Outlook: Some Thoughts On The Cargill Plant Closure

The major news of the past month surrounds Cargill’s decision to cease operations at its Plainview, TX, plant. The move effectively eliminates weekly harvest capacity by 15,000-20,000 head. The company explains the decision was largely the result of limited supply that has made the business environment particularly challenging in the region.

None of this comes as a surprise; timing was the only uncertainty that remained. Both the packing and feeding sectors have been chronically hampered by overcapacity for an extended period of time. That’s driven heightened rivalry in the sectors to ensure some semblance of operational efficiency. The current rate of cash burn at the packer level simply can’t be sustained indefinitely.

Understand The Impact: Cargill Plant Closing Drives Collapse In Futures

Cargill has opted for an alternative. That’s a telling pronouncement about the state of the business; the closure signifies the changing dynamics within the beef complex beyond just capacity and supply. Most notably, it speaks to the importance of managing capital efficiently.

There’s a huge financial commitment associated with maintaining and running a plant. If that working capital isn’t providing sufficient return, the company needs to reallocate it toward an alternative enterprise. What’s more, when capacity outruns supply, weekly procurement sometimes swings wildly simply to ensure plant volume and throughput.   

The move gets Cargill out of the weekly running for cattle for the Plainview plant. Plus, the company is now better positioned to manage capital more effectively. Combined better overall operational and financial efficiency should allow the company to be more competitive in offering customers longer-term price stability. The latter aspect is one that continues to be increasingly important for the beef business.

In the face of escalating food costs, restaurants and retailers are trying to remove price volatility from their business model. Simultaneously, packers are willingly accommodating that requirement to be more efficient from a financial standpoint (hence the Cargill decision). Much of that shifting environment is best demonstrated by diminished weekly spot volume in both the fed cattle and wholesale beef markets (see my “Industry At A Glance” charts on Captive Supplies and Out-Front Beef Supplies.)

But whatever the reason, the outcome has already priced its way into the market. Removing about 4% of the weekly harvest capacity has a negative effect upon fed cattle demand in the region (and throughout the system) – and it eliminates at least a portion of the supply/capacity imbalance at the packer level. Meanwhile, diminished rivalry for fed cattle will also have second-order effects upon the price of feeder cattle over time.

Market outlook

All that said, the discussion brings us to the outlook for the market in coming months. Last month’s column emphasized, “…the importance of consumer spending and its influence on the wholesale market – as the cutout goes, so goes the live market.” April live cattle have resurged back to the $132-133 level. Based on the last three years of data, that effectively implies the cutout needs to eclipse the $205 mark (and even more yet to work into a mid-$130 live market).

The cutout averaged about $192 in January, but finished the month at $185 (February’s first day of business started on a sour note with sales at $182.50). As such, Choice wholesale values need to climb about $20/cwt. to facilitate a $132-133 spring market currently being priced at the Chicago Mercantile Exchange. Historically speaking, that’s certainly doable (Figure 1).

However, there also needs to be some caution regarding beef’s pricing power in the current economic environment and the all-important overhead resistance at $200. For example, Tyson CEO Donnie Smith noted last week that the company is witnessing price resistance among consumers and some trading down,away from beef: “…maybe we are now seeing a legitimate shift from red meat proteins into chicken.” Only time will tell if that occurs in a significant way. If so, it will be translated fairly readily into the wholesale market and could provide a major challenge for this spring’s fed market. As such, risk management is especially warranted here.

Cargill’s announcement was especially timely given USDA’s recent inventory numbers. Not surprisingly, USDA declared the U.S. cowherd smaller yet again in 2013, down to 29.3 million cows. This represents an extension of an overall decline that’s been in play for 17 years (see this week’s “Industry At A Glance” chart on cow liquidation). Cattle cycles are a bygone era. Shortage of supply will continue to be an issue and the industry will witness further shuffling around because of it.

A Closer Look: Cargill To Shutter Plainview, TX, Beef Plant

Last, but not least, two important developments occurred on the international front:

• Russia announced that all imports of U.S. beef and pork will be suspended due to concern about use of beta-agonists.
• Japan has foregone its 20-month requirement for U.S. imports and will now allow beef products from cattle up to 30 months of age.

Russia represents roughly about $300 million in annual export value for the U.S. Meanwhile, Japan’s market will surpass $1 billion in 2012. But most likely, growth on the Japanese front will more than compensate for the loss of the Russian market until that issue is resolved. So, the export market is a mixed bag; it gives and takes away. That’s the frustrating nature of international markets – they demand constant and enduring attention. The dividends, though, are well worth the time, investment and energy.   

The business environment continues to generate new developments, considerations and complexities. Therefore, mentioned every month as an important reminder, there’s always the need to remain informed and maintain objectivity around all aspects of the business.