Corn Belt Troubles Trigger Protein Pricing Concerns
Business Wire -- NEW YORK, NY -- July 16, 2012 -- Excessive heat and dry weather conditions in the U.S. are likely to renew concerns about food inflation, particularly for protein, according to Fitch Ratings. The U.S. Department of Agriculture this week said corn production would fall 12% this month. That drop amid already tight supply is causing widespread concern among the investment community.Unfavorable weather conditions across the corn belt states have caused drought-like conditions, damaging crops and stalling a vital corn pollination period that improves yields. Conditions are expected to remain disadvantageous, as the U.S. crop moisture index indicates little near-term relief. With that, the price of corn has soared close to record high levels, currently at $7.50 per bushel.
We expect poultry, pork, and beef producers and processors to be most affected by any sustained increase in the price of corn as that will translate to a rise in the cost of feed for livestock, which could represent up to 40% of the cost of producing an animal. While some substitution away from corn towards wheat and dried distiller grains is possible, due to animal nutritional constraints, protein companies remain major purchasers of corn making them highly sensitive to swings in grain prices.
To be sure, protein companies are already dealing with lower profit margins versus other food companies, forcing them to pass a portion of the cost increase to consumers. Large red meat processors realized double-digit pricing and mix benefits with minimal effect on volumes in recent years due to tight supply, while chicken prices rebounded late in 2011 and into 2012 due to lower production.
We believe pricing may become increasingly difficult given a still-high U.S. unemployment rate coupled with slow economic growth, despite tight supply conditions and relatively strong exports. As of June 25, 2012, the USDA's Consumer Price Index is forecasting a 4% to 5% increase in beef consumed at home, down from 10.2% in 2011; a 2% to 3% increase in pork consumed at home, down from 8.5% in 2011; and a 3% to 4% increase in poultry consumed at home, up from 2.9% in 2011.
The ratings of Tyson Foods Inc. ('BBB'/Stable) and Smithfield Foods, Inc. ('BB-'/Stable) have been upgraded multiple times over the past several years due to significant debt reduction and above normal consolidated operating performance, particularly in pork and to a lesser extent beef. Negative rating actions are not anticipated in the near term as reduced debt levels allows these companies to absorb downside related to cost pressures, also taking into account further margin pressure. Furthermore, hedging practices for these companies has improved since the 2008-2009 period when corn prices spiked to more than $7.00 per bushel, and drastically declined soon after.
For more information on this topic, please see "1Q12 U.S. Protein Update: Meat Processors Feel Pressure -- Livestock Costs Remain High and Margins Compress as Consumer Price Fatigue Looms" (Feb. 28, 2012) and "U.S. Protein: Why $7 Corn Is Less of a Risk Today than It Was in 2008" (March 16, 2011). Both are available at www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
Applicable Criteria and Related Research:
1Q12 U.S. Protein Update: Meat Processors Feel Pressure
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=672357
U.S. Protein: Why $7 Corn Is Less of a Risk Today Than It Was in 2008
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=607985
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