Kay's Korner

Aug 31, 2012

Packer profits under pressure

When I first started writing about the beef industry 25 years ago, it was fashionable for cattle producers to regard beef processors as “the enemy.” They decried packers for their perceived market power and that they made millions of dollars per year. Such criticism, was, and still is, based more on emotion than reality.

I have surveyed the packing industry annually since 1988 and last December estimated that the top five packers in 2010 had a 78.7 percent share of total commercial cattle slaughter.

That’s against 78.6 percent in 2009. The top five’s share of steer and heifer slaughter was 89.9 percent versus 89.5 percent. In addition, USDA’s Grain Inspection, Packers and Stockyards Administration, in the 2010 annual report by its Packers & Stockyards Program, says that cattle slaughter and beef processing concentration has generally remained steady since 1995. Nothing changed in 2011.

Another myth is that packers make “exorbitant” profits at the expense of producers. My records show, though, that packers, for most of the 1980s and 1990s, struggled to achieve a margin (income versus total sales) of more than 1 percent. This tiny margin and the enormous amount of money required to operate a beef plant made me wonder why anyone would want to invest in the business. In fact, few people outside the meat industry did. So it was left to the likes of ConAgra Foods, Smithfield Foods (the largest pork processor) and Tyson Foods (the largest poultry processor) to buy into the beef processing industry.

By 2007, U.S. beef packers were enjoying larger profit margins, as high as 5 percent. Most packers reported record margins in 2010 and had another good year in 2011. Few people, though, criticized this, as they realized an economically sound packing industry was vital for the beef industry’s ability to turn live animals into beef items that consumers would enjoy and could afford. Moreover, fed cattle prices made new record highs in 2011 and then in early 2012, which boosted cattle feeding margins.

The past nine months though have proven to be much tougher for packers. Cargill in its 2012 annual report (its fiscal year is June- May) described the year as one of the toughest years for the U.S. beef industry. Examination of Tyson’s beef results also reveals the tough conditions. It had operating income of $31 million in the first quarter (October-December) of fiscal 2012. This was down from $116 million a year earlier and was only 0.9 percent of sales. The January-March quarter was even rougher. It reported a $1 million operating loss, versus a $94 million profit in the year earlier quarter. Profits returned in the April-June quarter, with Tyson reported operating income of $71 million, which was 2 percent of sales.

Tyson’s performance, though, was better than that of JBS USA Beef. It reported negative EBITDA (earnings before interest, taxation, depreciation and amortization) of $45.4 million in 2012’s calendar first quarter and a negative $9.1 million in the second quarter. This went against positive EBITDA of $270 million and $44.7 million, respectively, in the year earlier quarters.

JBS and other packers are hoping for a better supply-demand balance to maintain positive operating margins this year and next. They hope their competitors will show production restraint to the point that they can successfully manage the price spread between their raw material (cattle) and the products they sell.

This will become increasingly difficult however. U.S. cattle numbers continue to decline and this year’s most widespread drought since the 1950s almost guarantees that cattle supplies will not start to increase until 2015 at the earliest. Second, the market over the past year has shown there is significant resistance to wholesale beef prices above a certain point. Yet profitability for packers and the entire industry in the coming year will depend on Americans’ willingness to pay even more for beef. — Steve Kay (Steve Kay is Editor/ Publisher of Cattle Buyers Weekly, an industry newsletter published at P.O. Box 2533, Petaluma, CA, 94953; 707/765-1725. Kay’s Korner appears exclusively in WLJ.)