JSE-listed food producers are normally seen as defensive and relatively consistent portfolio stocks. But this cannot be said of the poultry sector; the producers of the ubiquitous protein beloved by South African consumers live a rollercoaster life of earnings cyclicality, and at present the profitability of the sector is stuffed.
High soft commodity prices, erratic load-shedding — leading to the use of expensive self-generated power — alongside the effects of the worst outbreak of highly pathogenic avian influenza (HPAI) experienced in South Africa, is now taking its toll on egg and poultry sector producers. The businesses of Astral Foods and, latterly, Quantum Foods, are severely affected.
Traditionally, the swings in poultry profitability have been tied to the cost of the soft commodity inputs of maize and soya. These two ingredients typically comprise 90% of feed, and their pricing has determined the earnings profile for cyclical poultry stocks for the two decades during which I have been analysing the sector.
Astral Foods is today the only JSE-listed pure play poultry counter. Groceries business RCL Foods receives a sizeable component of earnings from Rainbow Chickens, and small-cap Quantum Foods is an egg, contract farming and animal feed company. Over the years both Country Bird Holdings and Sovereign Foods have been delisted by private equity.
South Africa produces about 2-million chickens a week for consumption. Imports can be said to comprise a further 8-million birds, though this is a mix of low-value product such as carcasses, offal and mechanically deboned meat, which is the core ingredient of value-orientated products such as polony. The value-added imports of frozen bone-on chicken have always been contentious. The domestic poultry industry claims the product is dumped here at unfair prices and has successfully lobbied for tariffs on imports to be increased.
Feed is the largest cost in rearing domestically produced broilers, typically from egg to 1.85kg slaughter weight and to the table in 34 days. Energy is the second-highest cost component. The expense involved in both has affected the poultry sector for the better part of two years.
Since the start of 2022 the domestic poultry sector has been battered by events above and beyond the control of our highly efficient poultry producers. These blows have slaughtered the industry.
For one thing, the Russian invasion of Ukraine led to a prolonged period of higher international soft commodities prices as the markets fretted about global supply. The world was not short of grains; it was the disruption to supply chains that caused the surge in pricing.
In 2022, the South African futures exchange (Safex) price of white and yellow maize rose 19% and 33% respectively, and that of soya grew 31%. Given the rapid rise in key inputs, the poultry sector simply could not increase prices sufficiently to recoup higher production costs. In that period margin and profitability slumped.
What made the situation worse were the volatility of the commodity’s prices and the movement of the rand. In 2022, the price for yellow maize ranged from R3,440 a ton to R5,300 a ton — a swing of 54%.
Soft commodities peaked in late October 2022 and declined rapidly thereafter thanks to normalisation of supply and a reduction in the risk index. In the year to date yellow maize is down 11%, white 16% and soya 24%. However, they have been volatile again, affecting the procurement policies of the poultry stocks.
Lower input costs started to aid the poultry sector, but just as these benefits began to show, South Africa was hit by extended and progressively worse levels of load-shedding.
Because of the serious effect on electricity and water costs of having to run diesel generators, all food-producing stocks are reporting soaring costs of production. This has hit margins and profits. Astral Foods states in its recent pre-close results call that it is selling chicken at lower than production costs. This is unsustainable.
Companies such as Astral Foods, for which a clean, reliable water supply and the provision of electricity are crucial to the production chain, were forced to provide their own basic services. Hundreds of millions of rand were spend on water plants and generators. These capitals costs led to some curtailment in the normalised expansion of the poultry and feed business, as vast amounts of increasingly expensive diesel had to be bought to counter the effect of load-shedding.
Before the two recent diesel price increases of R2.84/l in September and R1.93/l in October, Astral’s monthly diesel costs at load-shedding stage six were R45m a month. It is now significantly higher, and has become an embedded cost in the production of poultry. Someone must pay for these increases. Ultimately, it will be the consumer.
Due to the the disruption of production caused by load-shedding and higher soft commodity prices, Astral Foods placed its additional costs at R1.9bn in a pre-results update in late-September and warned of a huge loss in earnings for its year ended September.
The growing ineffectiveness of the state, leading to crumbling infrastructure, is pushing up domestic poultry production costs. The sector says it needs price increases of R3/kg to recover these costs. These amounts do not include the expenses associated with the HPAI outbreak of 2023.
Astral Foods states in its recent pre-close results call that it is selling chicken at lower than production costs
The previous major HPAI outbreak was in 2017. It had a devastating effect on the layer and poultry sector. The broiler breeder sector was not as butchered as the table eggs industry. That HPAI outbreak involved 5.4-million birds. It is estimated to have cost the sector R1.87bn.
In the 2023 outbreak, there were 89 confirmed cases of HPAI H7 and the new, more deadly, HPAI H5 strain, said the department of agriculture, land reform & rural development at the time of writing. The outbreak, of which the epicentre has been in Gauteng, has led to the culling of 6-million birds to date and threatens the sustainability of the poultry industry. The egg, layer and broiler breeder flocks have been severely damaged.
This is so serious because when broiler breeders are culled the sector loses millions of fertile eggs that would hatch into day-old chicks that are reared for meat production. On a linear basis HPAI could result in the reduction of 20% of the national weekly production of chicken for human consumption.
Astral’s HPAI costs to date are estimated at R220m, and those of RCL Foods and Quantum Foods at more than R100m each.
HPAI should have been the mechanism that the poultry sector could use as leverage to recover higher production costs from retailers. Pricing discussions are under way for the important pre-festive period.
However, a spanner was well and truly thrown in the works with DTI minister Ebrahim Patel’s early October announcement that he seeks a temporary import tariff rebate. CEOs of poultry companies must have shuddered in disbelief at the Government Gazette statement. Just as they thought they could claw their way out of a crisis by using some leverage to gain higher prices to offset soaring costs, the government thwarted them.
IM can understand the minister’s noble intentions in trying to protect the consumer from the tight supply of chicken meat that may occur if HPAI continues to spread and leads to domestic production shortfalls. But the industry says it has sufficient strategic stocks to meet consumer demand in the busy pre-festive period. Imports, should the tariff rebate be approved, may only aid the consumer into 2024 due to supply chain issues. Patel may be seen as a fox in the henhouse because of his actions.
If Patel had really wanted to assist the sector, he could have softened the tariff rebate blow by also announcing that the government would provide compensation to the domestic poultry sector to cover the cost of the cull and the re-population of the poultry sector due to the impact of HPAI. South Africa stands out as an anomaly, as many oversees producer country governments aid their poultry sector during such force majeure events.
To counter the disease, the poultry sector has applied for the registration of vaccines, and dossiers are awaiting approval ahead of domestic clinical trials and vaccine production. The ministry says it is looking at fast-tracking the supply of vaccines to try to control HPAI. The sector expects the virus to be under control within 12 months.
Given the roasting egg and poultry producers have undergone, IM cautions investors about the sector. Ongoing existential problems have not abated, and may not do so for some months.
IM cannot advocate a recommendation of Quantum Foods, now trading at 470c, due to the share’s illiquid nature, as two opposing shareholder blocs control the business. Liquidity is tight. Eggs have been a highly volatile subsidiary of Quantum, often scrambling earnings.
Astral Foods, trading at R14.84, has been at near 14% in the past month. On any further price weakness IM would be tempted to pull out the wishbone and pick over the share price carcass.
IM recommends waiting for an update from the results to September, which are pending.
Astral is the Saudi Arabia of domestic chicken production due to its efficiency and scale. It needs to gain a price increase for every kilogram produced to recover latent costs. The strategic stocks will enable the company to keep the market supplied, aiding sales. Soft commodity prices are starting to feed into lower production costs and any curtailment of load-shedding will lower self-generation costs.
The year 2024 could be a materially more succulent one than the burnt offerings of 2023. Again, much depends on the containment of HPAI and the way imports are handled.
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