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Andrew Liyana

This article refers to livestock in general. For specific types of livestock, see the articles on Beef, Pork, and Chicken. For specific futures contracts, see Live Cattle Futures, Feeder Cattle Futures, Lean Hogs Futures, or Pork Bellies Futures.

Cattle (beef), pigs (pork), and chickens (poultry) are the three major categories of livestock raised for human food consumption. Each exhibit unique characteristics, such as different feed conversion ratios - for example, chickens convert feed mass into body mass 4 times more efficiently than cows.^[1]

However, prices for all three of these types of livestock are dependent on similar global trends and forces. Not only do increasing Corn Prices and other feedgrains like soybean meal, barley, and sorghum drive livestock expenses higher, it also increases incentive to use land to grow crops rather than raise animals for meat production, driving prices up even further. Rising input costs hurts companies like Pilgrim's Pride (PPC), Tyson Foods (TSN), and Smithfield Foods (SFD). On the flip side, strong global demand for meat boosts prices, which helps operating margins. Increasing wealth worldwide has driven meat consumption higher in 2007 and 2008, especially in emerging markets.^[2] In 1985, the average Chinese person consumed 20kg (44lbs) of meat annually. In 2008, the figure is 50kg (110lbs).^[2]

Another factor impacting this industry is global demand for corn-based ethanol, used as a fuel source.^[3] This demand has driven up Corn Prices and Soybean Prices, but comes at the expense of the livestock industry. Ranchers and hog producers have opted to liquidate herds rather than have to pay for another mouth to feed.^[4] This, in turn, has caused a supply spike and forced meat prices lower. So as futures prices of feedgrains rise, it does not translate to higher cattle and hog futures contract prices or help companies raising livestock. However, in the long-run, as producers switch from raising livestock to growing grains, livestock operating margins improve as more crops lowers costs of feed and less meat production supports prices.

The chart at left shows continuos front-month futures prices for Live Cattle traded on the Chicago Mercantile Exchange.

Which Companies Benefit From Higher Livestock Prices?

• Companies that raise and process livestock benefit most from rising livestock prices. Included in this category are Tyson Foods (TSN), Sanderson Farms (SAFM), Smithfield Foods (SFD), and Pilgrim's Pride (PPC). Rising meat prices, with feed costs constant, means these companies are able to generate a higher profit margin per pound of meat sold. Pilgrim's Pride is the largest chicken processor by volume.^[3] Tyson sells pork, beef, and chicken, while Sanderson mainly markets chicken. Smithfield is the largest processor of hogs.^[5]

• Businesses that have oilseed crush plants like Archer-Daniels-Midland Company (ADM) benefit from rising livestock prices. Approximately 82% of the soybean crush yields soybean meal, which is a protein rich livestock feed^[6]. Rising livestock margins promote building livestock stocks, which increases demand for meal.

• Antimicrobial manufacturers benefit when livestock prices increase. Factory meat farms, especially poultry ones, account for 70% of all antimicrobial consumption.^[7] Livestock is fed antibiotics in order to prevent disease from spreading and sickening/killing an entire flock or herd. Good margins support more livestock and increase demand for antimicrobials. Companies that produce antimicrobials include Sanofi-Aventis SA (SNY) and Merck (MRK), which own a joint venture, Merial, that sells animal health products.^[8]

Which Companies Suffer From Higher Livestock Prices?

• Firms like Monsanto Company (MON), Potash Corporation of Saskatchewan (POT), DuPont (DD), and Agrium (AGU) lose when livestock prices rise, but Grains Prices remain unchanged. These fertilizer and seed marketers benefit when crop acreage increases; better livestock margins keep ranching lands from transitioning into crop production.

• Restaurants, such as Texas Roadhouse (TXRH), Darden Restaurants (DRI), and Ruby Tuesday (RT) suffer from higher livestock prices. Their food costs rise and squeeze operating margins, because restaurants are not able to pass on all the higher costs to consumers.

What Impacts the Price of Livestock?

Corn Prices

Corn accounts for the largest portion of livestock feed in the United States.^[9] Between August 2008 and September 2009, the US government estimates that 5,200 million bushels of the total 12,072 million bushels corn produced will be used for livestock feed.^[9] In comparison, only 250 million bushels of wheat, 210 million bushels of sorghum, and 120 million bushels of oats are expected to be incorporated into feed rations.^[9]

Corn-Hog Ratio plotted using FutureSource^[10]

USDA Long-term Projections, "Livestock", February 2008^[11]

Domestic livestock owners compete with ethanol producers and the export business for corn. As a result, higher ethanol prices resulting from increasing Crude Prices drive demand for corn higher. Also, a weakening dollar supports foreign demand for corn as foreign currencies purchasing power rises. These dynamics in turn drive livestock margins down as input costs rise. Rather than feed cows, pigs, and chickens at flat to negative operating margins, livestock owners opt to slaughter more of their herd. This liquidation supplies the market with excess meat and drives prices lower in the short-term. Equilibrium is restored in operating margins by either greater supply of feedgrains driving input prices lower or decreased livestock production increasing market prices.

Corn-Hog Ratio

With corn being such an important component of livestock feed rations, traders use the hog ratio as a quick tool for determining hog margins and predicting future price.^[12] The corn-hog ratio is the price relationship between one bushel of corn and 100 lbs (1 cwt) of live market hog.^[13] The benchmark is 1:12. If the ratio is less than 1:12, it is estimated that hog production is unprofitable; above 1:12, it is.^[13] This chart shows how the corn-hog ratio has deteriorated since 2006. The price of a bushel of corn has rose much more relative to the price of 1 cwt of hog.^[10]

Substitution between Beef, Poultry, and Pork

Consumers have the option of substituting away from meat completely and into cereals and vegetables if prices are too high, but they also can shift consumption between the three main meat categories. In general, beef is the more expensive relative to chicken and pork. As of June 2008, a pound of Choice Steers cost 93 cents, while pork was 53 cents and chicken 81 cents.^[9] The variation in prices is largely due to variation in feed conversion ratios. Since chicken and hogs convert 1 kg of feed into 2-4 times as much body mass than a cow, it makes producing poultry and pork less expensive than beef.^[1] Therefore, in a time of rising feedgrain prices, one would expect that beef consumption/production would not grow as much as poultry or pork. The USDA forecasts this in its meat production projections through 2017.

Disease Scares

Outbreaks of livestock diseases temporarily shift consumption habits. Breakouts of Mad Cow Disease shift demand away from beef; thus, negatively impacting prices for cattle. Similar, scares of bird-flu or E. Coli decreases poultry demand and prices.

Increasing Standard of Living Supports Demand for Meat

Increasing wealth drives meat demand higher.^[7] In the developing world, an average person consumes 30kg (66lbs) of meat per year, but in industrial nations, a typical person eats more than 80kg (176lbs) of meat annually.^[7] Total global meat production is expected to be 280 mmt in 2008 and be nearly double that amount in 2050.^[7] Rising demand supports meat prices, but also, crop prices as well; more cattle, hogs, and poultry will put pressure on feed stocks.

Futures Contracts

Livestock prices mostly refer to the following four future contacts. All of them trade on the Chicago Mercantile Exchange

1. Live Cattle Futures (finished cows that are ready for slaughter): Global Exchange Ticker = LE: Contract Size = 40,000 pounds: Quoted in $ per 100lbs
2. Feeder Cattle Futures (650-849 pound calves that are to enter feedlots and eventually be sold basis the Live Cattle Futures): Global Exchange Ticker = GF: Contract Size = 50,000 pounds: Quoted in $ per 100lbs
3. Lean Hogs Futures (used in reference to cash hog and product prices): Global Exchange Ticker = HE: Contract Size = 40,000 pounds: Quoted in $ per 100lbs
4. Frozen Pork Belly Futures (based on pork meat packers supply and demand): Global Exchange Ticker = GPB: Contract Size = 40,000 pounds: Quoted in $ per 100lbs

Futures contract reflect underlying supply and demand, current market prices, and price relationships to feedgrains. High corn prices lead to decreased margins in cattle ranching. The lower profit margins contribute to liquidation of herds that floods the market with excess beef supply. In order to find demand, the nearby future contracts (the close months) will fall in price. However, more distant contracts would rise in price assuming that less cows will be available to meet future demand.

Recent News

Pilgrim's Pride (PPC) hedge losses

Pilgrim's Pride (PPC) is the largest chicken processor by volume.^[3] On September 25, 2008, the company warned that it will report a significant loss for its fiscal fourth quarter, which ends September 27th. The company blamed high Corn Prices and Soybean Prices for the losses.^[14] Pilgrim's Pride had purchased corn futures at peak prices during the summer of 2008 to hedge its business; however, Corn Prices fell $2 per bushel and created liquidity issues for the company. For the first nine months of 2008, the chicken processor already has a net loss of $197 million.^[3] In order to help curb losses, the company announced it will immediately close seven U.S. facilities and cut 1,100 jobs.^[15] The news sent stocks of competitors, Tyson Foods (TSN) and Sanderson Farms (SAFM), higher; less supply supports higher meat prices.^[3]

Food Versus Fuel Debate

TheHill.com "Food, livestock groups push policies to reduce corn prices" Livestock lobbyists, along with food and restaurant groups, are asking Congress to reduce ethanol production mandates, remove the 54 cent tariff on sugarcane ethanol imports, and permit early planting of acres restricted under the Conservation Protection Program.^[16] The lobbyists argue that ethanol production has driven corn prices higher, which has increased input costs for the livestock industry; 70% of pork production costs is feed.^[16] The U.S. Department of Agriculture released "The Impact of Ethanol Production on Food, Feed, and Fuel" in August of 2008, which claims that ethanol production has had a minimal impact on consumer food prices^[17], and therefore, could not justify reducing the ethanol mandate that calls for 9 million gallons of ethanol to be produced by 2009.^[16]

Data

United States and Canada Cattle Inventories

Commercial Red Meat Production: United States

NASS Livestock Slaughter^[19]

References

1. ↑ ^{1.0 1.1} Pork-Checkoff - Quick Facts - Pork Story
2. ↑ ^{2.0 2.1} Seeking Alpha: "Price Increases Create Supermarket Shock for Consumers, Strong Returns for Commodities Investors", January 11, 2008
3. ↑ ^{3.0 3.1 3.2 3.3 3.4} MarketWatch, "Pilgrim's Pride Plunges on Mounting Losses", Matt Andrejczak, Sept. 25, 2008
4. ↑
5. ↑ Wiki Article (SFD), Author: Morgan Alcalay
6. ↑ Soybean Complex by Abhilasha M. Rathi and Bhaskar Natarajan
7. ↑ ^{7.0 7.1 7.2 7.3} World Watch Institute "Meat Production Continues to Rise"
8. ↑ Merial Company Website
9. ↑ ^{9.0 9.1 9.2 9.3} USDA World Agricultural Supply and Demand Estimates, September 12, 2008
10. ↑ ^{10.0 10.1} FutureSource "Futures & Commodities Quotes, Charts, Analysis, and News
11. ↑ USDA Long-term Projections, "Livestock", February 2008
12. ↑ Global Futures Group "Feed Ratio"
13. ↑ ^{13.0 13.1} University of Kentucky: College of Agriculture "Animal Agriculture in the United States"
14. ↑ Yahoo! Business Articles, "Pilgrim's Pride to post big loss in 4Q, talking with lenders; shares drop nearly 40pct," Author: Emily Fredrix
15. ↑ USA TODAY, "Pilgrim's Pride shuts 7 sites, blames cost of chicken feed," Author: Edward Iwata
16. ↑ ^{16.0 16.1 16.2} TheHill.com "Food, livestock groups push policies to reduce corn prices"
17. ↑ Food and Fuel America: "Corn Ethanol Has Minimal Impact on Food Prices"
18. ↑ NASS United States and Canadian Cattle
19. ↑ ^{19.0 19.1} NASS Livestock Slaughter Archive