Category crunch: UK pork sector in state of flux
By Katy Askew | 5 December 2012
Pork prices driven up by higher input costs
The UK pork sector hit the headlines when Dutch food group Vion announced plans to exit the market. The sudden withdrawal of a major player highlights the challenges pork processors are grappling with, including rising input costs and tough pricing negotiations. Nevertheless, as the sector embarks on a process of consolidation and capacity is taken out of the category, the balance of power could be shifting down the pork supply chain. In part one of our two-part category crunch, Katy Askew examines some of the issues facing the sector.
Dutch food group Vion's announcement that it plans to quit the UK has shone the spotlight on the country's pork sector.
The company ended months of speculation with the news it will sell its entire UK business, which employs 13,000 people across 38 manufacturing sites and generated revenue of EUR2.35bn (US$3.07bn) in fiscal 2011.
Vion appears to have made quick progress in finding a buyer for its pork processing business, which has estimated sales of EUR0.8bn and a workforce of around 5,000. Reports suggest the unit will fall into the hands of management in a private-equity backed buyout.
Vion's decision to exit the UK was not entirely unexpected, although the sudden and definitive nature of the move surprised many. Vion, which has been present in the UK since the late 1990s, has suffered a series of UK setbacks including, most recently, the controversial decision to close its loss making pork processing unit, Hall's of Broxburn.
As Vion outlined its decision to close Hall's, Peter Barr, chairman of the group's UK operations, blamed "significant over-capacity" in the pork industry. Excess supply is a problem for pork processors.
Sukhdev Joha, reader of management strategy at Royal Hollaway University of London and co-author of research report Bringing Home the Bacon, argues that, as capacity utilisation drops, profit margins follow.
"If you are operating at 80-90% capacity utilisation you make money, much below this and you are working to cover your costs... It is in the last 15-20% of production capacity that profits are made," Joha explains. "Over-capacity has far reaching consequences that impact the entire chain."
Joha argues the UK's supermarkets have a "trader mentality" toward their procurement of pork products, which they use as a loss-leader to drive footfall. According to Joha, this results in fluctuating demand, which in turn limits capacity utilisation in the sector.
However, Shore Capital analyst Clive Black insists that capacity has come out of the industry of late. "The UK pork industry is highly competitive, albeit the industry is benefiting from capacity reduction in recent years," he observes.
The sector is also benefiting from slow but steady revenue growth, which is being driven by higher prices. According to figures published by Kantar Worldpanel, fresh pork sales increased by 4.5% in the 52 weeks to 8 July, as price inflation of 5.9% offset a 2.3% drop in volumes. Sausage and ham prices offset a modest volume decline to boost total sales by 0.8% in the period. Only bacon saw volume in the 12 month period increase, as sales rose 0.7% on flat pricing.
While processors have been able to increase prices this does not, however, signal that they have it all their own way in negotiations with retailers. Around 70% of total pork sales are generated by the UK's top four multiples - Tesco, Asda, Sainsbury's and Morrisons. This sizeable share of the retail market means that, as in other supply chains, the supermarkets pack a considerable punch in pricing discussions.
Flemming Enevoldsen, chairman of processed meats at farmer-owned cooperative Danish Crown, tells just-food pricing negotiations with UK retailers are tough, especially given the current economic climate, which is marked by constrained consumer sentiment.
Enevoldsen, who is acting CEO of Danish Crown's UK arm Tulip, says: "Retailers are business people, they have to look after their business. It is never easy to increase prices with retailers, in particular in these years where you have a global, if not recession, at least period where the financial climate has cooled off."
Nevertheless, Enevoldsen says retailers are aware of the "broader picture" in the supply chain, with rising input costs putting processors and producers under pressure.
"Our customers - the retailers - are certainly bright enough to understand the broader picture. On thing is what informs their strategy moves, how they make their decisions, another is how they view the day-to-day business with their suppliers... I think it is fair to say that it is never easy to increase sales prices with retailers. But it is not because they don't understand the global supply chain."
Farm costs have risen steeply due to higher global feed prices. Drought in the US this year meant corn and soybean harvests have been significantly lower than previous years, while Russia cut its forecast wheat harvest in the summer due to poor weather conditions.
Another issue driving higher pig prices, Enevoldsen adds, is lower European pig meat production. "This is partly a reflection of the poor earnings being a pig farmer in the past years. It is also a reflection on many European countries having very slow and difficult procedures in place if you want to upgraded your production. And, of course, the most important factor is the financial crisis, which led to financing being more difficult to obtain amongst farmers."
European pig farmers have also had to overhaul their farming methods in order to prepare for the 2013 European welfare regulations that come into force in January.
These changes, which will ban the use of sow stalls, will not impact UK pig farmers who already adhere to higher standards of animal welfare. However, UK-reared pigs only account for about 50% of the nation's pork sales, a situation that has created a degree of uncertainty in the supply chain, with the possibility that imports from the EU could fall off.
According to Cranswick CEO Adam Couch, these factors meant the industry saw some spikes in pig meat prices in October and November and processors could be facing further volatile fluctuations in the coming months.
Couch concurs retailers are aware of the issues impacting the supply chain, although he too concedes these must also be balanced against the poor consumer sentiment that currently prevails in the market.
"Retailers are certainly aware of the difficult economic climate, obviously with their customers. But they are also attuned to the poor harvest that has created a lot of problems for pig producers the world over. We have had to respond in terms of the price we paid for pigs and the retailers, we are still in dialogue, but we are having very constructive conversations in order to keep these producers in business in the medium to long term," Couch tells just-food.
"If there isn't a whole chain responsibility taken on board then it leaves producers facing down the barrel of a gun. It resonates with both retailers and ourselves to get that price recovery through. There is a more responsible approach being taken in the wider context by both retailers and processors alike," Couch claims.
Panmure Gordon analyst Damien McNeela agrees an understanding of the troubles facing the supply chain has been a major factor prompting retailers to increase the price that they are willing to pay for pork products, particularly given the potential of further pork price rises following the introduction of the EU sow stall ban.
"Security of supply is the watchword amongst retailers and the uncertainty that the exit of Vion - one of the largest processors in the UK - creates amongst the retailers should be beneficial for other well invested, large scale meat players," he suggests.
Indeed, the UK's largest retailer Tesco recently unveiled plans to set up direct contracts with farmers. The company said that it will link the price that it pays pork producers to the cost of production. Moreover, Tesco said prices would be adjusted on a monthly basis to avoid a situation where farmers are locked into loss-making contracts if the cost of production swings significantly.
"Pig farmers will be consulted to determine a fair price for pork and this will be linked to the swings in feed price. The price of feed varies greatly: it can go up very quickly and it can go down very quickly. It will work both ways, but pig farmers will always get a fair price for their meat," a Tesco spokesperson explained.
The spokesman said the move was a "Tesco investment" and would not affect the price that consumers pay for pork. He also insisted that it would not "take processors out of the equation".
"The processors are still going to do the job they always did but Tesco will have the direct contract with the farmer."
The news has been roundly welcomed by the farming community. "British pig-keepers have been plagued by short-term supply chains and volatile costs, which have prevented them from investing in the future," National Pig Association general manager Dr Zoe Davies says. The Tesco contracts "could help transform British pig production", increasing transparency and promoting a more even sharing of risk and reward, Davies says.
Even as supply chain relationships adjust in response to a growing recognition of the need to promote stability, the nature of the UK pork sector remains highly competitive as pork processors compete for market share. Higher prices should be good news for the margins of pork producer. However, given the weak consumer sentiment currently prevailing in the UK, there is the possibility that higher prices could retard volume growth.
In part two of our Category Crunch, we will examine the divergent strategies employed by the country's pork majors as they look to grow sales in the face of weak consumer sentiment.
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Category crunch: UK pork sector in state of flux