labeled product unless it’s repackaged. While in certain instances repackaging may be possible, it will incur extra time and expense in a liquidation. Consider the benefit doing so may have on the recovery of that inventory.