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Pork Commentary: Corn Moves Lower

by 5m Editor
10 May 2011, at 9:01am

CANADA - This week's North American Pork Commentary from Jim Long.

July corn has moved from $7.61 a bushel on 29 April to $6.86 a bushel 6 May that is a drop of 75 cents in a week. That is the right direction in our world, taking $7.50 per hog off swine cost of production. A drop of 10 per cent in July corn follows the downward trajectory of oil last week from over $1.10 a barrel to below $100. A couple of weeks ago we made the observation the corn market will follow oils trends, so far lock step. We expect corn will continue to follow oil price trend.

Hog Markets

At the end of last week US National Base 53 – 54 per cent cash lean hogs were 92.17 down 3.00 week over week. Prices are going in the wrong direction. It’s making producers jumpy with feed prices where there at not much of any profit in these prices.

Market hog numbers continue to decline with last week’s US numbers at 1.989 million head we expect going forward week up week of hog numbers fewer than 2 million will push up hog prices to $1.00 lean per pound.

Cash feeder pigs and early weans have come under price pressure, with cash early weans averaging $24.33 (18.00 – 33.00) and 40 pound feeder pigs $62.20 (50 – 54) both groups are down over $20.00 per head from recent highs. These price declines are a reflection of the cost of feed and lean hog future prices and market psychology. Prices of $24.35 for early weans will not encourage expansion.

Larry Pope CEO Smithfield

When the CEO of the worlds largest hog producer talks it’s time to listen. (One million sows). Below is an interview that appeared in the Wall Street Journal with Larry Pope CEO of Smithfield Foods Inc. (not many of us read the Wall Street Journal regularly). We believe it’s a producer’s well articulated assessment of where the hog industry is and our challenges. Read it, largest to smallest producers we have many of the same challenges.

By Mary Kissel

New York

Bobbie Jean Pope, the 81-year-old mother of C. Larry Pope of Newport News, Va., can't afford her bacon.

"I said, 'Mom, I'll get you some bacon.' And she goes, 'I can't afford y'all's meat anymore! Why is y'all's meat so expensive?' And I said, 'Mom, you ought to understand why it's expensive—it's 'cause our costs are so expensive.'"

Mr Pope is the chief executive officer of Smithfield Foods Inc., the world's largest pork processor and hog producer by volume. He doesn't mince words when it comes to rapidly rising food prices. The 56-year-old accountant by training has been in the business for more than three decades, and he warns that the higher costs may be here to stay.

Courtesy of? "I'm not going to say, 'a political policy,'" he tells me. (His senior vice president, a lawyer by training, sits close by, ready to "kick his leg" if his garrulous boss speaks too plainly.) But politics indeed plays a large role, as Congress subsidizes favorite industries and the Federal Reserve pursues an expansive monetary policy.

Ours is a timely chat, given the burst of food inflation the world is living through. Mr Pope is running a multibillion-dollar business in the midst of economic turmoil, and he has strong views about why prices are rising and what can be done about it.

The Southerner is an old hand when it comes to food. He graduated from William and Mary in 1975, spent a few years at an accountancy, then joined Smithfield and worked his way up the ranks. He's something of an evangelist about his trade: He boasts that Smithfield employs some 50,000 people, many of whom are high-school graduates and immigrants others would consider "hard to hire." It's a "good business" that "gives people a good start."

It's also a business under enormous strain. Some "60 to 70 per cent of the cost of raising a hog is tied up in the grains," Mr Pope explains. "The major ingredient is corn, and the secondary ingredient is soybean meal." Over the last several years, "the cost of corn has gone from a base of $2.40 a bushel to today at $7.40 a bushel, nearly triple what it was just a few years ago." Which means every product that uses corn has risen, too—including everything from "cereal to soft drinks" and more.

Inflation: An overview of the prices consumers really pay

What triggered the upswing? In part: ethanol. President George W. Bush "came forward with—what do you call?—the edict that we were going to mandate 36 billion gallons of alternative fuels" by 2022, of which corn-based ethanol is "a substantial part." Companies that blend ethanol into fuel get a $5 billion annual tax credit, and there's a tariff to keep foreign producers out of the US market. Now 40 per cent of the corn crop is "directed to ethanol, which equals the amount that's going into livestock food," Mr Pope calculates.

The rapidly depreciating dollar is also sparking inflation, although Mr Pope says that's a "hard" topic for him to discuss, trying to be diplomatic. But he doesn't deny that money is cheap. Investment bankers are throwing cash at the firm—a turnaround from 2008, when money was scarce—even though Mr Pope doesn't need it right now.

Rising prices are already squeezing food producers' "two to three percent" earnings margins. "Many of us had our costs hedged in the commodity markets and we all took on strident measures to control our cost structures," Mr Pope says. "In the case of Smithfield, we closed six processing plants and one slaughter plant. We also closed 15 per cent of all our live production business." But "once those measures are done, we have no choice but to pass those prices down" to consumers.

Now food price inflation is popping up across the country. A pound of sliced bacon costs $4.54 today versus $3.59 two years ago and $3.16 a decade ago, according to the Bureau of Labor Statistics. Ground beef is $2.72, up from $2.27 in 2009 and $1.74 in 2001. And it's not just Smithfield's products: "You eat eggs, you drink milk, you get a loaf of bread, and you get a pound of meat," he drawls. "Those are the four staples of what Americans eat in their diet. All of those are based on grains."

"Maybe to someone in the upper incomes it doesn't matter what the price of a pound of bacon is, or what the price of a ham, or the price of a pound of pork chops is," he says. "But for many of the customers we sell to, it really does matter." Workers can share cars when the price of oil rises, he quips, but "you can't share your food."

Mr Pope also worries about the impact on farmers, who are leveraging up operations to afford the ever-rising price of land and fertilizer that has resulted from the increased corn demand. "There are record prices for livestock but farmers are exiting the business!" he exclaims. "Why? Farmers know they won't make money."

Weather is a factor, too. "We've had the luxury for the last three years of extremely good corn crops, with high yields and good growing conditions. We are just one bad weather event away from potentially $10 corn, which once again is another 50 per cent increase in the input cost to our live production."

Mr Pope says companies are coping by increasing prices "substantially" or shrinking "what's in the package." "That's the alternative way of passing on price increases . . . 'cause we're all trying to reach price points with our customers in terms of what we can sell somethan' for." "You're ultimately going to buy less bacon. . . . We're going to sell pizzas with less pepperoni on 'em." (Mr Pope's team also laments the effect on beer prices.)

Not all companies will survive this economic whirlwind. Mr Pope recalls what happened the last time there was a surge in corn prices, in 2008: "The largest chicken processor in the United States, Pilgrim's Pride, filed for bankruptcy." They "couldn't raise prices, so their cost of production went up dramatically." Could it happen again? "It darn well could!" Mr Pope exclaims.

Food price inflation isn't a problem confined to America's shores. "This ethanol policy has impacted the world price of corn," Mr Pope says. The Mexican, Canadian and European industries have "shrunk dramatically. . . . We have an unsustainable meat protein production industry," he says. "We're built on a platform of costs, on a policy that doesn't make any sense!"

Nor does the science. The ethanol industry would supply only 4 per cent of the nation's annual energy needs even if it used 100 per cent of the corn crop. The Environmental Protection Agency has found ethanol production has a neutral to negative impact on the environment. "The subsidy has been out there since the 1970s," Mr Pope says. "If they can't make themselves into a viable economic model in 40 years, haven't we demonstrated that this is an industry that shouldn't exist?"

So what's the solution? First, Mr Pope says, get rid of the ethanol subsidies and the tariff. "I am in competition with the government and the oil industry," he says. "It's not fair." Smithfield's economists estimate corn prices would fall by a dollar a bushel if ethanol blending wasn't subsidized. "Even the announcement that it is going away would see the price of corn go down, which would translate very quickly into reduced meat prices in the meat case," he says.

He also advocates lifting regulatory and tax burdens on business. "I fundamentally don't understand the logic of corporate income taxes," he tells me. "If I have a 35 per cent tax, all I do is take that 35 per cent tax and I transfer it into the price of bacon and the price of pork chops."

Then there's the challenge of opening up export markets, which Mr Pope sees as a long-term opportunity for US agriculture. "This is a land-rich country, with rich soils, with the right kind of temperatures and the right kind of cultivation practices," he says. "We can raise livestock and compete with anybody in the world. That's how we can help the balance of payments." (Smithfield has European operations but has had a hard time cracking Asia, and especially China. "It's easy to invest," Mr Pope says, but "it's hard to make money" there thanks to rampant intellectual-property rights violations and other hazards.)

While Mr Pope waits to see how the politics of ethanol and trade play out, he's not standing still. He's assigned one of his senior executives the task of figuring out what else Smithfield could possibly feed hogs, other than corn. Could Mr Pope have envisioned setting up such an enterprise a few years ago? "Absolutely not" he says. "It's me trying to change our business model to adapt to the realities that I have to live in."

Mr Pope says the "losers" here "are the consumer, who's going to have to pay more for the product, and the livestock farmer who's going to have to buy high-priced grain that he can't afford because he's stretching his own lines of credit. The hog farmer . . . is in jeopardy of simply going out of business 'cause he doesn't have the cash liquidity to even pay for the corn to pay for the input to raise the hog. It's a dynamic that we can't sustain."


Ms Kissel is a member of The Journal's editorial board.