SOUTH AFRICA - The poultry sector could slowly start to emerge from an extended downturn in the second half of this year, making it one to watch for analysts and fund managers.
The industry has been through a difficult few years, weighed down by cheap imports, soaring feed costs, weak consumer demand and impending regulations to cap the levels of brining allowed in frozen chicken products.
According to BusinessDay, nine smaller producers have either gone under, filed for business rescue or been absorbed by larger companies in recent months. Astral Foods has recently snapped up the assets of two producers at liquidation auctions.
The sector had something of a reprieve last year when tariffs were imposed on imports from most regions — though Europe was exempt due to free-trade agreements. However, the sector has since lobbied for duties on "below-cost" imports from Europe.
The International Trade Administration Commission of South Africa (Itac) sent an investigative team to Germany and the Netherlands between 26 March and 10 April as part of its verification process.
Itac spokesman Thembinkosi Gamlashe said that the investigation "is still in progress" and a preliminary determination — which could grant interim protection — is expected to be made within the next two months.
Market commentators have been divided over the justification for the sector’s protection from imports. Some say consumers will bear the brunt in the form of higher prices, while others say chicken is clearly being "dumped" at below the cost of production.
Vunani Securities analyst Anthony Clark — who has voiced negative views on the sector for two years — said the sector "is now starting to look very interesting". Contributing to a turnaround would be a possible decline in maize prices and import protection.
But the recovery will be very gradual, he said, as "there are too many variables out there which are beyond the control of anyone in the sector". The upturn will be held back by food price inflation and a rising interest rate cycle, which will further stretch consumers.
Mr Clark said, importantly, the bigger maize harvest this year could translate into lower input prices in the second half of the year. Feed costs, which are largely made up of maize, account for about half the costs of raising a chicken.
Input costs have been abnormally high in recent months on high international maize prices and local shortages.
Mr Clark said the harvest in the US — which influences world prices — is expected to be decent, though this is not certain.
But depending on the local and US harvests, "the input price could be lower in the second half of 2014, which bodes well for the costs of the poultry sector".
While maize prices have come down in the past month, this will feed into the system only from the middle of the year as producers buy on the forward market.
Though Mr Clark has no "buy" recommendations on poultry producers yet, his stock picks would be Sovereign Food Investments, followed by Country Bird Holdings as a long-term play, and then Astral. He leaves out Rainbow’s parent company, RCL Foods, as its upstream diversification means poultry is now only a small component of the group.
Mr Clark said recent efforts by some producers to grow their African footprint is "a highly positive move" — partly because it mitigates weak conditions in SA, where "the days of making super profits are way over".
The rest of Africa offers exposure to rising populations and incomes, and to markets with "a limited supply of quality chicken and more fast food companies and retailers going into these developing markets". Retailers and food outlets "want consistency and quality of supply".
Chris Logan of Opportune Investments believes "there’s a good story here from a recovery play". His company has been buying shares in Astral and Country Bird, and has held Sovereign shares for some time. Mr Logan believes local producers "are probably where their American counterparts were in about 2009-10" — when US companies experienced a downturn due to oversupply.
US producers emerged far stronger after improving efficiencies, reducing production and increasing exports — which helped boost pricing power.
"Here it looks as if the local producers are establishing pricing power through scaling back production and shutting out imports," Mr Logan said. He said producers such as Astral have been cutting back on costs while increasing capital expenditure.
"It’s a cyclical industry and generally the seeds of the upturn are laid in the downturn."
Mr Logan said that due to the strong pricing power and market dominance gained by American producers, "the correlation between the chicken producers and the corn price has broken down".
While he believes the sector is on the up, producers "need to double up on the good efforts they’ve got under way so they can emulate their American counterparts".
South African Poultry Association CEO Kevin Lovell expects that by midyear, the maize price should drop, while the association is hoping for "provisional protection against European dumping" by the end of next month.
"It will take a little while for the effects of that to flow through. So there’s a chance that quarter three could start to look better," Mr Lovell said.
However, "unpredictables" remain — including weak consumer demand and the market’s reaction to upcoming elections results. "We are still in the bottom of the trough. I don’t think it’s going to get worse but I do think it’s going to take a little while before it gets better."
Mr Lovell said he does not expect brining regulations to be finalised "much before the end of this year". He said the government intends to give the industry six months from the date that brining regulations are gazetted until the laws become effective.
There is still no certainty on what these regulations will entail, he said. Further consolidation is possible as producers look to build scale, Mr Lovell said, while he also expects to see "attempts to start changing the product mix wherever possible".
Analysts have highlighted the need for producers to reduce their exposure to individually quick-frozen products, which will be subject to brining regulations.
Producers such as Astral Foods have a large weighting towards frozen products.
Poultry stocks have made some strong gains since late February. Sovereign hit its 52-week high on 9 April, while Astral, Country Bird and RCL have all reversed share price slides as of late February.
TheMeatSite News Desk