Rabobank flags US beef packing opportunity not seen in decades

Analyst Dustin Aherin says ‘a unique combination of factors that we haven’t had in decades’ presents investors capable of surviving a full cattle cycle with a ‘great opportunity on the other side.’

Lingering effects from last decade’s drought-induced herd contraction have helped create the greatest opportunity in decades for expansion of US beef packing capacity, said a Rabobank analyst.

If the US can avoid major herd liquidation during the cattle cycle’s current contractionary phase, investors will have an opportunity to support a 5,000 to 6,000-head-per-day expansion of packing capacity, Dustin Aherin said in a Rabobank US beef report.

The report said such expansion is needed to restore “historical balance” to profits throughout the supply chain and facilitate a broader shift in focus away from commodity production toward meeting global demand for specialized protein products.

“We have a unique combination of factors in the beef industry right now that we haven’t had in decades,” Dustin Aherin told Agri Investor. “If a group of investors can put together enough capital to survive a full cattle cycle and get things through the trough, there is great opportunity on the other side.”

Aherin told Agri Investor recent history explains why, despite recent profits, there has not yet been substantial expansion in US beef processing capacity. Though packers averaged more than $100 of operating income per head harvested between 2015 and 2019, he said, the years between 2002 and 2014 saw them lose an average of $10 per head as the High Plains drought exacerbated market cycles.

“People experienced in the packing sector realize its cyclical and the good times are going to be followed by tougher times,” said Aherin, who, in addition to his St Louis-based role at Rabo AgriFinance also manages a seedstock herd in Kansas, according to his LinkedIn profile.

Private investors have typically focused on smaller, more specialized beef packing operations, said Aherin. About 80 percent of overall US capacity is concentrated among four multinational companies – JBS, Tyson, Cargill and Marfrig-owned National Beef – that have spent recent years closing their least efficient operations.

“Thinking back to what those plants went through in the mid- and early 2010s, they are probably not quite willing to give up the leverage that they have right now in the marketplace versus cattle feeders,” Aherin explained. “From an incumbent’s standpoint: make your money, build your capital reserve and prepare yourself for tighter supplies in the future.”

During the early and middle years of last decade, drought led to a contraction in cattle availability that drove all but the most efficient processors out of business, Aherin wrote. After the drought ended, elevated cattle prices and reduced feed costs combined to prompt a herd expansion that peaked in 2018.

The US breeding female herd had previously contracted from a high of 32.7 million head in 2006 to 29 million in 2014, Aherin said. After peaking again at 31.5 million head in 2018 and registering at 31.3 million in January 2020, Rabobank expects contraction to a low of 30.5 million by 2022.

Recent investment by incumbents and newcomers, Aherin said, has focused on addressing labor challenges that have also helped limit processing and operational capacity.

“Data collection and process efficiency projects as well as even some long shots in the dark towards automation and robotics; that really stems from labor being a major challenge in these plants,” he said, adding covid-19 highlighted the need for distributed processing capacity.

Since mid-2020, Aherin said there have been formal and informal construction or expansion announcements totaling about 1,000 to 1,500 head per day of processing capacity. Examples include a 500 head per day newbuild facility in Jerome, Idaho by Boise-headquartered Agri Beef, which is privately-held, and a multi-year expansion of a 7,500 head per day facility in Augusta, Georgia by privately-held FPL Foods.

Many recent expansions have focused on smaller facilities producing specialized products with attributes that fetch higher prices domestically and in increasingly welcoming export markets, said Aherin.

“With those 1,000 to 2,000-head plants, you are not going to be able to fully capitalize on economy of scale like the really big plants do, but with a smaller plant, you can keep it staffed a bit better, you have fewer cattle to source,” he added.

Beef processing plants typically cost around $100 million to $120 million for 1,000 head per day of capacity, according to Rabobank. Because greenfield construction is most likely to occur when packing margins are favorable, Aherin wrote, investors backing expansion are likely to see the cattle cycle turn during the “multiple” years required to meet complex regulatory and permitting requirements.

As a result, new processing facilities are likely to be greeted by stiff competition for tighter cattle supplies and negative profits for the first few years. Aherin said companies already established in other parts of the beef supply chain will be most likely to seize the opportunity highlighted in his report.