Ariel Bezalel, Head of Strategy, Fixed Income at Jupiter, explains how the huge pork supply loss from China that has resulted is likely to reshape the global protein market for years to come.
There is a cruel irony that 2019 marks the year of the pig in the Chinese zodiac. African swine flu is harmless to humans but fatal, incurable and highly contagious for pigs. Since the outbreak began in China last August, the government has been working hard to get the disease under control, with limited success. The virus has now also spread to pig populations in other countries in the region. In May, Vietnam reported1 that they had culled 1.5 million pigs in an effort to stem the epidemic.
Official reports from China last year initially indicated that only 1% of their hog population (or 1 million) had been culled to prevent further contamination. Then, in February 2019, reports stated a 17% year-on-year decline in hogs and a 19% decline in sows.2 This translates into around 62 million on an absolute basis. Given this data is delayed and the disease is still far from under control, actual numbers may well be higher.
Pork is a key staple food in China and before the culls the total pig herd population in China was around 400 million. China is both the world’s largest producer and consumer of pork. It produces 47% of the world’s pigs, or more than 54 million tonnes in 2018. It is a minor net importer of pork, having consumed about 55 million tonnes of pork last year, almost half the global total.3 Analysts at BofAML estimate the supply gap left by the disease could be up to 17 million tonnes, which is 30% of China’s pork production and 15% of global production.4
Given the huge supply loss in China and across the region, and the fact that it can take up to two years for hog production to get back to pre-contamination levels, it was no exaggeration when the CEO of Tyson Foods said in May that he had “never seen an event that has the potential to change protein production and consumption patterns as African swine fever does."5
The supply loss in China has already driven higher demand and higher prices for alternative sources of protein like chicken and beef, as well as pork. China imported 106,000 tonnes of pork from the US during just one week in May this year, despite 62% tariffs – an increase from just 1,300 tonnes the previous year. Pork processing margins are expected to increase by around 300bps in 2019.6 Another tailwind for chicken producers has been declining Chinese soybean demand (as it’s a key hog feed component), which is contributing to lower poultry feed costs.
The US and Brazil are two of the largest animal-based protein producers in the world, with the natural resources to support the world with chicken, beef and pork meat. Based on recent data, US chicken pricing has already risen 4.3% year-on-year with margins expanding by 667 basis points (chicken prices benefit from the shorter animal lifecycle, which allows producers to more easily fill the pork supply gap with a cheaper protein). US beef pricing has also benefited, rising 4.0% year-on-year with margins increasing 184bps from 10 year-highs achieved in 2018.7
My team at Jupiter realised the impact African swine flu could have on global markets shortly after the outbreak began last August. In our global unconstrained bond strategy, we already held securities from JBS USA, which is the US credit entity of Brazil-based JBS S.A, the largest global beef and pork processing company. Our credit research in this area and relationship with JBS management alerted us early on to the widespread impact the swine flu outbreak could have on global protein production. When JBS took advantage of renewed investor appetite this year (its bonds are trading at their highest levels for two years and its share price is at an all-time high) to issue bonds to reduce their refinancing risk, we didn’t hesitate to participate in its new issuance, given their market share, low leverage, and strong free cash flow.
Our exposure to the protein producer theme now makes up 2% of the bonds in our strategy. As well as JBS, we also hold bonds from Pilgrim’s Pride, which represents JBS’s poultry operations in the US, Mexico and Europe and already has a strong credit profile; Marfrig, the fourth largest beef producer in the US; as well as two special situations already in the strategy, poultry producers Boparan (UK) and Simmons Foods (US), that have benefited from increased export demand, higher chicken pricing and lower feed costs. Given the severity of African swine flu outbreak, the supply loss, and the time it takes for herds to recover, we believe the market may well be disrupted for at least the next one-to-two years, which should benefit these global protein producers.
1Bloomberg, 20 May 2019
2Bank of America Merrill Lynch, June 2019
3USDA, Financial Times
4Bank of America Merrill Lynch, June 2019
5Noel White, Tyson Foods CEO, Q1 earnings call update, 6 May 2019
6USDA, Bank of America Merrill Lynch, Jupiter research
7Bloomberg, June 2019