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Morgan Alcalay

Pilgrim's Pride is the largest producer of chickens in the United States and the second largest producer in Mexico. In fiscal 2007, the company dressed 7.1 billion pounds of chicken, posting net sales of $7.6 billion and net income of $47 million.^[1]

Approximately 32% of Pilgrim's Pride's profits come from prepared chicken sold to both retail and food service customers, a percentage that the firm hopes to increase in the future.^[2] These products are sold at higher margins, even in times of rising commodity prices - whereas fresh meat is sold to butchers, who then mark up the product to earn a profit. Processing the meat itself allows the company to earn maximum profit from each sale and to pass a higher percentage of input costs onto consumers.

Pilgrim's Pride's profitability is highly dependent on feed costs, which represented 35.8% of total cost of sales in fiscal 2007.^[3]. Significant increases in the costs of soybeans and corn, the main components of chicken feed, have had an adverse effect on profit margins.^[4] Demand for corn, spurred by ethanol production, increased corn prices nearly 60% in 2007 and early 2008.^[5] Increased commodities prices depress margins as Pilgrim's Pride is unable to pass the entire increase in feed prices through to consumers without losing business.

Company Overview

Pilgrim's Pride operates in five primary segments: prepared foods, fresh chicken, exports, other, Mexican production, and turkey.

Prepared Foods

Prepared foods, or any meat that isn't fresh chicken, comprise approximately 32% of total sales.^[6] Approximately 80% of prepared food was sold to food service customers (primarily chain restaurants).^[7] Since 2003, chicken sales to food service customers have grown at an annualized rate of 26.9%.^[8] The remaining 20% was sold to retail customers (primarily whole sale clubs and grocery store chains). Chicken is sold under the brand names Pilgrim's Pride, Pierce, Easy-Entree, and Wing-Dings. Pilgrim's Pride hopes to shift a larger portion of sales to prepared foods in order to take advantage of profit margins higher relative to fresh chicken.

Fresh Chicken

Fresh chicken comprises approximately 43% of total revenue.^[9] Approximately 70% of fresh chicken was sold to food service customers, with the remaining 30% sold to retail customers. Chicken from this division are usually of specific weight ranges pre-cut to customer specifications in order to enhance value and promote product differentiation.^[10]

Exports

Exports comprise approximately 9% of total revenue.^[11] Pilgrim's Pride hopes to increase revenue through international sale of dark meat, as US customers largely prefer white meat. Primary international customers include Eastern Europe, Russia, the Far East, and Mexico.

Other

The other segment comprises approximately 8% of total revenue.^[12] This segment is predominantly made up of table egg sales, with production capacity of more than 42 million dozen cartons of egg a year.^[13]

Mexico

Operations in Mexico comprise approximately 7% of total revenue.^[14] Sales consist primarily of fresh chicken to wholesalers, large restaurant chains, fast food accounts, and supermarket chains. Pilgrim's Pride hopes to begin moving into prepared foods in Mexico in 2008^[15]

Turkey

Turkey production and sale comprises less than 2% of total revenue.^[16]

Financials

As of fiscal 2007, Pilgrim's Pride had $1.3 billion of long-term debt on a $3.7 billion balance sheet. Cash reserves are $66 million, as the company spent much of its retained earnings to acquire Gold Kist in 2006 and the chicken division of ConAgra Foods in 2003. The chart to the left illustrates revenue and operating income from 2003 to 2007. While revenue increased, operating income decreased slightly due to rising commodity prices. The graph on the right illustrates Pilgrim's Pride's sales by operating segment.

The majority of Pilgrim's Pride's revenue is from US fresh chicken and prepared foods sales. Prepared foods, however, offer the largest profit margin so the company hopes to shift a greater portion of revenues to the segment. Additionally, Pilgrim's Pride views Mexico as an emerging chicken market and hope to greatly increase revenue in that segment.

Key Trends, Risks, and Forces

Rising Feedstuff Prices Cut Pilgrim's Pride's Margins

Pilgrim's Pride is heavily dependent on favorable pricing of feedstuff, such as corn prices and soybeans, as feed makes up to 49% of the cost of chicken production.^[17] Corn prices have risen sharply since the beginning of 2007, as ethanol producers have increased their demand for the commodity (rising oil prices, in turn, have increased demand for ethanol). Corn,also the main input for many other products such as high fructose corn syrup, has been facing increasing worldwide demand - but nonetheless the USDA expects U.S. farmers to plant 8% less corn in 2008, lowering supply and increasing prices. ^[18] Pilgrim's Pride engages in various hedging activities to "lock in" to current prices and protect itself from price increases. It does this by buying forward grain contracts at current prices. This means the company is protected in the case of raising prices, but is also liable in the case of falling prices because it will continue to pay the contracted rate. Any long-term, significant increase in feedstuff prices has the potential to seriously depress margins and reduce profitability.

Pilgrim's Pride Has Significant Exposure to Several Customers

In 2007, Pilgrim's Pride's top two customers represented 18% of net sales. The top customer, Wal-Mart was responsible for 12% of sales.^[19] However, Pilgrim's Pride does not have long-term sales agreements with any customers and does not, therefore, have a guaranteed source of revenue. The loss of one of these top customers would have a significant impact on Smithfield's balance sheet.

Pilgrim's Pride's Transition towards Prepared Meats Will Increase Margins

Pilgrim's Pride is looking to increase revenue from prepared meats (currently just over 30% of revenues).^[20] These products carry a higher margin than fresh chicken, because they are sold one step closer to the consumer on the supply chain - to stores, rather than to butchers who then mark up the meat once again before selling to stores. Furthermore, prepared meats decrease feed costs from 33-49% of total production cost to 17-24% of total cost.^[21] Rising commodity prices factor into the price that consumers must pay for their chicken, but these input costs cannot be passed on in their entirety. By eliminating an extra step in the sales process, Pilgrim's Pride can pass a higher percentage of production costs onto the consumer as well. As of 2007, Pilgrim's Pride sold $2.4 billion of prepared chicken versus $3.3 billion of fresh chicken.^[22]

Poultry Prices Fluctuate Often

Though chicken prices are mostly responsive to input feed prices, they are also affected by international competition, high domestic production, seasonal fluctuations, and fear of avian bird flu. Though only 15% of total domestic production and only 9% of Pilgrim's Pride's production is exported, international competition can drive chicken prices up or down.^[23] Strong export markets have been the main drivers of the poultry industry's growth, so a global surplus has an adverse effect on domestic producers.^[24] Global surpluses can be exacerbated by domestic surpluses, the shortest of which can cause long lasting price swings.^[25] Next, seasonal hatchings create a variable supply of chickens which in turn cause prices to fluctuate. Finally, fears of avian flu decrease chicken demand, and therefore chicken prices, as consumers react to outbreaks of the disease and substitute other protein sources, such as pork or beef, for chicken.^[26]

Competition

Pilgrim's Pride is currently the world leader in chicken production and has approximately 25% of the market share in United States chicken, according to the company's estimates.^[27] In 2006, the last year for which data was available, approximately 35 billion pounds of chicken was produced in the US.^[28] Of this, 7.7 billion pounds were produced by Pilgrim's Pride.^[29] Though the market leader, Pilgrim's Pride faces competitive pressure from a number of different sources:

Tyson Foods Tyson Foods has the second largest share in the US chicken market. Unlike Pilgrim's Pride, Tyson Foods produces beef and pork in addition to chicken. Tyson Foods's chicken segment, which posted $8.1 billion in sales in 2007, is more heavily weighted towards value added branded products.^[30]

Perdue Farms Perdue Farms is a privately held poultry company with an 8% share in the US poultry market. Perdue Farms sells branded retail poultry primarily to customers in the eastern and southeastern United States.^[31] Perdue Farms largest customers are national restaurant chains, the U.S. military, and the national and regional distributors.

Sanderson Farms (SAFM) Sanderson Farms has a 5% share of the US chicken market. Sanderson Farms concentrates its sales predominantly in the southeastern, southwestern and western United States.^[32]

Below is a graph detailing total US market share, by total pounds of chicken produced, among chicken producers. Pilgrim's Pride and Tyson Foods (TSN) dominate the market, with over 45% combined market share.

^[33]

The following graph details relevant operating metrics for the major US protein companies: The following graph

^[34]

References

1. ↑ [1]PPC 2007 10-K, Item 1, pg.4
2. ↑ [2]PPC 2007 10-K, Item 1, pg.5 (Total Prepared Foods/Total net sales)
3. ↑ [3]PPC 2007 10-K, Item 1, pg.12
4. ↑ [4]PPC 2007 10-K, Item 1a, pg.24
5. ↑ [5] National Corn Growers Association Futures Quotes
6. ↑ [6]PPC 2007 10-K, Item 1, pg.9
7. ↑ [7]PPC 2007 10-K, Item 1, pg.11
8. ↑ [8]PPC 2007 10-K, Item 1, pg.14
9. ↑ [9]PPC 2007 10-K, Item 1, pg.9
10. ↑ [10]PPC 2007 10-K, Item 1, pg.15
11. ↑ [11]PPC 2007 10-K, Item 1, pg.9
12. ↑ [12]PPC 2007 10-K, Item 1, pg.9
13. ↑ [13]PPC 2007 10-K, Item 1, pg.17
14. ↑ [14]|PPC 2007 10-K, Item 1, pg.9
15. ↑ [15]|PPC 2007 10-K, Item 1, pg.18
16. ↑ [16]|PPC 2007 10-K, Item 1, pg.9
17. ↑ [17]|PPC 2007 10-K, Item 1, pg.5
18. ↑ [18]|"USDA Bets on Soy, but Farmers Like Corn"
19. ↑ [19]|PPC 2007 10-K, Item 1a, pg.19
20. ↑ [20]|PPC 2007 10-K, Item 1, pg.9
21. ↑ [21]|PPC 2007 10-K, Item 1, pg.5
22. ↑ [22]|PPC 2007 10-K, Item 1, pg.9
23. ↑ [23]|"Poultry"
24. ↑ [24]|"Chicken prices: Gradually coming back to Earth"
25. ↑ [25]|"Challenges and opportunities for marketing of poultry products"
26. ↑ [26]|"Meat and Poultry Prices Rise"
27. ↑ [27]|PPC 2007 10-K, Item 1, pg.5
28. ↑ [28]|U.S. Broiler Industry: Background Statistics and Information
29. ↑ [29]|PPC 2007 10-K, Item 1, pg.4
30. ↑ [30]Wikinvest, Tyson Foods
31. ↑ [31]Perdue Farms: Our Products and Services
32. ↑ [32]Sanderson Farms Reuters Online
33. ↑ [33]|Pilgrim's Pride Corporate Fact Sheet
34. ↑ [34]Wikinvest, Tyson Foods