With swine flu sweeping through China and its neighbours, we consider the implications for the corporate credit market.
Hogging market share: pork is big in Asian diets
As Asia’s wealth has grown, so too has the portion size of protein on the average plate. Fish tops the menu, accounting for just over two-fifths of protein consumed in Asia. Pork (35%) is a close second, largely due to demand from China, which consumes five-times more pig meat than any other country.1
The swine flu spreading across Asia is squeezing pork supply hard. Some 200 million of China’s 360 million pigs could die from the disease or be culled, and pork prices may rise by 70%.2 The market for pig products could take a decade to recover.
Beefed-up demand — but a hitch for Brazil
Global impacts include lower soybean demand as there’ll be fewer pigs to feed. While bad for soybean producers, lower feed prices would boost chicken producers’ profit margins. However, rain-delays to planting in the US cornbelt have driven up corn prices, offsetting the helpful impact of cheaper soybeans on feed costs. Longer-term, Chinese appetites may also change, with fish and chicken likely to be the main substitution for pork on Chinese dinner plates, thus taking a larger share of Asia’s protein market. Beef exporters also look set to increase market share.
Producers in Latin America and elsewhere are eyeing higher exports to the huge Chinese market.
High tariffs make it unprofitable for the US to export beef, so producers in Latin America and elsewhere are eyeing higher exports to the huge Chinese market, especially in light of the US-China trade dispute. China mainly imports beef from Brazil, Australia, Uruguay, New Zealand and Argentina, which together captured 90% of the Chinese beef market in 2017.3
Brazil, China’s top beef supplier, looked well-placed to build on its dominant position. But China-bound shipments of Brazilian beef were suspended in early June after a case of mad cow disease was reported in Mato Grosso state. Brazil’s authorities say the occurrence was “atypical” and while Brazil implemented the ban to be prudent, it may lift the export suspension soon. This could further increase scrutiny on Brazilian protein exporters which has ramped up in recent years following some isolated governance-related issues.
This suggests an opportunity for Brazil’s Latin neighbours Argentina and Uruguay. Argentina, which exports almost all the beef it produces, already sends more than half of its total beef exports to China.4
Prime cuts: the importance of selectivity in the protein market
While investors may be tempted to pile into bonds issued by protein producers, selectivity will be key. Recent events have provided a boost for some of the corporate bonds we have invested in, but they do not outweigh solid fundamentals and decent valuations in our decision-making process.
We are paying particular attention to:
- Valuations: some firms poised to gain from a bovine boost are trading at lofty valuations.
- Governance: Latin America’s meat producing industry has seen various governance-related issues. Good governance is key to sustainable returns, in our view.
- Corporate events: After consolidation in the Brazilian pulp and paper industry, the proteins industry appears to be following suit, seeking product diversification and cost-saving synergies. This will lead to winners and losers.
Swine flu is shaking up the protein market but other factors will also play a role in determining the investment prospects of individual corporate credit issues. Investors should remain selective.
1 United States Department of Agriculture, ‘Livestock and Poultry: World Markets and Trade’, 9 April 2019 https://apps.fas.usda.gov/psdonline/circulars/livestock_poultry.pdf
2 Reuters, 12 April 2019 https://uk.reuters.com/article/us-china-swinefever-pork/up-to-200-million-pigs-to-be-culled-or-die-from-swine-fever-in-china-rabobank-idUKKCN1RO0MP
Emerging market: These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.