040322 Meat Seesaws On Diet Craze and Mad Cow

The industry had recovered from a lean stretch. Inventory that built up over the prior 18 months had been cleared out, restoring a supply-demand balance.

Prices of pork and poultry had stabilized after sinking in 2002. The popularity of the high-protein Atkins diet was fueling demand for meat, and a reduced supply of beef - in the face of hefty demand - pulled up wholesale beef prices.

Strong pricing combined with rising demand helped some top players fatten up profits. But just when it looked like the industry was moving full throttle, an air of uncertainty clouded the outlook. In December, the first case of mad cow disease was discovered in Washington state.

Since then, Japan, Thailand and South Korea, among others, have banned U.S. beef imports. Japan is the No. 1 importer of U.S. beef and South Korea is No. 2. Together they bought more than 50% of U.S. beef exports in 2002. Prolonged bans stand to eat into producers' sales. Last year, U.S. beef exports rose 5% to a record $4 billion, says John Nalivka, president of Sterling Marketing Inc., an economic consultant.

Then, in early February, we saw the avian influenza hit the U.S. for the first time with an outbreak in Delaware. Since then, the disease has affected flocks in other states such as New Jersey and Texas. In response, Japan and South Korea have banned U.S. chicken imports. And Russia is banning goods from the infected states.

"The good thing is domestic demand for meat is very strong because of the low-carb diet craze," said analyst Joseph Agnese of Standard & Poor's Corp. "That's offsetting the negative impact of the Avian flu and mad cow disease."

But, if bans are kept in place long term, it could create an oversupply in the U.S. and drive down prices. That happened in 2002 when Russia banned U.S. chicken.

Still, players are in better shape than they were last year. In its third quarter, pork and processed meat firm Smithfield Foods Inc. saw profits jump 660%. Poultry company Pilgrim's Pride Corp. posted a 218% profit gain in its first quarter.

"Supplies have been cut back, and supply and demand is now getting back into balance," said C. Larry Pope, Smithfield's president. "So (the situation) is more stable."

1. BUSINESS

Since meat processors sell basic commodity goods, they operate in a cyclical field. Their fortunes are tied to the balance between supply and demand of goods, which in turn dictates pricing.

Over the past few years, they've moved away from strict commodity offerings toward value-added and prepackaged goods like frozen entrees and marinated meats. These items are more profitable on a per-unit basis and they take away the cyclicality, says analyst Andrew Wolf of BB&T Capital Markets.

Take the efforts at Hormel Foods Corp. , the meat and poultry processor, well-known for Spam. It marinates meats, precooks them and then puts them in convenient packages. Among its offerings are Jennie-O-Turkey Store "So Easy" turkey, stuffed with varieties such as cheese and broccoli, or pepper cheese and rice. These items fetch a higher price than fresh meats.

"We're moving beyond just a slab of raw meat in a white tray to value-added products that give a family a good dinner in between five andfifteen minutes," said CEO Joel Johnson. "Our strategy is to become less (commodity goods oriented) and bring a lot of consumer-friendly initiatives to the fresh meat case."

Hormel has upped the percentage of value-added goods to 78% of its total mix from 62% in 1997. That effort has helped vault its operating profit margin to 8.1% in 2003 from 5.5% in 1997.

"The way to make money in this business is to take all the items off the animal and process them as far as they (can) go into things like hot dogs, smoked hams and deli hams vs. fresh ham," said Smithfield's Pope.

Smithfield is the nation's No. 1 pork processor and the world's biggest hog producer. It consumes most of the hogs it produces. This way, it controls the genetics, feed source and the manner of raising the pigs. It also assures consistent quality.

It boasts an array of value-added, branded pork products such as Gwaltney's 40%-less-fat bacon. In the third quarter, sales of value-added goods grew by double digits from last year.

- The name of the game: In a commodity business, it's key to be an efficient operator, since margins run only about 1% to 2% of sales.

"That means you have to have your raw livestock right, have competitive wages, and buy your supplies like cartons and boxes right," Pope said.

To keep down costs, Smithfield equips plants with the latest in safety gear, and pours big bucks into upgrading equipment.

Hormel, for one, ships products to retailers in a prepacked, pre-priced and pre-labeled from, says analyst Timothy Ramey of D.A. Davidson & Co. This cuts the grocers' labor.

2. MARKET

The field is consolidating. This is a way players gain efficiencies, spread best practices and gain value- added products, says S&P's Agnese.

Over the years, Smithfield has emerged as a major buyer. Last October, it bought pork and beef processor Farmland Foods. This gave Smithfield a strong brand name in the Midwest and more capacity for fresh meats and processed meats in that region. It also added a different set of customers to its mix.

Through acquisitions, Smithfield aims to lessen its reliance on pork and diversify into other proteins like beef. In 2001 it bought beef processor Moyer Packing Co.

Customers are consolidating too. Hormel now gets much of its business from a few top chains like Wal- Mart Stores Inc. , Johnson says.

Hormel tries to meet chains' growing demands by working more closely with them in areas like product category management, merchandising and inventory management, he says.

3. CLIMATE

In 2003, per capita consumption of red meat and poultry rose to 99.9 pounds from 99.6 pounds in 2002, according to Department of Agriculture Department data compiled by Hormel. The USDA sees it rising to 103.2 pounds in 2004.

The protein-geared Atkins diet has helped lift demand, mainly in beef but also in pork, analyst Ramey says.

Also, during the height of the economic upturn, consumers improved their diets and acquired more of a taste for beef.

"The commodity cycle is as close to equilibrium as it has been in the recent past," says Hormel's Johnson.

The pricing of goods is at a level that's sustainable throughout the supply chain - from processor to stores to consumers, he says.

Still, uncertainty abounds.

"You have a . . . volatile situation, that's not all supply and demand driven," said Sterling's Nalivka. "The uncertainty revolves around (how) mad cow disease will affect the export market, and in turn, on the beef industry's profits."

4. TECHNOLOGY

The big push is to improve food safety. Hormel, for one, led the pack with high pressure pasteurization for some deli and pre-cut hams, Johnson says. It puts them under intense pressure that kills pathogens as effectively as radiation.

Some firms equip their plants with imaging device that electronically profile and calculate where the cuts in the meat should be, says Dom Castaldo, assistant editor of Meat Processing Magazine. This helps maximize the number of high value products players get from a piece of meat.

5. OUTLOOK

The industry will continue to grow slowly, says analyst Wolf. But it will stay resilient. Even if the Atkins diet peaks in popularity, lots of Americans will stick with the high-protein, low-carb regimen, he says.

As the economy improves, Americans should have more to spend on meat products, which will be a plus for the industry, says Agnese.

Strong consumption trends bode well for players in 2004 and 2005, says Ramey. Also, they should continue to reap benefits from their value-added products.

Still, there's a downside. Export bans on poultry and beef are still in effect.

Another wild card is the direction of raw material costs. Corn prices are high now and soybean stocks are low, says Agnese. It's possible we could see a volatile feed climate this year, which would raise raw materials prices for firms in the pork field, in particular.

Despite cost pressure, most firms should enjoy operating profit growth averaging 4% to 5% in 2004, writes S&P analyst Richard Joy. The gain will be driven in part from cost savings they derive from acquisitions, he says.

Source: Investor's Business Daily

RETURN TO HOME PAGE

E-mail: sflanagan@sprintmail.com