After some of the steepest profit declines in recent memory, meat producers are feeding at the trough again.
Profits are growing amid tight supplies, rising prices, lower feed costs and a modest uptick in demand.
U.S.-based operators plumping up again include Sanderson Farms (SAFM), Tyson Foods (TSN), Pilgrim's Pride (PPC) and Smithfield Foods (SFD).
As the economy comes back, "even a little positive demand in the face of reduced supply" gives a boost to the industry, said analyst Stephen Share of Wisco Research.
The meat production industry is cyclical. But the 2008-09 down cycle was "deeper than most," said Mike Cockrell, chief financial officer of chicken processor Sanderson Farms.
Profits on chicken got leaner in 2008 when corn — a key feedstock — traded at $7 to $8 a bushel, up from its usual $2 to $3. It now hovers around $3.50.
The recession heaved another punch as consumers trimmed back on restaurant visits.
To cope with falling profits, meat processors reduced production, cutting not only the fat but down to the bone — and then some.
The U.S. chicken industry cut supply 8% to 9%, Cockrell says. That was far deeper than the 1.5% to 2% cuts made in the prior two downturns.
Pilgrim's Pride, once the largest poultry producer in the U.S., slashed plant capacity but still couldn't deal with financial woes, including debt from its recent acquisition of GoldKist.
It filed for bankruptcy in late 2008. Thanks in part to an $800 million cash infusion from Brazilian beef giant JBS, it emerged from bankruptcy this past December. JBS USA owns a 64% stake in the firm.
"The Brazilians are now in the U.S. chicken business," Cockrell said.
The whole of the meat industry is mature, says Wisco's Share.
"So it's not surprising to have consolidation," he said. "It's a pretty constant theme."
1. Business
Chicken, beef, pork and turkey are viewed as commodities, affected by the ups and downs of supply and demand.
Since producers cut back production, supply is still relatively tight. That means higher prices.
"Fundamentally, supply and demand is in a much better place this year, even to the point of short supply," said analyst Diane Geissler of Credit Agricole Securities. "That's the result of a lot of work the industry has done to reduce the number of animals raised."
Meat processing is largely a business of spreads — what's left when you figure the difference between the price you can fetch for the product and the cost to produce it.
While most chicken processors pay third parties to raise chicks, they still pay for the feed and control overall operations.
Beef and pork processors usually buy animals from independent ranchers just before slaughter. So their spread is the wholesale price of the beef minus the cost of the live cattle. Their margins are lower than for companies that control the entire process.
Smithfield does both: It raises its own livestock and outsources to third parties.
Hormel Foods (HRL), known for Spam and other canned meats, buys pork mostly from independent growers. Its business model is less volatile than other meat processors.
"It's a packaged foods company with a lot of protein products," Geissler said. "It has steady growth year in and year out."
Meanwhile, beef packers have been enjoying a run-up in prices.
"Since February, the beef market has really taken off," Share said. One reason is that imports from Australia — accounting for about 30% of U.S. beef imports — were down sharply in January and February.
Of the four protein groups, only chicken production is likely to rise this year, about 1% to 2% vs. last year, Geissler says.
A limited supply of other meat makes chicken more attractive on a relative basis, wrote analysts from Deutsche Bank Securities.
Chicken is more seasonal than beef and pork. Prices usually peak in the summer as backyard grills fire up.
Geissler expects chicken breasts to average $1.50 per pound this year vs. $1.20 last year, peaking at $1.80 over the July Fourth holiday.
While the price gain may seem modest, the analyst notes that Tyson produces nearly 2 billion pounds of boneless skinless breast meat a year.
"Small pricing moves can have a meaningful impact on both the top and bottom line," she wrote.
Value-added products such as nuggets and marinated meat have higher margins and steadier buying. Geissler figures Tyson gets about a $1-per-pound premium on its value-added products.
Name Of The Game: Keep a close eye on production so that supply doesn't exceed demand. Include high-margin products in the mix.
2. Market
Consumers are the end-users, but grocery stores, restaurants and other food service operators buy most meat products from producers — either direct or via distributors.
Domestic demand for pork is picking up in part because of fast-food operators' focus on breakfast (think bacon and sausage). One beneficiary: hog producer Smithfield Foods.
Per capita meat consumption typically rises only 1% to 2% annually, based on total supply and modest population growth.
Since 2004, per capita consumption has declined, Geissler says. One reason: Increased exports have taken some of the supply out of the domestic market.
Also, 2004 was a banner year by comparison: The Atkins diet was all the rage, and McDonald's (MCD) rolled out new Select products for the Athens Olympics. Chicken breasts hit a record $2.57 a pound that year. It's hovered around $1.65 in recent weeks.
"We don't sell to McDonald's, but it doesn't matter. They absorb a lot of product," Cockrell said. "When they buy a lot of product it helps the supply-and-demand balance."
3. Climate
Tires and chicken don't seem to go hand in hand. But after the U.S. imposed a tariff on Chinese tires in September, China responded in February by levying tariffs on U.S. chicken. The nation imposed another round in late April.
China is a big consumer of chicken feet, or "paws," which have little demand in the U.S. China has paid around 70 cents per pound for the product. A lot of it is said to still be reaching Chinese markets through Hong Kong, bypassing tariffs.
Meanwhile, Russia — also a major chicken importer — continues its ban on U.S. chicken over the use of chlorine washes American processors use to disinfect it. Talks between the two countries to resolve the five-month-old ban continue.
U.S. pork seems to be faring better overseas. The Department of Agriculture forecasts a 5.7% recovery in pork exports. Russia and China recently lifted bans on U.S. pork that began last spring after the swine flu outbreak.
In the U.S., the federal government is holding antitrust hearings on competition in agriculture, with new rules for the meat industry due out this spring.
It's also investigating whether big meat packers are driving down cattle prices.
4. Technology
New technologies are being tested to combat E. coli contamination in beef, incorporating such things as bacteria-eating viruses, vaccines and paper-bleaching chemicals.
In the poultry industry, new technology and equipment is optimizing yields and efficiency, with improved automatic de-boners and X-ray technology. New work modules are capable of processing up to 120 birds per minute.
Tyson is opening a new plant to produce renewable diesel fuel out of chicken byproducts. Unlike the ethanol and biodiesel industries, which use food stuffs such as corn and soybean oil to make fuel, the plant will use non-food-grade animal fats.
The company is also looking into ways to turn feathers into bioplastics, bioadhesives and nonwoven materials.
5. Outlook
Demand for meat products is picking up from food service operators and distributors as consumers start spending more on dining out. That's a good thing: Though grocery sales can take up some of the slack from a falloff in restaurant spending, restaurant sales need to improve for producers to reach peak earnings potential, analysts say.
With supply seen as tight until at least late 2010 or early 2011, higher demand should support protein prices.
Chicken is the only protein that will be more available in the U.S. vs. last year, so consumption is expected to increase. Deutsche Bank analysts estimate that chicken production will increase about 4% this year and another 4% to 4.5% in 2011.
Upside: Lower-than-expected feed costs and a stronger-than-expected economic recovery bode well for the industry.
Risks: Since price increases take time to trickle down from grocery stores and restaurants to end-consumers, the question will be whether price increases can stick, says analyst Share.
Also, a sudden, sharp rise in corn and soybean prices would crimp poultry profits.
A strong U.S. dollar and weaker international economies might limit export demand. Surprise health or safety issues could hurt sales.
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