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Market Preview: Packers Feeling the Pain

by 5m Editor
21 February 2009, at 8:26am

US - Weekly US Market Preview provided by Steve R. Meyer, Ph.D., Paragon Economics, Inc.

Smithfield Foods’ announcement this week stating plans to close six processing plants, eliminate 1,800 jobs and reduce the number of operating business units from seven to three is definitely a sign of the times. While efficiency has always been important, it is now indispensable. Even the juggernaut that was (and still may be) Smithfield, is not immune to that requirement.

Some industry observers have long marveled at Smithfield’s standard operating procedure of buying another company, making sure it had good management and systems in place, and then more-or-less leaving it alone. The practice worked pretty well for years and Smithfield’s stock soared from $1.30/share in early 1990 to a peak of over $35 in mid-2004. It’s hard to argue with success.

But difficult times have hurt Smithfield and many other companies in and out of the food and agricultural sectors. Obviously, Smithfield management decided it was time to streamline. The operating units will be centered on the company’s three largest packing entities – Smithfield Packing, John Morrell and Farmland Foods. The closures have no impact on Smithfield’s packing capacity since all of the companies’ slaughter plants were spared.

That is an important message, I think. The John Morrell plants at Sioux Falls, South Dakota, and Sioux City, Iowa, have long been on the short list of US slaughter plants that are long in years and perhaps short on efficiency. The Sioux Falls plant was once considered a definite dinosaur, since it dates to the day of four-species (beef, pork, lamb and veal) operations under one roof. But the addition of major processing capabilities in the ’90s has made it a very important plant for Morrell’s value-added products.
,br> Sioux City, on the other hand, is strictly a kill-and-cut operation located near a revitalized downtown area. It doesn’t even have the stockyards next door anymore. How much longer will it last in this kind of environment? I hope it is needed for a long time, but the same change in philosophy that led Smithfield to make this week’s changes could impact this plant and industry capacity as well.

With that said, I do not think we are at great risk of losing a slaughter plant this year. US market hog production will be lower in 2009, especially in the second quarter. Imports of Canadian market hogs will be much smaller, too. I expect no more than 500,000 or so this year (compared to 2.3 million in ’08) and, depending on how the mandatory country-of-origin-labeling (COOL) soap opera turns out, perhaps far fewer. Feeder/weaner pig imports will decline as well in 2008. I expect them to fall from last year’s seven million to 5.0 to 5.5 million this year.

These reductions will not leave large chunks of unused slaughter capacity for long periods of time. Utilization rates will indeed be lower than in 2007 and 2008, but closing a plant is pretty much a forever decision, and I don’t think 2008 supplies will dictate that it be made – especially after Smithfield has passed on an opportunity to close a plant that many industry observers believe to be vulnerable.

The exception may, sadly, be the Meadowbrook Farms plant in Rantoul, IL. The plant is closed at present due to a cash flow crunch caused by a contract dispute with a major customer. There are no plans to permanently close the plant, but the situation is serious. USDA’s Grain Inspection Packers and Stockyards Administration met with Meadowbrook suppliers last week and they usually only get involved when serious livestock payment issues arise. I hope the plant survives because I have friends involved as owners and as staff. Undeniably, the prospects don’t look good in the current economic environment.

With all of that said, it is important to realize that the current situation for pork packer margins is abysmal (see Figure 1). In a period of six months, US packers have gone from the highest per-head margins in the past nine years to the lowest per-head margins in the past 12 years. What is even more unusual is that the margins fell apart in September and October – the very time of year when pork packer margins usually strengthen.

Why the dismal performance? In a nutshell, packers are paying too much for hogs relative to cutout and by-product values. Meat margins (the spread between the cutout value and the hog price) have been negative in eight of the past nine weeks. By-product values have actually recovered some since Christmas, but last week’s $15.25/head (7 February) is over $8/head lower than last summer’s record high.

I think packers are trying to maintain both customer and supplier relationships as they wait for warmer weather and, hopefully, a seasonal increase in pork demand. It is a logical approach but one that, at least for now, is getting a bit expensive.