Meat Cos. Find Pigs Do Fly, But Chickens Sales Flap

By Doug Cameron

Of DOW JONES NEWSWIRES

Wall Street Journal

August 1, 2008 10:50 a.m.

CHICAGO (Dow Jones)--Back in the days when U.S. airlines still served meals, no coach-class journey was complete without the tough choice of whether to opt for the "chicken or the beef."

Now, with both airlines and meat producers hammered by rising energy costs, parallels between the two sectors are as close as the taste of the entrees.

High energy prices, domestic overcapacity and a greater focus on international markets are all shared by the carriers and meat industry leaders such as Tyson Corp. (TSN), Pilgrim's Pride Corp. (PPC) and Smithfield Foods Inc. (SFD).

The U.S. meat industry also shares the need to make better use of its high fixed costs such as processing plants, just as the airlines have to fill planes. It may not be staring at the $10 billion loss faced this year by U.S. carriers, but it is an industry in trouble.

Overcapacity in the chicken sector is countering the improved performance of beef and pork segments, which are both being helped by rising export sales to emerging markets.

"It is pretty common knowledge that in the long run, the industry cannot continue the level of losses that are being incurred," said Dick Bond, Tyson's chief executive officer during a conference call this week.

Tyson, the world's largest meat processor by revenue, barely broke even in its fiscal third quarter this week, weighed by its poultry unit.

Consumers Face 'Sticker Shock'

Bond is not averse to hyperbole, particularly when directing his ire towards the ethanol industry subsidies that he blames for high feed prices.

However, the losses run up by Tyson and Pilgrim's Pride - the largest U.S. chicken processor - in the June quarter highlight the challenges faced by executives.

Clint Rivers, Pilgrim's CEO, said the industry needs chicken breast prices to rise to $2.15 a pound to break even, and to $2.25 for normalized earnings. Instead, overcapacity during the peak U.S. grilling season left prices at $1.33.

Rivers has cut production by 5%, but said other processors have boosted rearing following a period of capacity discipline at the end of last year.

Bond warned losses in the chicken unit could worsen in the current quarter, though is optimistic more input costs can be passed on to consumers.

Tyson and Pilgrim's have both cut the length of contracts to the foodservice clients that supply restaurants from a year to 90 days in order to keep abreast of price changes. Retail customers will also be challenged to pay more at the grill.

"American consumers should brace themselves for sticker shock in the meat case over the next 12 months," said Rivers on a conference call this week as the company reported a $52.8 million second quarter loss.

Hedging The Problem

A key ingredient for the meat industry is improving its risk management to counter the impact of high energy and grain prices.

Southwest Airlines Inc. (LUV) has been the standard bearer for using hedges to navigate through volatile input costs. It has racked up 69 consecutive quarters of profitability, helped in large part by successful fuel hedges. "Certainly Southwest has used hedging to great effect, and all of the major carriers are now hedging their fuel costs to a degree," said Stephen Brown, director of corporate finance at Fitch Ratings.

Meat producers have been slower to develop hedging strategies because, until relatively recently, their input costs were less volatile than jet fuel, according to Dale St. Denis, vice-president at SolArc Inc., a Houston risk-management company whose clients include Southwest and Tyson.

"The protein producers face a bit more of a challenge," said St. Denis, noting increased efforts by the industry to beef up their efforts.

"Their finished product is not something that can be hedged directly," he continued. While airlines have good proxies for jet fuel in heating oil futures and swaps, food producers have to hedge multiple inputs.

As well as feed grain and animal costs, producers also have to factor in diesel for transportation and gas for drying grain.

"It's been difficult to figure out what position to take," said Rivers at Pilgrim's Pride, which appointed its first chief risk officer just last year, but generally declines to comment on its hedging policy..

Chicken producers are hardest hit, as there is no active poultry futures market, in contrast to the hog and live cattle contracts available through, for example, CME Group Inc. (CME).

CME made several attempts to launch a poultry future a number of years ago, but the proposals lacked support from the industry at a time when prices were less volatile.

International Rescue

With domestic markets in trouble, meat producers are turning to the international arena to restore profitability. The shift to more protein-rich diets in emerging markets is providing meat producers with the same tailwind international passengers give to U.S. airlines.

Pork producers such as Smithfield Foods, the market leader, have been the main beneficiaries, with China boosting imports after an outbreak of disease in its domestic herd created shortages.

The beef market has been boosted by regulatory changes, just as airlines have used liberalization moves such as the open-skies deal between the U.S. and the European Union to boost their international exposure.

The reopening of the South Korean and Japanese markets earlier this year following long-running concerns over quality controls has been key. Bond predicted Tyson's current quarter would be a "blockbuster" for beef sales.

Even beleaguered U.S. chickens are enjoying more popularity overseas, notably in the Middle East. Rivers said Pilgrim's Pride, helped by the weak dollar - was successfully selling whole birds into a market that had historically been limited to lower-margin leg quarters, wings and paws.

-By Doug Cameron, Dow Jones Newswires

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