An analysis of profit margin hedging strategies in the broiler industry

The focus of this study on hedging strategies differs from previous studies in four major ways: l) both costs and selling price are simultaneously hedged, 2) profit margins are computed daily for up to nine months into the future, 3) hedges can be placed five to six months in advance of production, and 4) production costs and profit margins are computed on a weekly basis.

Weekly RTC iced broiler production costs were estimated using weekly changes in corn and meal prices and monthly changes in other feed costs, processing costs, transportation and offal value. Weekly production costs were compared to weekly N.Y.C. wholesale broiler prices to determine profit margins. These estimated weekly profit margins served as a benchmark for evaluating alternative hedging strategies.

Expected future monthly net profit margins (ENPM) using futures prices and basis estimates for corn, meal, and iced broilers were estimated daily using the production cost formula. The daily ENPM were analyzed to determine their ability to forecast actual profit margins. The ENPM's were poor predictors of actual profit margins. They demonstrated seasonal biases and substantial over and under estimation of actual margins. Forecasted and actual profit margins varied inversely, so positive profit margins were locked in, while negative profit margins were not.

Five hedging strategies were developed based on the relationship discovered between expected and actual profit margins. Over the time period 1970-1975, these strategies doubled profit margins and cut profit margin variation substantially.