PPC – WHY SHOULD TSN AND SAFM CUT CAPACITY?

If I were a ruthless CEO of a competitor to PPC, I would make them suffer. For PPC to survive under the weight of significant losses and an over leveraged balance sheet one of two things needs to happen (1) corn prices decline by another 40% which would allow the company to return to profitability given current market prices (corn would need to fall below $4.00) or (2) the industry cuts capacity allowing chicken price to rise by more than 40%, so the company can return to profitability.

According to Agri-Stats, no matter whether you measure by bird numbers, live weight or by total tonnage produced, the U.S. broiler industry expanded production in 2007, and 2008 is on track for increased production, too. Importantly, ownership and control of production has been consolidating into fewer and fewer firms. In 2008, EMI Analytics forecasts look for U.S. output to total about 36.6 billion pounds of RTC (bone-in ready to cook) chicken. Estimates show the 4 largest firms will control roughly 57% of broiler production - Pilgrim’s Pride, Tyson Foods, Perdue Farms, and Sanderson Farms. The 8 largest companies will account for 71% of U.S. production, and the 20 largest will supply over 93%.

As I see it, the fate of PPC is in the hands of eight companies that control 71% of U.S. production. If those eight firms decide not to cut production in any meaningful way, industry pricing will remain under pressure. Going back to my point about being the CEO of one of PPC’s competitors, it would not make sense for Tyson, Sanderson Farm, or Perdue Farms to cut production as the increase in market prices would provide the most incremental benefit to PPC as it is the market share leader (holds 25% of the market). PPC’s competitors have the financial flexibility to withstand current pressures over the next 6-12 months until market prices stabilize and would most likely rather watch their biggest competitor sweat it out.

The issues around PPC’s balance sheet have been well documented. Right now the issue with PPC is not liquidity, but rather the company’s ability to maintain the fixed charge coverage ratio if the industry turmoil continues well into 2009. Depending on how you measure it, PPC has $500 to $600 million of liquidity. For the company to maintain its fixed charge coverage ratio, it must return to profitability in 2009.

Right now that looks highly unlikely.