Poultry Producers Weigh up Risks

US - The nation's leading poultry companies have been using risk management tools, with varying degrees of success.
calendar icon 24 October 2008
clock icon 6 minute read

In the game of chicken production, the major players employ risk-management tools like commodity hedging - which can produce some winning hands and cause others to fold, according to Morning News for NW Arkansas. It all depends on how well the players bet.

Poultry giants like Springdale-based Tyson Foods Inc. and Texas-based Pilgrim's Pride Corp. said they routinely manage commodity price risks through the use of futures contracts, which allow the companies to lock in grain prices - as well as chicken prices to their customers.

All the bets have been placed, and in the next couple of weeks these poultry players will show their hands.

"The most effective way a poultry company can utilize hedging strategies is to tie down both sides of the equation"
Dr Paul Aho

When grain prices are heading upward, as they did for the first half of this year, hedging those expenditures with grain futures can provide the companies some protection. But when prices decrease rapidly, those holding longer contracts can incur steep losses, said Gene Martin, commodity analyst with the Arkansas Farm Bureau.

Mr Martin said because the commodity rules allow for a liberal 1:10 leverage ratio, the losses can occur quickly in a volatile market.

As corn prices rallied from $3 last October to more than $7.90 in June, chicken producers had to decide which way to bet. By August, prices were down to $4.90, representing huge swings and potential problems for those who bet wrong.

Grain is the largest input cost that processors incur in raising a chicken. Raw feed ingredients - corn and soybean meal - comprise about 67 percent of the total cost. This is up from about 52 percent a couple of years ago, according to Richard Lobb, spokesman for the National Chicken Council.

The US Department of Agriculture estimates it takes 261 pounds of feed to produce 100 pounds of poultry.

Last year, Tyson Foods processed roughly 251 million pounds of chicken each week. Pilgrim's processed another 272 million pounds, continues the article, citing Watt Poultry USA.

That is a lot of corn and soybeans, leaving both companies with hefty grain bills. Tyson Foods estimated it would spend an additional $500 million in grain expenses this year.

As publicly traded companies, both Tyson Foods and Pilgrim's must disclose to shareholders that they hedge certain input costs in their federal filings with the Securities and Exchange Commission.

Neither company will discuss their specific hedging positions. But in recent days Pilgrim's Pride said it expects to report a 'significant loss' in the fourth quarter as it suffered 'significant negative impact' from its hedged grain positions.

At the same time, Tyson Foods said it has been able to offset its grain costs through effective hedging to the tune of $59 million in the third quarter.

Ann Gilpin, analyst with Morningstar.com, said Pilgrim's lack of experience with risk management looks like a large liability of the company, continues the article.

"The losses relating to hedged positions are largely responsible for the Pilgrim's violation of its debt covenants, which it has not yet been able to renegotiate," Ms Gilpin said.

Pilgrim's only last year tried its hand at risk management. Ms Gilpin said they appointed a single person to manage the company's risk.

"It is likely that Pilgrim's locked in a grain contract during the summer highs, betting that prices would keep escalating. In retrospect, we know that corn and soybeans are selling for half their summer prices," said Andrew McKenzie, professor of agri economics and risk management at the University of Arkansas.

Tyson Foods, on the other hand, has been involved in commodity risk management activities on a relatively small scale for many years. But it expanded in 2003 to include managing commodity risks for grain, meat and fuel, said Gary Mickelson, spokesman for Tyson Foods.

Tyson Foods' hedge positions are not public record. CEO Dick Bond was asked in an August earnings call if the company expects a hedging loss in the fourth quarter. Bond said the company did not expect a significant market-to-market hedging loss in its chicken segment for the period ending September 30.

A key ingredient for the poultry industry is improving its risk management to counter the impact of high energy and grain prices, economists said.

McKenzie said Tyson Foods has one of the most experienced risk management teams in the country, in terms of its effectiveness.

Given the risks, some might wonder why poultry companies sit down at the risk management table at all.

Poultry economist Paul Aho said chicken producers have been slower to develop hedging strategies because until relatively recently, their input costs have not been that volatile.

The most effective way a poultry company can utilize hedging strategies is to tie down both sides of the equation, Dr Aho said.

"They can sell their products via long-term contracts to food service vendors, securing for themselves a known set price. Then they utilize grain futures to lock in grain input costs. By nailing down both ends, they know what their operating margins will be," he said.

With chicken prices at historic lows, and grain prices down substantially from recent highs, it is unlikely poultry companies are holding any long-term contracts, analysts said.

Mr Martin agreed that with cash prices lower for grains, he expects the poultry companies to use a hand-to-mouth approach until higher meat prices return and they chose to lock in longer-term chicken prices, the Morning News article concludes.

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