The biggest factors affecting the profitability of the beef processing sector is the domestic price of cattle and the corresponding beef sales price for finished product, while processing costs have traditionally remained relatively static.
Our 2016 expectation for short term pain in the processing industry proved to be correct. Improved seasonal conditions allowed cattle growers to rebuild their depleted cattle numbers through either organic growth (breeding from existing stock) or market purchases, subsequently tightening supply. This imbalance led to the Eastern Young Cattle Indicator (EYCI) peaking at 726 c/kg cwt in August 2016 (a 161% increase on the July 2014 low). 1Processors struggled to get sufficient supply in some regions, with a number of facilities either being operated below capacity or closing temporarily between 2016 and 2018. Needless to say, processor margins were tight during this period.
This trend has started to unwind in 2018, as the herd rebuilding phase slowed due to poor seasonal conditions. A hot, dry summer and negligible winter rainfall to date has reduced pasture feed availability throughout Queensland, New South Wales and Victoria. The EYCI has reacted to the poor seasonal conditions, dipping below 500c/kg in for the first time in over three years. The fall in cattle prices has certainly been timely for processors, with margins reportedly being “back in the black” for many processors.
Where to from here?
Despite the poor seasonal conditions currently being experienced across the eastern seaboard, the Australian cattle herd is expected to grow by 3% in 2018-19, with the domestic price of cattle expected to fall further, although remaining above the 10-year average.2 This domestic cattle price outlook may provide some comfort to processors and, in the absence of any substantial rainfall this season, prices may fall more rapidly than the forecasts suggest.
With respect to the sale price processors receive for finished product, increased domestic supply in the USA and a relatively static Japanese market (two of Australia’s key beef markets) is expected to have a limiting influence on price. A flat outlook is also expected for the domestic beef market. Despite a significant improvement on the previous two years the overall outlook remains cautious for processors.
The longer term outlook for Australian beef processors, however, remains positive given the fundamentals are in place – i.e. high quality domestic supply base, high entry barriers for new participants and well established export markets. Long term, domestic cattle prices are forecast to decline in real terms, 3 and the opportunities for beef export growth, particularly into China and other Asian regions, remains strong.
Future challenges, opportunities and critical success factors
While the longer term outlook is positive, there’s no getting away from the inherent volatility in the cattle price as well as the uncertainty around global trading conditions at the moment. Looking into the future, some of the key challenges, opportunities and critical success factors facing the meat processing sector include:
* Security of quality supply: Processors who are able to achieve consistent lines of cattle that meet customer expectations generally have some form of vertical integration in place, at least to the feedlot stage. Processors may achieve this through either owning and operating their own facilities, or entering into strategic alliances with established, component feedlot operators. Security of quality supply also provides processors the ability to forward sell.
* Building strong relationships with customers: Beef is an inherently inconsistent product, and the ability to provide a consistent high quality product for the customer requires downstream supply chain participants to have clear specifications to target. The adoption of pricing mechanisms to reward highly grading carcasses will lead to better products being delivered to the customer.
* Sound capital structure: Beef processing is a cyclical business with significant swings in both cattle prices and finished product, and as such is not suited to a high debt structure. Processing businesses need to sustain prolonged periods of low or negative trading margins in order to survive the business cycles. Vertical integration will often lead to large swings in working capital requirements as processors expand or contract the amount of cattle on hand, dependent on the prevailing market conditions and sales price outlook. The ability to fund cattle through alternative funding solutions, such as bespoke livestock finance or leasing may be attractive to some processors.
* Adoption of technology: The industry will have significant opportunities to increase profitability through the adoption of technology, particularly through further automation. Technology may be used to enhance product quality and consistency, processing efficiency and in providing enhanced feedback to producers allowing them to target price points, subsequently improving the end product for customers.
Though the outlook remains positive, ongoing variability will continue to be a key feature of the industry. However, savvy operators who are able to identify and implement strategies to manage the key swings in trading conditions will position themselves for success over the longer term.
Share Ag News Via