August 17, 2012
China's feed sector consolidation
Value added products and services are the best long-term survival strategy.
by David LIN
An eFeedLink Hot Topic
Entering the 21st century, there has been a sharp rise in the prices of China's macro feed ingredients. A portion of small and medium-scale feed mills, increasingly challenged by escalating ingredients costs and shrinking profitability, were squeezed out of the industry. Meanwhile, large feed mills, which enjoyed the advantages of economies of scale and strong capital backup, continued to expand by mergers, reorganisation and expansion of production facilities. Statistics show that in 2006, there were 15,501 feed mills in China.
The number rapidly decreased to 13,612 in 2008, and to 10,834 in 2010 - a sharp reduction of 30% in a short span of 4 years. From 110 million tonnes in 2006, feed output jumped almost 54% to 169 million tonnes in 2011. This output rise was mostly driven by an increase in the number of large-scale feed mills and in their average capacity level.
In 2006, there were 140 feed enterprises with annual output of 100,000 tonnes of feed or more. By 2008, there were 187 feed mills of such scale. By 2010, 283 feed mills produced 100,000 tonnes of feed or more, 30 feed mills with annual production exceeding 500,000 tonnes, and 19 producers with annual output above one million tonnes. Enterprises producing 500,000 tonnes of feed annually have captured 43% of China's market.Currently, there are 11 listed feed companies in China, namely New Hope Liuhe, Haid Group, Da Bei Nong Group, Tecon Animal Husbandry Bio-Technology, Tong Wei, Zhenghong Science and Technology, Ningbo Tech-Bank, Tong Wei, Shenzhen Jinxinnong Feed, Zhengbang Technology, TRS Group and Kondarl Group.
According to these companies' annual report statistics, their combined sales of feed in 2011 increased by a prominent 29.71% from 2010 levels. With the addition of Wellhope Agri-Tech, (which is currently applying for listing), these 12 companies produced a total of 33 million tonnes of feed last year, accounting for 19.58% of China's supply - the result of consolidation over the past several years.
Fast growth of newcomers
Out of the 11 listed companies, other than Kondarl, Zhenghong, New Hope and Tong Wei, which had their companies listed before 2000, the remaining seven companies were all listed after 2007.
Statistics show that growth rates of new listed companies were higher than those of the companies listed earlier. In 2011, growth rates of the four companies that were listed earlier were between 10% and 20%, whereas companies listed after 2007 generally achieved higher growth rates.
For instance, the sales of Da Bei Nong's in 2011 rose by 51.62% to RMB694 million (US$108.8 million), and 89.21% of this sales figure was contributed by feed sales, which increased 44.49% to 1.81 million tonnes. Haid Group's feed sales amounted to 3.39 million tonnes, helping to boost its annual revenue to RMB11.98 billion (US$1.88 billion), a tremendous rise of 55.58% compared with 2010. By restructuring itself and focusing on the livestock sector, Zhengbang successfully pushed up its sales of feed to 3.53 million tonnes, registering the highest increment of 47.94% last year.
Low profit margins vs high ROE
Last year, other than Kondarl, whose net profit jumped 36% due to a sharp rise in water supply business' revenues, the gross and net profit margins of all listed feed companies were on the low side. Da Bei Nong achieved the highest gross profit margin of 18.58% while Zhengbang had the lowest, at 3.75%; on average, the gross profit of listed feed companies was 9.6%. Although feed producing enterprises enjoy tax benefits, the net profits of feed manufacturing were unimpressive.Da Bei Nong recorded the highest net profit margin of 6.43%, while Jinxinnong, Haid and Tecon had about 2% of net profit margin. Other listed feed companies made less than 1% net profit margins. However, feed companies have done well with regards to return on equity (ROE), ranking among the highest in agribusiness. This is because of the high turnover and sales of the feed industry.
Challenges, strategies
Orient Securities pointed out that high turnover in feed industry has been overlooked. Feed is usually regarded as an industry with low gross profit margin and little technical content. Hence, the advantages of high turnover rates are often ignored, resulting in low attention and valuation of feed companies' stocks. For instance, in 2011, the ROE of feed sector is seven times, six times and 4.5 times that of seed, aquaculture and vaccine sectors respectively. According to Haid Group's annual report, average days sales outstanding (DSO) was 4.68 days and average days sales of inventory (DSI) was 22.32 days.
As Haid Group wrote in its annual report, there is a high dependency on manpower due to high turnover and sales rates. In other words, the advantage of the industry is also its weakness in the past few years, as China's surging labour costs have cut into thin profit margins.
In recent years, domestic production of feed grains has seen its growth decelerate. Animal husbandry faces chronic shortages of feed grains and protein meal ingredients. Prices of soymeal have been volatile while those of corn stood stubbornly at record-high levels, 50% higher than what they cost in the west. As corn and soymeal account for about 55% of raw materials costs, the strong prices are putting considerable pressure on feed suppliers.
In response, feed companies adopted different strategies. Since 2009, New Hope has centralised its procurement of raw materials, utilising the company's economies of scale. This approach has proved effective in lowering ingredients costs. On the other hand, Haid
Group began trading grains as a means to control raw materials inventories and manage procurement risks. On a similar note, Da Bei Nong buys Dalian Commodities Exchange future contracts of corn, soymeal, oils, rice bran, cottonseed meal, rapeseed meal and flour among others as hedging instruments. There appears to be no right method, as the success of a particular strategy seems to matter more than the strategy itself.
After several years of development, feed companies succeeded in having nationwide operations throughout China, whose land mass is as large as that of the US. This resulted in price competition in some regions.
For example, in Guangdong province, shrimp feed market has been engaged in price wars in the recent years, disguised in various forms of discounts and promotion ac tivities – at the expense of feed mills' profitability. While price wars between large companies and their smaller counterparts helped the former to expand, a fight between larger players would only result in a lose-lose situation.
To avoid such a situation, many feed companies pursued product specialisation. For example, Haid Group focused on developing specialised high-grade aquatic feed with an investment of RMB110 million (US$17.24 million) last year in this area, a jump of 121.41% compared with 2010's input. Over the same time, its R&D staff more than doubled to 668, from 307 staff in the previous year, a strong indication of the company's dedication to research in coming years.
With a different emphasis, Da Bei Nong leads in piglet feeds, which boast a robust growth of 67.91% in sales to RMB1.8 billion (US$282.13 million) last year. Its two core feed products, one for pre-weaned piglets and the other for weaned piglets, increased 101.37% and 61.34% in sales respectively. The company invested RMB184.92 million (US$29.0 million) in R&D in 2011, researching on various areas ranging from microbial feed ingredients to rice and corn seeds.
Clash of the titans
Although the feed sector has been under rapid consolidation since the beginning of this century, the degree of industry concentration lags that of agricultural sectors. In 2010, the average feed output of 10,843 feed mills in China was only 14,900 tonnes, far below the average of feed industries in developed countries. Industry consolidation is set to maintain its momentum, especially with feed ingredients costs soaring and the livestock sector increasingly integrated. Smaller feed mills will fall out from a race that undeniably favours large players.
Two other development directions of the feed industry will be vertical integration and product specialisation, depending on the feed type. While the aquatic and piglet feed sectors will see more specialised products in the market, the poultry feed sector will see more companies becoming integrators running poultry feed and farming operations.
Only companies large enough to list a decade ago or those which listed and grew rapidly over the last five years will have the resources to resist being taken over or driven out of business. For now, the size of large feed companies will increase, as smaller participants leave the industry.
Eventually, however the time will come when large powerful feed firms will have to face one another squarely. By then, there would have been a shift from product competency to value chain competency, a contest to see who can offer more added value.
In future competition, analysts predict that the ones that can provide differentiated products with high performance-price ratio, have more comprehensive services and offer more added value will have the competition advantage. Largely undeveloped, these competency frontiers are the best survival hope of China's emerging feed industry giants.
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