The current situation and outlook for packer margins is a hot topic these days as market participants try to understand the pace of livestock slaughter and potential supplies coming to market in June and July.

We will quickly outline the conditions in both the beef and pork markets but before we continue one point needs to be underlined. The attached charts do not give you an actual packer margin. Rather, they are a rough calculation of gross margins (Meat Revenue + By Product Value - Livestock cost). Actual margins will vary by packer, depending on the size of the plant, capacity utilisation, age of the operation, etc.

The shaded area in the chart provides what we think the packer needs to get, in dollars per head, in order to cover all their other costs. Again, it's rough guidance so use appropriately.

Beef: According to our calculations beef packer margins were down sharply in the first two weeks of May.

This may appear a bit counter intuitive, especially given the run-up in the value of the cutout recently. Part of the problem with the calculation is that it depends what values you think truly represent the meat value the packer is receiving.

In the past we have used a weighted average of the choice and select cutout as reported by USDA in their weekly sheet. Last week, the average choice cutout was $213 and the select cutout was $201.7.

The weighted average for choice and select calculates to $210.30. However, the comprehensive cutout value reported by USDA for week ending May 13 was $204.94/cwt. Why the difference?

The comprehensive cutout captures not just trades done in the spot market but also formula trades, forward trades as well as beef sold to export. It is supposed to provide a broader understanding of the meat value packers are deriving from their sales.

The difference is quite significant, reducing the implied gross margin by almost $45 head. The value of the meat is only part of the revenue that packers are deriving.

Cattle by-products are quite valuable, with the hide accounting for about half of the derived credits. For week ending May 13 the by product value was calculated at $11.14/cwt live or $150 per head.

Last year, the by product value was about $183 per head. As for the cost component, we used a weighted average feedlot price of $211 dressed for last week. This is a live equivalent of almost $134.

What would happen if feedlot price stays at around 133-134 but cutout moves to $219 (this was the value last night). Gross margin would jump over $200/head and continue to stimulate packer buying.

For now fed cattle futures are reluctant to consider that possibility, evident in the huge basis levels currently in place. Much will depend on those cutout values that reflect post Memorial Day business.

Pork: As with beef, pork packer margins were excellent in April but they have been drifting lower in the last two weeks. They are still positive, however.

Different from beef, USDA does not produce a comprehensive cutout for pork so we have no choice but to use the weekly cutout value.

Last week it was quoted at $83.07/cwt, up about $1 compared to where it was two weeks ago. The national average net hog price, however, jumped about $5/cwt, thus eating away at some of those cushy margins.

Part of the reason the packer has been able to pay up a bit more for hogs, however, is that the value of the byproducts has increased. Last week the pork by product value was quoted at $18/head, about $3.60/head higher than in early March and $1.14 higher than a year ago.

Packers continue to buy hogs aggressive as their margins remain positive. But the cushion is much smaller than it was.

By-product values remain an important consideration, especially if export markets continue to show improvement.