June 9, 2010
Stagnation & integration in China's swine sector
The easy money days of record pork prices are over. Costs are up, consumption is down, and only large-scale integrators can beat back foreign competition.
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by SHI Tao in Shanghai
After China's 2007 swine hyperinflation saw the cost of pork double in less than a year, a combination of high prices, the substitution of cheaper meat lines such as poultry and the following year's nasty recession dented both the consumption and production of pork. What is more surprising is that given China's world-leading economic recovery, its swine sector continues to wallow in the doldrums.
Consumption down, imports up, costs rising
This is partly due to pork demand, which has not yet ascended its pre-recession peaks. Even though overall meat consumption continues to rise strongly, per capita pork consumption went from 29.4kg in 2007 40.1kg in 2008 before falling back to 34.8kg in 2009. While consumption will keep pace with population growth, per capita consumption remains well below its 2008 peak, increasingly only marginally.
Going forward, with inventories stagnant, slack mid year hog prices will give way to a stronger autumn. In the late third and early fourth quarter, hog prices should gradually strengthen from RMB10/kg to RMB11-11.5/kg amid rising seasonal demand.
While these prices are relatively high compared to historical prices, they are far below their RMB19/kg peak and have trouble covering record high feed costs. This is particularly true in the case of corn, which costs twice as much in China than in the west. It is for this reason that COFCO, one of China's leading swine integrators, was behind much of the US corn imported into China this year.
On the positive side, China's pork exports to neighbouring Asian countries will respond to this year's low prices by increasing.
At the same time, recent years has seen the country become a net pork importer and will continue to be one. After signing a pork import liberalization agreement with Brazil two years ago, this year has seen China re-open its market to American pork imports. This puts considerable price pressure on domestic pork, though ironically, the resulting lower price makes more of it exportable to its Asian neighbours.
Disease, sow infertility impact inventories
In fact, current low pork consumption and sagging swine inventories not withstanding, unless China can get its hog inventories on a consistent, long-term growth track, the industry will lose increasing market share to imports.
Pork production in 2010 is estimated at 44.502 million tonnes, lower by 3.78% compared with last year's 46.248 million tonnes. At 410.4 million head, early second quarter hog inventories remain roughly 18% below their peak of approximately 500 million several years back. By the end of the year, eFeedLink expects hog numbers to rise to no higher than 416.9 million head.
Over the next quarter, due the disease outbreaks which lowered sow fertility and piglet survival earlier in the year, swine inventory growth will be marginal. Demand wise, hog producers, especially backyard farmers, are not very eager to expand piglet inventories while rearing returns linger around breakeven levels. Hence, we expect piglet replenishments to stay sluggish over the summer.
Moreover, the fact swine rearing revenues have barely kept up with feed costs has done much to destroy the profit motive for hog rearing. Yet, there are also other factors at work. Chief among this is the impact unrelenting disease outbreaks are having on swine rearing profits.
For example, the last few years have seen sows suffer a slew of reproductive difficulties, many of which arise from the mycotoxins often found in their feed. Along with disease outbreaks that impacted both sows and the general hog population, many farmers, fearing further losses, were cautious in their sow and piglet replenishment. Needless to say, this dented inventory growth.
This is not to say the industry has been slow in adjusting. Much consolidation has occurred but much more must still happen, especially if China expects its pork to be globally competitive.
Four years ago, backyard farms containing fewer than 100 swine accounted for 60% of all hog releases to market. Today, they make up 15%. Commercial farms, which made up 30% of hog releases in 2006, now account for 60%.
Integrate or lose competitiveness
In the future however, both commercial and backyard commercial and backyard producers will give way to integrators. They made up only 10% of swine releases in 2006 but account for 20% today. By the end of this decade, they will comprise at least 50% of all hog releases to market.
Furthermore, the rise of integrators will also produce changes in the way meat is processed and hogs are slaughtered. The number of slaughterhouses has fallen sharply. Yet, their number will fall and scale rise even more sharply over the next few years.
The number of outdated manual or semi-automated hog slaughterhouses will fall 30% by 2013 and by 50% by the end of 2015. To better control environmental pollution, 80% of slaughterhouses located in large cities will be eliminated.
To ensure slaughtering reaps economies of scale in large consumer markets, cities with 5 million people or more may not have more than 4 slaughterhouses. In smaller urban areas, cities above the prefecture level are allowed no more than two slaughterhouses. In rural areas, only one slaughterhouse will be allowed for each county.
Only in western China, which is less developed, will the slaughterhouse consolidation be more flexible. Such remote rural regions will be allowed to establish modernized, small slaughterhouses but they must still be operated according to the Management Rules of Hog Slaughtering.
At ground level, this transformation on the part of the hog sector is being reflected in the emergence of roughly half a dozen dominant companies. They are all expanding their hog rearing, slaughtering and meat processing while acquiring smaller competitors in order to absorb their market share.
Yurun, for example, has been and continues to build several slaughtering facilities. By December 2009, it's slaughtering capacity jumped from 10 million to 25.5 million head from a year earlier. It is expected to expand further to 30 million by late 2010.
Shineway Group's slaughtering capacity has reached 15 million head by end of last year and is projected to reach 25 million by late 2010.
Zhongpin Food, which started out as a humble hog slaughtering and farm produce processing enterprise, leveraged its US IPO listing to finance a rapid expansion. In Henan province alone, it has the capacity to slaughter 5 million hogs per year.
By end of 2009, the company Zhongpin had built eight processing plants, located in Henan, Jilin, Sichuan and Tianjin provinces, with the combined capacity to slaughter 7.5 million head. In just a decade, it has come from no where to become the fourth largest hog slaughtering enterprise in China.
COFCO acquired US-owned Smithfield's Maverick Food subsidiary last year while building three ecologically friendly hog farms in Tianjin, Wuhan and Jiangsu provinces respectively. Each of these new facilities can release over a million hogs annually. The company aims to expand its slaughtering capacity to 3 million head per year in the near future.
Tangrenshen, which started in hog breeding, is now constructing an integrated facility with the capacity to raise 10 million and slaughter 5 million hogs each year. Adjoining the new hog raising facility is four pork processing lines.
Since 2008, Thailand-based Chia Tai Group (a.k.a CP) has built integrated 4 hog farming and meat processing facilities. Each one of them has the capacity to raise and release one million hogs annually. In 2009, it made plans to build another 5 similar farms with a combined release of 4.5 million hogs. When the latter's construction is completed, it will double Chia Tai's hog production capacity, and perhaps make it the largest hog integrator in China.
In conclusion, despite the hardship and unemployment integrator-driven consolidation will cause among commercial and backyard producers, there is no alternative. High input prices and thinning profit margins are doing more than driving smaller producers out of business: their undercapitalized nature makes them unable to achieve the scale necessary to bring down swine rearing's unit costs.
Similarly, it is usually smaller, cash-poor producers who are unable to afford high quality feed and try to make up for it by abusing supplements. The resulting disease outbreaks, particularly among sows and piglets, then holds back the growth of inventories. Such a situation, if left unchecked, could make China's pork uncompetitive relative to imports.
The only producers capable of lowering swine rearing's cost base are integrators. Given their rapid expansion, the next five years should see integrators take over from commercial farms as the main drivers of China's hog sector.
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