May 20, 2011

 

US chicken companies wait for competitors to decrease production

 

 

Affected by increasing feed costs and poor demand, chicken companies are considering of reducing production as long as their competitors initiate the cutting.

 

However, none of the large producers, including Sanderson Farms Inc. (SAFM), Tyson Foods Inc. (TSN) and Pilgrim's Pride Corp.(PPC), wants to be the first to cut back. Therefore, supplies stay stubbornly high, prolonging a down cycle that threatens to hit earnings this year.

 

Analysts have been warning of oversupply since last fall but yet eggs set in incubators which are signs of future chicken supply continuing to post small weekly gains.

 

Shares of Tyson and Pilgrim's sank earlier this month following their earnings reports. Pilgrim's reported a greater quarterly loss than expected, and Tyson's stock fell, even as the company reported profits in its chicken business, after its leaders minimised the need for industry cuts. Both companies, which together make up more than 40% of the industry, are hedged on grain costs for several months, giving them little incentive to cut back significantly.

 

Sanderson Farms, which does not purchase its grain in advance, has even expanded production by opening a new plant in North Carolina in January. Although company officials said the timing was bad, they were not about to upend years of planning simply to fend off charges the industry is undisciplined.

 

"I do not think anyone has ever cut production for the good of the industry," Mike Cockrell, Sanderson Farms' chief financial officer, said.

 

Sanderson, which is expected to report a big quarterly loss next week, is counting on a strong balance sheet with little debt to carry it through the down cycle, leaving it in a solid position as competitors fall by the wayside. Pilgrim's and Tyson are making similar bets. However, the process of weeding out weaker companies is taking longer than expected.

 

Tyson, one of the few producers that has remained profitable in chicken, is counting on help from improved chicken demand, and higher prices, as bargain-hunting consumers switch from beef and pork.

 

Its competitors, and many analysts, are not convinced bargain-hunters will be of much help. Sanderson Farms is largely dismissive of that assumption, and Chief Executive Joe Sanderson Jr. told investors on Tuesday (May 17) that an expected bump in demand for Mother's Day as families go out to eat never materialised.

 

Pilgrim's Chief Executive Bill Lovette said the expectation that consumers would trade down to chicken has prolonged the problem, as companies are holding off on production cuts until demand improves. Instead, demand has stayed sluggish since Easter, Lovette told investors on Tuesday (May 17).

 

"Consumers are not as willing to spend as much money on total protein as we expected," Lovette said.

 

Lovette and Sanderson expect supplies to start to decline this summer. Although eggs set in incubators have continued to climb each week for months, Sanderson said a seasonal increase in May eggs sets has not been as high as usual, which could lead to fewer birds by July. Lovette said that as the summer progresses and demand remains sluggish, some producers will start to cut back more aggressively. On Tuesday (May 17), he projected industry output would drop 1% in third quarter and as much as 4% in the fourth quarter.

 

But a Morgan Stanley analyst does not expect producers to start reducing eggs set until the end of summer, which would mean prices would not increase until later this year.

 

Meanwhile, producers, who were highly profitable in 2009 and 2010, generally have less debt than they had during the last down cycle, in 2008, which could allow them to survive longer. That is true even for the smaller companies, Cockrell said.

 

The wild card for the industry is weather in the US Corn Belt. Corn futures are already historically high, having more than doubled since June, and a substandard crop will make high prices well into 2012 a certainty, analysts said. Corn is a major cost for chicken producers.

 

Soggy weather has slowed farmer planting of corn this spring, which could limit the number of acres planted and depress yields come harvest.

 

"All bets are off on animal industries until we have some idea of whether we have got a corn crop or not," said an economist.