Volatility continues to permeate the dairy industry as the world economy contemplates a return to “normal.”
CME spot cheddar is the most pronounced example, having rocketed up to $2.40 at the time this recording.
Why? T3 explains how it’s a symptom of an environment where the entire industry is guessing.
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Anna: Welcome to The Milk Check, a podcast from T.C. Jacoby & Co., where we share market insights and analysis with dairy farmers in mind.
Ted: Maybe we ought to start the discussion by someone telling us why the cheese market is doing what it’s doing.
T3: Okay.
Anna: Good luck.
T3: I’m assuming you mean me.
Ted: Yeah.
T3: So, how about we use the analogy of we’re on a roller coaster and we just went down the big hill and now we’re going up the big hill.
Ted: It’s gotten much higher than I thought it would ever go. I thought the thing would be ready to crash at $1.90.
T3: Yeah. I think everybody’s kind of in the same boat. To me, it’s a combination of factors all hitting at the same time. You still have retail sales running at 20% to 30% above normal, you now have foodservice distributors refilling the pipeline that emptied out when COVID-19 started. Well, now, restaurants are starting to open back up and they’re trying to refill the pipeline in preparation for everything going back to normal. And I just talked to one of the big cheese mozzarella manufacturers here late last week who told me his foodservice orders are running at 120% of what they normally would this time of the year. In addition to that, you have the food box program, the USDA Food Box Program, which is quickly becoming a debacle because a number of the winners of the program did not properly calculate or hedge the cheese and butter portion of their purchases to put the program together to deliver to, you know, the charities. So, when they bid that price, they bid it at a fixed price. Now, there was an interview with one of the larger regional foodservice distributors about a week ago, I’m going to paraphrase here.
But basically, what this owner said was that they bid on the Food Box Program and they were told their bid was too high. And what he said was he goes, he believed the winners of many of the bids did not have their head around what the true costs were to put the whole program together. And that they may have been underestimating what the cost of some of the products were, specifically cheese and butter on the dairy side of things. And his comment was U.S. Foodservice, Sysco, Performance Food Group, all bid on the program and all were told their bids were too high because there’s no way that some of the winners of this program could possibly put together some of these boxes at some of the costs that they bid if they won the program and these guys didn’t. So, that has to be very concerning. And that was before the cheese price raised to what is now $2.40. But you add that demand on top of foodservice distribution demand running at a 120% of normal because they’re refilling the pipeline on top of retail demand, that’s still running at about 120% of normal. And that’s the recipe for cheese market that is raised from $1.01 to $2.40 in the span of a little more than three weeks and is likely to keep going higher before it comes back down.
One of the things that I think also plays into this is the fact that production planning, distribution planning, you know, all of these big companies, whether you’re a foodservice distributor or a restaurant group, restaurant chains, or cheese manufacturers, they all have planning departments. So, they can plan production, they can plan what their demand is, they can plan what their sales are, they can plan what their purchases should be. This COVID-19 experience, I mean, it’s pretty safe to say that every single planning department in the country has probably taken their original plans and throw them out the window. They’re chasing their tail right now trying to figure out what they think their actual needs are. And one of the things that I think is going on is they probably over-aggressively cut back on their needs as the market was dropping and now, they’re probably overreacting and overly optimistic about what their demand will be now that we’re going back up. What I suspect is going to happen is this, foodservice demand, yes, it’s coming back, yes, the restaurants are going to start opening back up. They’re not going to open up and start doing business, you know, at 110% or 120% of what their projections were going into the year.
And so, we’ll probably see foodservice demand kind of peak out in the next week or two and then sometime around mid-June really start to fall back down. Maybe even, you know, 80%, 70% level for a while, as they’re just trying to kind of stabilize the volatility swing between what their guess in demand could be and what it is. The pipeline will be refilled, but it’s going to be a while before they really have their head around exactly how much product that they need. The cash market today is at $2.40, July futures is for a $1.90, August futures are at $1.80, September futures are at $1.75 and most people in the marketplace that I’m talking to feel that those numbers are much more realistic than the $2.40 that we’re at today. You know, the last thing that’s playing into this is milk production. Now, I’ll throw this back to you and Anna, but I think even the USDA is really having a difficult time determining what exactly has happened to milk production in the last three months. How much has it been reduced? Has all that milk production come back? Is some of the programs that some of the major co-ops put out there, are they still in place? Are they still working? If we have less milk, if we have truly reduced the milk supply and in a way that is sustainable, we can see prices stay…maybe not stay up here at $2.40, but we could see prices stay elevated for a while.
Ted: Well, let me try to field that one because it is confusing and I wouldn’t blame USDA or the Federal Milk Market Administration for being a little bit confused also. You know, if we go back to March, when all this was starting, remember, we had decided that maybe a 1% increase year-on-year of milk production was about normal and that disappearance would give us a pretty tight market in the fall at that level of increase. And then we came in, I think, at 2.4% for one month and probably it was April. And then for May, depending on whether or not we count…how we counted and whether we count dumped milk for April and so on, we’re probably looking at an increase for May, not a decrease. Now, I know that in certain areas of the country, they talk about a 10% reduction and a 5% reduction, how are they going to do that? Are they going to do it by changing the feed ration on May 1st? Are they going to do it by going from three times to two times per day milking on May 1st? My inclination is to believe we’ll probably see something down from 2.4% and 1.6%, but I doubt that we’re going to see anything below a 1% increase for May. And I think that what will probably happen is when everybody gets a load of a Class III price is probably going to be close to $20 at least for June, it’s gotta be hard to figure how anybody will think that changes in production are going to be necessary. That reductions in production are going to be necessary. So, I’m thinking that we’re going to wind up with the worst of all worlds, where the production is coming much faster than we can handle when we get into the—later in the summer.
T3: I don’t disagree with you. I mean, the old saying that “Money makes milk” has proven to be true time and time again.
Ted: Yeah. And that’s where we’re going to say, the only thing that could change that would be a precipitous drop in the cheese market. And if the box program is a debacle and the program would be canceled or something like that, well, maybe we might see that. But right now, I don’t see it. I think the coming out, if you will, or the recovery of people coming out and going back to restaurants, traveling more and so on, I think they’re going to do that, but I think it’s going to be much slower. So, projecting 110% or 120% of normal from the foodservice industry, I don’t think it will. So, again, I would say that retail sales will continue, people are used to buying milk now, maybe they’ll continue to buy it. So, they’ll probably continue strong. But to think that we’re all of a sudden going to be back above normal on sales, that’s a stretch. I think they will be above normal on production, but below normal on sales.
T3: And I agree with that. And I think everybody in the industry and in the foodservice distribution industry would agree with that. But what’s happening right now, if you’re running at 120% of normal not because of orders at the restaurant level, but because of the orders that the foodservice distributor level to make sure that they have in their pipeline, in their warehouses, in distribution, you know, enough stock so that when the restaurant do order, they can fulfill that. So, that will tail off. And I think most people expect it to tail off somewhere between the middle and the end of June. But I also think that it’s more than a little bit of, you know, the dog chasing his tail because nobody has a really good feel for exactly what demand is going to be like. I mean, sales planning is difficult enough in a normal year, in a year like this, it’s virtually impossible. And so, you have large segments of the food industry overreacting to everything because they are guessing and they’ll freely admit they’re guessing, but they’re more afraid to make the mistake of not having product than of having too much right now.
Ted: Well, I have to concede, I’m guessing too. And then we have the government fingering into it, so the normal laws of supply and demand have been skewed.
T3: Well, let’s throw this at you and bring Anna into the conversation. You know, the other thing, dairy farmers have not yet received any money from the CFAB program. Anna, do you have a feel for how that program is going to play out?
Anna: Well, actually, I have the website pulled right now and there’s payment calculators on there. It really, for the farm, I think what they get really depends obviously on volume and then on the way they identify themselves. If it’s an LLC or a partnership, then their caps are higher. But honestly, looking at it right now, it looks like a relatively easy process whether or not it plays out that way, I don’t know. But applications where you can start submitting them as of last week and you can do it through August 20 and, you know, they do have to go through their local farm service agency and everything to fill it out. But it’s, I mean, it’s a pretty cut and dry thing. There’s no components, there’s no ‘how much did you actually lose?’ It’s just based on weight.
T3: I know there was some talk about not having a cap that basically…
Anna: There is still a cap. The payments cannot exceed $250,000 and that’s for anything that you have on there. If you’re just dairy, then it’s $250,000 on dairy, but if you have crops and wool and other things, it’s kept on all of it at $250,000. If you’re a corporation or an LLC, or you have a partnership, the cap is increased to $500,000 and $750,000.
T3: But that money in addition to the high June milk prices is going to come to the dairy farmer all sometime this summer most likely, correct?
Anna: They say that the payments should start going out for some people within a week. Now, I’m assuming once they start getting a bunch of applications in at the same time, that process slows down a little bit, but it sounds like they’re ready to start putting checks out pretty quickly at least initially.
T3: That would indicate to me that at least from a simple dollars and cents standpoint, most smaller dairy farmers who are most vulnerable are probably going to end up being okay. Especially when you combine that with what’s going to happen to the June and probably July pay price.
Anna: Well, just for reference, if you had a million pounds a month, January, February, and March, you would be eligible for, according to the website, $148,000. But if you have 9 million pounds a month, you hit those caps pretty quickly. You know, as far as actual losses on premiums and freight and all those other things, you know, dumped milk and everything, you know, just judging by our producers, I would say that’s a pretty generous assistance, you know. But you have to factor in lost price as well obviously prices dropped incredibly low.
T3: A million pounds of milk a month, that’s a farm with about 500 cows?
Ted: Yeah. About 500 cows would be about right. Rule of thumb is 300 cows, it’s a load of milk every other day. So, 700 cows would be a million five.
T3: Okay. So, probably about 500 cows.
Ted: Probably about 500 depending on how good the cows are.
Anna: I wouldn’t say depending how good. I mean, if they’re 80 pounds a day, it’s a little over 400 or something. So, yeah, it’s in the neighborhood.
Ted: I think the production number is probably the key to this whole thing right now, with all this confusion, with all these panicky programs to try to bail out the industry with the disruption caused by the virus, we’re probably going to wind up with over-bailing and wind up with a glide of milk going into next year. If we see a $20 plus milk price for June, even with huge negative PPD, we’re still going to wind up with a pretty high price and that negative PPD will be reimbursed when you get back to July and August. The incentive for anyone to depart the industry, particularly with unemployment the way it is right now is got to be zero. So, my sense of it would be that everything’s turned upside down, we’re probably going to be looking at at a second half, which will be rather tepid.
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T3: So, how do we think this is going to play out?
Ted: That was a question that I was just going to ask also. It’s hard to visualize that what we’re doing right now is going to cause any decrease in production.
Anna: I would agree.
T3: And I would agree with that too.
Ted: And if that production stays up… Remember Phil’s model?
T3: Yep.
Ted: If it stays up where Phil’s model is, or even close to it, let’s just say 2%, then we’re going to have a lot of milk out there. And I don’t think the economy is going to recover quick enough to absorb that milk.
T3: If I go back to where my mindset was before any of us had heard the phrase COVID-19, I was of the belief that the second half of this year was going to end up being longer than most of the industry anticipated because we were going to have more than enough milk production. Now, after the gymnastics of the last three months, when it came to supply and demand, most people threw all of their forecasts out the window. But we’ve gone back up high enough now, it’s fair to consider the possibility that we may go all the way back to a situation where we’re going to have more than enough milk in the second half of the year to fulfill all the needs. Now, my one concern would be, most of our customers are telling me, you know, traditionally on June 1, you know, we’ve gone through the heaviest part of the flush, but we’re still producing more cheese than we’re selling. That shift doesn’t quite take place until the middle of July where you start actually seeing demand be a little bit stronger than supply as milk production curtails and cheese demand rises going into the school year. What my customers are telling me is usually this is the point in time where they’re starting to see their inventories reach their near maximum levels for the year, where they actually are today in 2020 on June 1 is their inventory levels are low and they’re living hand to mouth and they’ve essentially used up any and all cheese that they tend to build up this time of the year.
So, we’re going into the summer at low inventory levels, at least at what I would call the converter segment of the industry. And that would indicate to me that wholesale demand for cheese will be higher than normal between now and the end of the year because nobody has their inventory built up but if we have more than enough milk, that means the cheese plants are going to be able to run close to full between now and the end of the year as well and they’ll offset each other. But we’ll still probably maintain relatively high prices. We won’t wash out, you know, to a $1.40 or a $1.30 cheese price which is what I probably would have considered a possibility back in January before this all took place. So, you know, I can argue both sides of the coin. I can argue a scenario where demand is a lot weaker than expected in the second half of the year because the economy is going to be weak because we’re still recovering from everything that’s gone on in the last three months. I can make the argument that a weak economy plus extra milk production may mean lower prices. But I don’t think you can ignore the fact that people don’t have their working inventory levels at a place where they usually do this time of year. And so, that’s going to cause probably a little bit of increase in what they are willing to buy at the same time. I can argue both sides of the coin.
Ted: And I can argue both sides of it too right now. But one thing I think does have a bearing on it, you look at what’s going to recover and what’s not. The food service would include hotels and restaurants, the deli counter at the grocery store to some extent, but it doesn’t include baseball games, football games, hockey games, sports events in general. And that I think is probably what’s going to be slow to recover. So, let’s assume that assumption is correct for a moment. What are the people who are going to the football games, hockey games, baseball games, what are they going to do? Well, are they going to stay home and drink milk and barbecue and have cheeseburgers? And maybe we’re seeing a little bit of that right now at the retail level and with the pizza people and so on, there are home delivery. Where they’re not going out to the baseball game and they’re staying home and they’re eating chips and the cheese dip and so on. So, arguing that side of the thing gives me a little bit of a sense that even if the recovery doesn’t go as quickly as everybody would like it to go, it could be that the food and dairy recovery might be pretty aggressive. People going to baseball games aren’t eating cheese, but they eat more if they stay home and it could be that’s what we’re looking at. And maybe why we’re seeing now with the increase in usage is bearing that out a little bit.
T3: That’s possible. I would argue this, when I think of what are the demand segments that I would expect to continue to be well below normal in the second half of the year, the first that comes to mind is your fine dining restaurants. I think they will continue to struggle. I mean, it seems like most of the states that are just starting to open back now and are allowing restaurants to open up are saying they have to be at 25% of capacity. I wouldn’t be surprised at all if we’re still at 50% or 75% of capacity by the fourth quarter of this year. They’re not going to go all the way to 100% soon. I think that’s going to be slow and it’s going to be the fine dining restaurants and the casual dining restaurants that are going to be hurt the most by that. I think hotels…I have trouble believing that hotels are going to be running anywhere close to normal between now and the end of the year. I think there’s going to be a lot less travel. And so, I think, you know, when you think about, you know, the breakfast you have at hotels and things like that, that’s going to be suppressed. I think breakfast restaurants in general, you know, that’s more kind of fits the casual dining segment, but also when you travel, you’ll go out to eat for breakfast, if you’re not traveling, you’ll tend to eat at home. So, I think that’s going to be suppressed. I think it will continue to be suppressed through the end of the year.
So, your casual dining, your fine dining, your hotels, you know, when we talk about sporting events, you know, I guess I have trouble believing that you’re going to see stadiums as packed as they were anytime in 2020. I have to believe that even if we do have NFL football with fans, my gut tells me that, you know, those stadiums are going to be maybe 60% full or even maybe 30% or 40% full when they open back up. I struggle to believe that they’re going to be operating at 100% capacity, and the result is more people at home where I agree with you, they will consume more cheese. And one of the things, if we have enough data now that we’ve seen clearly is the consumer during this time is kind of defaulting to comfort food, which in the cheese industry means dairy cash cheeses. Like your store brand shreds and chunks and your cheddars, you know, so cheddars and crafts, Tillamook, that cheese is moving well. But your deli cheeses, both the deli cheese behind the counter and even including the deli cheese in front of the counter that’s prewrapped, they haven’t had the same bump as the dairy case has. And I think that’s going to continue as well. Is there going to be…you know, everybody’s aware that, economically, this has not been good for the economy and so, I think everybody’s kind of, you know, they’re making better choices, making less expensive choices. They’re kind of defaulting to comfort foods that they tend to consume a lot of, which is more cheddar, less things like Brie or Gruyere.
And so, there’s a dynamic there that I think is going to play out. Overall, what does that mean for dairy? Quite honestly, it becomes a capacity issue more than a fluid milk demand issue, because it’s easy to imagine that your cheddar cheese plants continue to run at full capacity because they usually went close to full capacity all year round anyway. But if so, what happens is that your specialty cheese demand continues to be suppressed, that milk has to go elsewhere, and it’s not like they’re going to be just able to just make cheddar out of it because those plants will be maxed out. And so, they’re going to have to find new forms for that milk, and ultimately, the plants that balance the milk supply tend to be your butter powder plants in which means your butter powder plants in the second half of the year may run in a higher percentage than normal in the fall.
Ted: It’ll certainly will if we have a burst in production without a corresponding increase in usage and disappearance. I think that’s about as far as we can go, I think. Stay tuned.
Anna: We welcome your participation in The Milk Check. If you have comments to share or questions you want answered, send an email to podcast@jacoby.com. Our theme music is composed and performed by Phil Keaggy. The Milk Check is a production of T.C. Jacoby & Co.
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