China’s Growing Appetite For Pork To Impact U.S. Meat Industry

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Quick Take

  • Smithfield Foods (NYSE:SFD) agrees to be acquired by China-based meat processing company Shuanghui International.
  • Rising demand for pork at home and livestock feed supply issues has prompted the Chinese firm to acquire the North American firm.
  • Higher exports to China will lead to higher domestic pork prices, which will increase the input costs of U.S. based packaged meat companies.

Smithfield Foods Inc. (NYSE:SFD), the world’s largest pork producer by sales volume, has agreed to be acquired by Shuanghui International Holdings, a privately owned meat processing company headquartered in China, for $7.1 billion including debt, valuing the company’s equity at $34 per share. [1] Although the deal still needs to receive shareholder and regulatory approvals, we believe it can have a significant impact on the North American meat industry as it will lead to higher pork prices in the U.S. Packaged meat companies like Hillshire Brands (NYSE:HSH) are expected to witness higher input costs and an improvement in volume market share in the long run as a result of this deal.

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What Drove The Deal?

The meat industry in China is facing issues such as:

  • rapidly growing demand due to rising income levels of a huge population size,
  • rising production costs due to livestock feed supply issues and shrinking available land due to industrialization, and
  • quality concerns that keep surfacing in events such as the tainted milk scandal in 2008 and more recently, the illegal dumping of hogs in river water.

These problems formed the basis of Shuanghui International’s quest to acquire the North American meat producer. The Chinese company is looking to reduce supply uncertainties that come along with the scarcity of livestock feed in order to be able meet the rising demand at home. It also aims to reduce quality concerns at the same time by selling “American” meat to consumers in China.

Pork is the most popular meat in China as it forms more than three-fourths of total meat consumption in the country. The nation produced more than half the world’s total pork in 2012, while consumers spent around $183 billion consuming it. Moreover, demand for the meat is only increasing as disposable incomes of more than 1.3 billion people in China are rising. It is also reflected in per capita consumption of meat in China that has increased more than four times since 1980 to almost 60 kilograms annually.

On the other hand, the availability of arable land is declining rapidly in China due to industrialization, which is limiting the supply of crops used as feed for livestock. Imported feed costs more and has led to higher costs of meat production in China than in the U.S. During 2012, China imported around 60% of the world’s total soybean produced, primarily to feed pigs. [2]

What Does It Mean For the U.S. Packaged Meat Industry?

The deal is subject to Smithfield Foods’ shareholder approval and approval from the Congressional Committee on Foreign Investment in the U.S. However, if the deal goes through, it will imply higher meat exports from the U.S. This will lead to higher domestic prices and an increase in costs for packaged meat companies such as Hillshire Brands. This was also reflected in hog futures on the Chicago Mercantile Exchange (CME) that spiked to a two-year high on Monday, June 10. Smithfield is a vertically integrated meat player which also sells packaged meat products along with maintaining livestock farms. With an increased focus on pork export to China once the company is acquired, it will also reduce competition in the domestic packaged meat market. While the extent of the rise in input costs transferred to consumers will depend on the pricing power of each brand, the volume market share for domestic players is expected to grow in the long run.

We currently have $37 price estimate for Hillshire Brands which is around 10% above the current market price. We expect the company’s retail market share by revenues in the U.S. packaged meats market to rise to around 3.5% over the forecast period. The market share increase will primarily be driven by the growing brand strength due to increased marketing. Apart from Smithfield Foods, the company competes with other players like Tyson Foods (NYSE:TSN), Kraft Foods Group (NASDAQ:KRFT) and Hormel Foods Corporation (NYSE:HRL) in the U.S. food market.

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Notes:
  1. Changing China Food Safety Key to Shuanghui on Smithfield, www.bloomberg.com []
  2. China’s taste for pork serves up a pollution problem, www.guardian.co.uk []