With feed-ingredient costs ranging near historic highs and chicken companies unable to pass those costs along to consumers, the industry’s business model is broken and needs fixing, said the chief executive of the nation’s second-largest chicken company where cost-based pricing of chicken is part of the fix.

Pilgrim’s CEO Bill Lovette said the chicken industry appears to be headed toward production cuts between 6% and 8% by the fourth quarter of 2011, which would help raise chicken prices in 2012, but something more is needed – a way to pass high and volatile ingredient costs along to consumers. As a result, Pilgrim’s is adopting cost-based or market-based pricing of chicken in 2012 contracts with retail and foodservice customers.

Pilgrim’s reported a net loss $128 million in the second quarter of 2011, even as it continued to improve operating efficiency and reduce costs. In an earnings conference call, Lovette estimated that Pilgrim’s will pay $500 million to $600 million more in feed ingredient costs in 2011 than in 2010. Actual feed ingredient purchases were approximately $254.7 million higher during the second quarter versus 2010, with corn increasing by 92% and soybean meal increases reaching 29%.

“Significant pricing improvements are needed with costs of feeding ingredients continuing to range where they are today. The chicken industry’s business model is not sustainable at these ingredient cost levels and that’s why we are taking a much different approach with respect to pricing with our book of business. The model where 12 months of volume is committed at a fixed price is not sustainable in our business and Pilgrim’s is planning to move to pricing contracts that are either cost or market based,” he said.

Initial discussions with customers about the new pricing model have gone well, Lovette said. “Many customers already buy a significant amount of their inputs on a market-price basis. QSR burger chains, for example, buy beef trimmings on market-based pricing, so this is a concept that they understand.”

Steps to reduce costs, improve yield 

In addition to the new pricing model, the company has set operational goals for profitability:

  • Achieve consistent performance in the top quartile of Agri Stats, an industry benchmarking service
  • Capture $400 million in improvements on an annualized run rate in plant cost and yield by the end of 2011
  • Improve the company’s balance sheet by turning assets into cash to pay down debt and minimizing capital spending

Lovette said the company’s improvements in plant cost and yield were approximately $270 million on an annualized basis as of June. “We still have some work to do on price and mix but we’re committed to achieving that $400 million run-rate goal by the end of the year,” he said.

As a part of the plan to reduce working capital, Pilgrim’s is reducing inventories, with a goal of reducing total inventory to approximately three weeks of operating supply. The company also expects to achieve cost reductions from the closing of its Dallas processing facility by the end of September. Production volume from the plant will be consolidated into three other Texas plants, allowing them to operate nearer full capacity. Live weights at two of the plants will be raised, and the closing of the Dallas plant will not affect growers, he said.

Forecast depends on economy, sustained industry cuts 

Lovette said the company’s and the industry’s profitability in 2012 hinges on a number of factors, including the general economy and how deep and sustained the industry production cuts turn out to be.

“I think it is going to take a combination of supply cuts and an improvement in the economy for industry profitability to get back to normalized ranges. We are not seeing the seasonal demand for chicken that we would have expected, especially at these low prices in the face of record high beef and pork prices at retail,” he said.