ANALYSIS - The challenges being experienced by the Russian pig meat sector are likely to accelerate the consolidation of a fragmented pork industry, according to a report by the credit ratings company Moody's, writes Chris Harris.
The consolidation will allow the leading producers to gain market share from the smaller farmers forcing them out of the market.
According to the Russia's Ministry of Agriculture, the number of pigs raised on domestic farms fell by 665,000 last year, indicating that smaller players may be already exiting the market, the report's author, Sergei Grishunin said.
Speaking to TheMeatSite, Mr Grishunin said that the larger producers are also better protected against the effects of African Swine Fever and the potential the disease has to hit production and profits.
"The larger producers are better protected than the smaller one," he said.
"They are very cautious about genetics, so when they buy pigs for breeding purposes, they carefully choose the pigs.
"The smaller farms and factories have the problems because they do not have the same good genetics and they do not check the farms.
"Because of this many smaller farms do not ensure protection."
The report also shows that the Russian pig sector has been hit by high feed prices as pig products have around the world.
The report follows the release of the annual results of one of Russia's leading integrated pig meat producers, Cherkizovo, which shows that in 2012 its EBITDA margins for its pork sector fell by 35 per cent - compared to 41 per cent in 2011 - mainly because of higher feedstock costs and lower selling prices for pork in the fourth quarter of the year.
"In 2012, prices for grain, the main feed for pigs, jumped by 70 per cent to 100 per cent in Russia owing to the poor harvest (approximately 70 million tons last year versus 94 million tons in 2011), driving up pork producers' costs," the report says.
The report adds that the weaker performance of Cherkizovo's pork business shows that higher feedstock prices and lower domestic selling prices are an increasing negative for the Russian pork producers.
"Continued pricing pressure combined with elevated feedstock costs are likely to depress Russian pork producers' profitability across the board for the next two to three years, squeezing their liquidity and potentially forcing less efficient players to exit the market," the report says.
"In such an environment, smaller, less-diversified producers are the most vulnerable. Bigger players, such as Cherkizovo, Miratorg and Rusagro are likely to fare better as they are more diversified - 55 per cent of Cherkizovo's EBITDA in 2012 came from poultry sales for which prices are more stable - and also benefit from low-cost, modern facilities.
Mr Grishunin also told TheMeatSite: "Cherkizovo has also started to develop its own grain growing and because of this it has become more protected.
"While it 2013 it might not be so protected in future years, 2014 and 2015 it will be."
He added: "Now its strategy is changing and the company has got its own land bank."
However, the report says that the challenging market conditions will squeeze margins in Cherkizovo's pork business to near breakeven levels in the first quarter of 2013, while less efficient pork producers are likely to record losses.
"The need to replenish grain stocks at high prices is also pressuring producers' liquidity as they typically hold around three months of supplies."
Pork producers' margins and liquidity may improve in the second half of the year if the forecast of the Russian Ministry of Agriculture that the domestic grain harvest will be better this year than last comes true.
This will boost supplies and bring down prices.
The report adds that the forecast from Cherkizovo pork prices will rise in in the second half of the year is a reasonable assumption given the likely cessation of destocking and the rise in pork consumption during the summer barbeque season.
The Russian government also plans to grant the sector 6 billion rubles ($200 million) in subsidies and to continue import bans on meat following recent food scandals in Europe which will give additional support to the sector.
"We expect that these the subsidies coupled with the rising pork prices and falling feedstock prices in the second half of 2013 will result in a gradual recovery of EBITDA margin of Cherkizovo's pork business up to 25 per cent to 30 per cent by the end of 2013," the report says.
"We would expect larger players to record lower margins in their pork businesses of around 20 per cent.in 2013 compared with 35 per cent to 40 per cent in 2011 and 2012."
Moody's says that Cherkizovo will report a consolidated EBITDA of around 15 per cent in 2013 compared to 20 per cent in the full year of 2012 and 22 per cent in the first nine-months of 2012.
However, the ratings company said that wholesale domestic pork prices have fallen by around 20 per cent since the start of the last quarter of 2012, making the situation worse for pork producers.
"The drop in prices was mainly driven by an increase in domestic pork production of around 200,000 tons in 2012 and destocking by less efficient producers in response to rising feedstock prices - a trend that has become more pronounced in the first quarter of 2013.
"A 30 per cent jump in cheap pork imports3 after Russia reduced import duties following its accession to the World Trade Organisation (WTO) in August 2012 have also added to the pricing pressure, although this was partially offset by the effects of a series of bans on imports of live pigs from certain regions including North America, Brazil, Germany, Poland and Lithuania that Russia has introduced since 2012.
"Since joining the WTO, Russia has introduced a series of bans on pork most recently on live pig imports from the US, EU and South America citing concerns over the use of antibiotics and the growth stimulant ractopamine as a feed additive.
"If these restrictions and/or Russia's latest subsidy programme for the sector are found to breach WTO rules and Russia is forced to eliminate these measures it could result in further growth in pork imports over the next few years, although pricing pressure may decrease as the difference between domestic and import prices is likely to narrow as we expect feedstock prices to remain at elevated levels globally," the report concludes.