CME: Why did JBS Purchase Cargill?

US - Cargill and JBS USA decided to launch some fireworks this week when they announced that JBS would buy Cargill’s pork business, write Steve Meyer and Len Steiner.
calendar icon 3 July 2015
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This was a very well-kept secret as we have found no one that saw this coming. JBS will pay $1.45 billion for all of Cargill’s current pork business including packing plants, feed mills and hog production facilities.

Included in the sale:

  • Two pork packing plants that Cargill acquired in 1987 when it entered the pork business. The plants at Ottumwa, IA and Beardstown, IL hare able to process 18,400 and 19,400 head per day. Both have been modernized in the past few years and are considered to be high quality facilities.
  • Four hog farms — two in Arkansas, one in Oklahoma and one in Texas. The farms are primarily breeding, gestation and farrowing facilities that provide weaned pigs to nurseries and finishing facilities in Missouri, Iowa and Illinois. Cargill has been very active in signing up contract growers in Missouri over the past few years with those barns to finish pigs from Cargill sow farms and then shipping them to the two packing plants listed above.
  • Five feed mills, Two of those are located in Missouri and one mill is located in Iowa, Arkansas and Texas.

So why is is this deal being done and what happens next? JBS has been aggressively buying meat and poultry assets all over the world the past few years so the fact that they are buying is no surprise.

This will be, to our knowledge, their first foray into primary hog production — at least on any scale as significant as this. According to Successful Farming’s 2014 Pork Powerhouses listing of the nation’s largest pork producers, Cargill ranked 8th with 161,000 sows.

JBS is already quite familiar with vertical integration, though, as it is the majority shareholder in Pilgrim’s Pride, a major US chicken producer.

Cargill did not say why it is exiting the pork business. Its press release did say it was not looking to sell but JBS made an offer that demanded consideration. Cargill has long been the fourth largest US pork slaughter firm, trailing Smithfield, Tyson and JBS.

At least one analyst speculated that the inability of moving to one of the top two spots in the industry — the General Electric philosophy, we think — might have been a factor in accepting JBS’s offer.

Pork margins were record high last year on robust domestic demand and PEDv shortened hog and pork supplies.

They have fallen back to more normal levels so far in 2015 but it could well be that Cargill’s management believed that these assets might never have this much value again, especially given the recent completion of the Texas production facility.

The sale is subject to regulatory review and approval and will likely get some close scrutiny from the Department of Justice (DOJ). Putting together the 3rd and 4th largest pork packers will increase the industry’s four-firm concentration ration (CR-4) by 8.2% to 63.0% by moving Hormel to the #4 spot in the rankings.

More importantly, combining these high-ranking companies will drive up the Herfindahl-Hirschman Index (HHI) by about 190 points. The HHI is a measure of concentration computed by summing the squares of each company’s market share.

The pork packing sector has been classified as moderately concentrated for several years due to its HHI of around 1300. We say “around” because our calculations are based on rated capacity and not actual slaughter since we do not know what actual slaughter was for each company.

This merger will move the HHI to about 1500, still well short of DOJ’s 1800 demarcation of a highly concentrated industry. But any increase of 100 points or more in a moderately concentrated sector “raises significant competitive concerns” according to DOJ merger guidelines.

JBS and Cargill are direct competitors for hogs in eastern Iowa for their Marshalltown and Ottumwa plants and in southern Illinois when procuring hogs for their Louisville and Beardstown plants.

The merger does not change concentration in hog production but will almost certainly become a political football for presidential candidates desperately seeking attention in Iowa.

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