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Biggest Pork Player In The World, Should You Invest In It?
Corporate Digest | 26 September 2014
By: Shane Goh
Articles (99) Profile

On 5 August, WH Group (288:HK), the world’s largest pork company with leading market shares in US, China and key markets of Europe listed on the Hong Kong Stock Exchange.

Through its three business units, the firm produces pigs, fresh pork and packaged meat.

In Asia, WH Group has Shuanghui Development, the continent’s largest animal protein company.

In September 2013, the company acquired US’ biggest pork company, Smithfield, for US$4.9 billion.

Through its 37 percent stake in the Campofrio Food Group, WH Group has a stake in the largest packaged meat company in Europe by sales.

World Pork Consumption Driven By China
Based on data from US Department of Agriculture, China made up more than half of the global pork consumption in 2013 due to growing income. And the figure is set to rise.

In 2012, the Chinese consumed 53.9 million metric tons (MT) of pork, compared to a total global consumption of 105.1 million mt. By 2018, China is estimated to devour 64.6 million mt against a worldwide consumption of 118.3 million mt.

Source: WH Group IPO Prospectus

Noticeably, China’s pork intake has outnumbered its production from 2008 to 2012, and the trend is set to continue.

This means the nation has to rely on imports to make up the shortfall. In WH Group’s case, the acquisition of Smithfield helps take advantage of that gap.

China Offers Favourable Margins
Apart from the pork supply deficiency experienced in China, the margins offered are expected to be favourable as well.

From 2008 to 2012, average hog prices in China has ranged from US$1.64/kg to US$2.65/kg, compared to US$0.93/kg to US$1.47/kg in US.

On the cost side, corn, a key feed ingredient for swine, has been on an upward trend from US$0.21/kg in 2008 to US$0.35/kg in 2012. In the US, corn price has swung between US$0.15/kg to US$0.24/kg.

By using Smithfield’s production facilities in US to cultivate the hogs and exporting them to Shuanghui in China to process and sell, WH Group would be able to maximise the margin in the value chain.

Source: WH Group IPO Prospectus

However, one hurdle to cross is the use of ractopamine, a feed additive to promote leanness, in US pork production, which is banned in China. Although ractopamine-free pork produced in the US has been increasing, it only represents a small percentage of total production.

PED Virus In US
Apart from ractopamine usage, there is a lethal substance that has contaminated US hogs.

Since May 2013, a swine virus, known as Porcine Epidemic Diarrhoea (PED), has spread quickly throughout the US pig industry. This has resulted in the death of millions of pigs and a surge in pork prices.

Apart from having fewer hogs for sale, the fear of the disease has led some countries to restrict the imports of live US pigs. Needless to say, the fall in export would hinder the financial performance of US-based pork producers.

Expired Meat Scandal
Additionally, the protein production industry faces a very real threat of perishability – the act of our food going bad quickly.

At home, if our bread or milk is expired, we’ll think about the money lost (not consumed) while disposing it.

The same thing applies to multi-national corporations. In their case, the money lost numbers in the millions. This may force some firms to falsify their expiry dates in order to sell off the goods.

In July, a Shanghai subsidiary of food-processing firm, OSI Group, was found to repack and sell expired meat to restaurants. Clients including Starbucks Corporation and Burger King Worldwide have since withdrawn their orders, undoubtedly harming OSI’s reputation and future financial performance.

Margins Susceptible To Weather
For the three common proteins: chicken, pork and beef; feed cost is a key factor in the cost of production. Corn and soybean meal make up majority of the feed cost.

As both are soft commodities grown in fields, the temperament of the weather affects the crops output and yield.

Over the past two years, the price of corn has endured a rollercoaster from a record high of US$6 to US$7 per bushel in 2012 to about US$3 per bushel presently.

The recent low was achieved on the back of a record US corn crop due to the wet weather experienced while the previous high was pushed by a severe drought sweeping the nation.

The change was seen in WH Group’s income statement. The firm’s FY13 gross margin has improved 5.7 percentage points to 15.8 percent while net margin (excluding listing expenses) gained 3.6 percentage points to 8.3 percent.

SI Research Takeaway
Although WH Group boasts leading market shares in various markets with a product that is set to grow, we need to be concern of external (viruses/weather) and internal (expired meat scandal) factors which may pose a threat to the company.

As the Smithfield acquisition took place in September 2013, it may take some time for the firm to fully integrate its processes and harness the synergy offered by the two entities. This will also be a potential near-term downside to an investor, or long-term, if WH Group is unable to bring out the value of the acquisition.

Currently pursuing his Chartered Financial Analyst qualification, Shane provides coverage on the property, consumer and environmental sectors at Shares Investment.

Please click here for more information about this author.

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