What does it take to be upbeat in a business faced with a cost-price squeeze created by record-high production costs and weak prices for finished products amid one of the worst economic patches since the Great Depression? Oddly, it must help to be a top executive at a U.S. chicken company.
For every positive economic indicator identified by four executives participating in the National Chicken Council’s Industry Outlook Panel, they found more economic pitfalls. Nonetheless, the panel gave a generally optimistic outlook for the U.S. chicken industry in coming months (See sidebar: US chicken industry recovery by spring 2012?).
The details of this poultry business scenario, however, are worse than is apparent at first glance. High feed production costs are being egged on by a federal bureaucracy seemingly content with creating shortages in the corn supply through mandates for the production of corn-ethanol. What’s more, the panelists said they expect U.S. economic growth to be only at a near-stall in the foreseeable future.
U.S. chicken producers, as a result, are facing continued financial losses headed into 2012. Mark Kaminsky, chief operating officer and chief financial officer, Koch Foods, summed it up: “The combination of an economy that just can’t get out of bed and high-priced production inputs is like double zero on the roulette wheel for the chicken industry. It is a losing situation.”
Profit pitfall No. 1 – corn prices
There are numerous pitfalls for industry profitability in 2012, only a few of which are under industry’s direct control. The biggest challenge, however, is the high and volatile prices of commodities, especially grains, and particularly corn.
Mike Helgeson, chief executive officer, GNP Company, said, “The biggest challenge the industry has had in 2011 is the high cost of feed – resulting primarily from higher corn costs.”
Adding to the economic damage to the chicken industry is the unprecedented level of volatility of input prices. “Swings in corn prices can take your business from profitability to losses in a single day. The chicken industry isn’t structured to handle that level of price volatility in the cost of inputs,” Kaminsky said. “Chicken is not a hedgeable business,” he added. His company has tried unsuccessfully to get a chicken leg quarter contract established on the Chicago Board of Trade – something that would provide the chicken industry with hedging tools as now available to the beef and pork industries.
Unfortunately for the chicken industry, high and volatile corn prices won’t end in the foreseeable future, according to Clint Rivers, president, foodservice and supply chain, Perdue Farms. “Grain supplies and prices are huge unknowns for the industry. The reality is with 40% of the U.S. corn crop going to the production of ethanol, the chicken industry is operating in a new economic paradigm and must operate differently than in the past,” he said.
This industry cycle is different
Is the current industry cycle different than past cycles? William Andersen, senior vice president, Keystone Foods, said the industry’s current economic challenges are unprecedented. “At one time, even though the chicken industry rode the roller coaster of supply and demand, corn prices were more stable. Today, the business is more complex, involving the diversion of corn supplies to ethanol production, greater government regulation, international currency fluctuations, expansion of the Brazilian and Chinese poultry industries, and many trade barriers.”
With high grain prices and an economy stuck in first gear, the chicken industry’s response must be different to achieve profitability in 2012, the panelists agreed. Helgeson explained: “Cycles in the past were more a function of supply and demand. The chicken industry overproduced, prices were weak, and there was a wait for demand to pick up. Grain prices would also take care of themselves after a period of time.” Present conditions are different, he said, with the economy showing no immediate signs of recovery and government ethanol mandates distorting grain markets.
Andersen echoed the idea that industry profitability will not improve simply with the passage of time. “In past industry cycles, demand was growing enough that it, along with some adjustment to supply, would pull the industry out of an economic downturn. But I don’t think the present industry downturn is going to be as easy to solve due to the number and complexity of factors outside industry control. It may take the industry working together for the next couple of years to see a return to normal profitability,” he said.
Pricing power is required
The new requirement for the future success of the U.S. chicken industry is pricing power, according to the panel executives. Not only must the industry continue to show production restraint, chicken companies must begin to exert pricing leverage with customers.
“Chicken presents a good value opportunity, but the pricing power of chicken producers is essentially non-existent in both the foodservice and retail channels,” Kaminsky said. “Hopefully the situation will change because grain prices, while lower now, are going to be above the norms for our industry in the coming year.”
The chicken industry’s lack of pricing power is evident in the fact that some of its best retail grocery and foodservice customers are now keeping ample margins on chicken while financial losses mount for chicken producers, according to the panelists.
This unprofitable irony was explained by Kaminsky: “The conversation in customer calls typically goes like this: ‘My soft drink supplier is increasing my costs, my pork supplier is raising my costs, my beef supplier is raising my costs, and you, Mr. Chicken Supplier, can’t give me an increase in costs.’
“The chicken industry has positioned itself as the supplier of its customers’ most profitable item,” he continued, “so what was to the industry’s betterment for many years is now a detriment. By developing leverage, chicken marketers must take some of that power away from the retailers and the restaurant operators to be able to increase prices and return the industry to profitability.”
Guarded optimism
So why the optimism on the part of the industry executives? They named two major factors underpinning their outlook – recent declines in broiler egg sets and high retail prices for competing meats. The panelists also pointed to a third factor benefiting the industry – lower energy prices compared to early 2011.
“The biggest positive for the industry now – but one which has the potential to turn negative in the future – is lower energy prices,” Kaminsky said. “Nothing has taken more discretionary income out of the consumer’s pocket than rising fuel costs. When the price of gasoline rises above a certain level, the consumer’s reaction is immediate and we see lower chicken consumption.”
U.S. domestic demand weak
U.S. demand for chicken is weak in both the retail grocery and foodservice businesses, though the foodservice sector has been hardest hit by the economic downturn. New financial risk exists there as a result, according to Kaminsky. “Very few high-profile bankruptcies have occurred in the chain restaurant business, but cracks are starting to appear in the financial armor of some customers,” he said.
Demand is only marginally better for chicken at retail, where it has been flat for the past 18 months. But retail demand there should be stronger in 2012 due to the high prices of beef and pork, according to Helgeson. He predicted demand would improve with more features of chicken at retail grocery stores.
Rivers also pointed to the possibility of improving retail demand for chicken. “The value proposition of chicken should begin to show itself in 2012 if the prices of competing proteins stay high,” he said.
Is this a growth industry?
“Is the U.S. chicken business still a growth industry?” That was the question posed by an audience member to the panelists. Their answer was a qualified yes – if the growth in international demand is factored into the business.
“That is part of the new paradigm that we find ourselves in because this is not the growth industry that it once was,” Rivers said. “Per capita protein consumption in the U.S. topped out at about 260 pounds. Next year, it is forecast to be 232 pounds. So that’s about a 10% reduction in two years time. A lot of that decrease is being driven by the weakness in the economy, but as prices rise, people will eat less protein. The industry’s domestic growth is going to have to come from growing our market share, but even that growth is going to be smaller than historically has been the case. That is something that we have to factor into our business strategies today.”
The industry also looks overseas for growth. Helgeson said: “We have to look for growth opportunities outside of the U.S. Globally, as consumer incomes rise, populations prefer to increase the amount of protein they consume. The U.S. chicken industry is well positioned to increase our exports and capture growth in the developing markets of the world.”
Export surprise in 2011
“So far in 2011, U.S. export volumes and values are over those of last year,” Rivers said. “Fortunately, as Russia has cut back its imports of U.S. chicken, the bloc of ‘other’ countries importing U.S. chicken has grown its purchases. We are getting more diversity in our customer base for exports.”
Exports were the big surprise in 2011, according to Kaminsky. “Without question the shining star of our industry in the past year has been exports,” he said. “I would not have believed anybody who said at the beginning of the year that we would only ship around 4,000 metric tons of chicken to Russia but would still experience a 23% increase in year-over-over prices.”
More global complexity
With more and more of the industry’s future growth coming from international markets, the industry faces new business complexities. Andersen named just a few current challenges:
- Reduction in Russian demand for U.S. chicken
- China’s rising demand for chicken being offset somewhat by its domestic production
- Worldwide desire for chicken produced close to home
- Brazil’s competitiveness in chicken production
- International currency fluctuations
“There are so many things outside of the U.S. chicken industry’s control that it should cause us to be much more cautious about how we plan and operate our businesses,” he said.
Mergers and acquisitions ahead
Multinational mergers and acquisitions will continue to occur, and the chicken business will become more global in nature over the next decade, the panelists agreed.
“The greatest long-term growth is outside the U.S. in areas like Brazil and India and China,” Andersen said. “Those are the fastest growing markets, which is an important consideration not only for companies that are entering the chicken business in the U.S. but for U.S. companies to consider their business strategies.
“There will be investment available for new international ventures whether for foreign companies entering business in the U.S. or U.S. companies entering business in other countries. Operating internationally, however, is not an easy thing to do. It is just as hard to run a business in China for different reasons and challenges as it is to run a business here,” he noted.
This elevates the importance of developing appropriate business strategies that focus on the U.S. market or international markets for sales growth, according to Andersen. If a company’s strategy is to be on three or four continents, there are advantages to developing product solutions that focus on the needs of selected customer groups.
Multi-protein companies
Will U.S. chicken companies be acquired by beef companies in the future? Odds are this will occur, Kaminsky said. “I think there will be continued consolidation in the U.S. chicken industry. Where are the buyers going to come from? Foreign investment is one possibility, and beyond that there will be consolidation of protein companies,” he said.
Andersen suggested that as the U.S. beef industry rebuilds its herds from historically low levels, there may be beef companies that choose to enter the chicken business. “There is value in companies offering customers multiple meat proteins,” he said.
Full recovery will require time, discipline
What’s the timetable for the industry’s economic recovery? Here is Andersen’s answer: Improvement in chicken industry economics will require discipline and time.
“It takes time to be able to pass the costs that the chicken industry has incurred on to the retailers and foodservice operators and on to consumers. There is a period of time over the next year and a half in which that occurs. There will be some immediate price improvements, but the industry won’t be able to achieve this solely based on supply and demand. The industry’s economic fundamentals look good and are improving, but it is going to take some time to complete the commodity cycle.”
