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'Good chunk' of industry looking at profits despite hurdles

National Hog Farmer/Kevin Schulz Side-by-side farrowing stalls with sows and litters
Demand is questionable until we get a solution to coronavirus that allows the full re-opening of U.S. restaurants.

There are just too many hogs! The sow herd needs to shrink! No, we just need another packing plant! But wait, the sow herd is already shrinking rapidly according to some vested interests.

You hear a lot about the size of the U.S. breeding/sow herd these days, and as well you should. So let's take a systematic look at the facts and what they imply.

The first question that must be answered in this discussion is "Is there enough demand for U.S. pork to support normal output levels from the current breeding herd?" Whether producers like it or not, it all starts with demand. And demand is a challenge and may become more of one.

Domestic demand is two-fold: Retail and foodservice. We all know what has happened to foodservice demand in general due to COVID-19. Massive shutdowns of foodservice establishments mean significantly less volume moved through those venues. I fear that these reductions have been worse for pork than for other species because it has shut down many eat-in establishments that more or less specialize is breakfast. Yes, we probably have sold some more biscuits/muffins, but that business was pretty robust before we lost most of the sit-down diners and restaurants that move a lot of pork.

By all measures, retail demand is good. It almost has to be since so many consumers are buying a higher proportion of their food from grocery stores.

Export demand has been terrific so far in 2020, but it has been a one pony show: China. And the pony is getting tired. China took 14% of U.S. production the week ending April 23. Last week, it took about 5% of production. We can discuss and argue all we want that there is a massive shortfall of pork output in China, that they need to import huge amounts of pork, that their prices are five times those in the United States, and thus someone should be arbitraging the difference, yadda, yadda, yadda. They even delisted a bunch of plants in other countries over COVID-19 cases while not delisting U.S. plants that have led the world in COVID-19 cases.

And lastly, the U.S. plant that is owned by a Chinese company that was re-tooled to send carcasses to China has been switched back to break carcasses into primal and subprimals. The only logical conclusion is that the government of China has told its companies to not buy U.S. product or to at least not buy very much U.S. product. And shipments to every other export market is down, year-on-year, from 2019 export levels.

My conclusion is that demand is questionable until we get a solution to coronavirus that allows the full re-opening of U.S. restaurants. I don't know when that will happen. Futurist Peter Zeiman told the National Pork Industry Conference's virtual meeting this morning that it cannot happen until April 2021 if progress for a vaccine is rapid.

The U.S. breeding/sow herd has already reached its zenith and started to contract. As can be seen in Figure 1, the herd peaked at 6.461 million head on Dec. 1 and has already dropped by 125,000 head to 6.326 million head on June 1. The June 1 figure represents the first year-on-year decline since 2016 and is the largest year-on-year decline since September 2010 when the U.S. industry was completing its 473,000 head reduction driven by circovirus vaccines and subsidized ethanol-driven production costs. More reductions are coming, but how much and how fast remains to be seen.

Figure 1: U.S. Hogs and Pigs Report breeding herd

Some look at this year's sow slaughter (Figure 2), see plus 8.6% year-on-year growth and conclude that the sow herd is being reduced rapidly. I'm not so sure. Some of those big slaughters back in May were depop-repops and will not be a net reduction. Note that the last two observations in Figure 2 are based on sow purchases reported under mandatory price reporting, so actual slaughter may or may not reflect those two precisely.

Figure 2: Federally inspected sow slaughter (USDA-AMS)

There is no doubt that sow slaughter has been higher but this is a larger sow herd so slaughter should be larger. Figure 3 shows the history of sow slaughter as a percentage of the breeding herd and changes in the breeding herd. Historically, it has taken slaughter of 1.1% of the breeding herd to get significant and sustained reduction in the U.S. sow herd. Note that we have touched on that 1.1% level in only two weeks and the eight-week average hasn't gotten near there. But the June 1 herd was 85,000 smaller than one year ago so there is some responsiveness of the herd even short of that 1.1% level — and you can see that in 2003-05 and again in 2013-14. But the reductions in the breeding herd in those years turned out to be small. I still think we have to ramp up sow slaughter to a consistent 70,000 per week to get a significant reduction in the breeding herd, and we have gotten to that level in only one week so far this year.

Figure 3: Weekly sow slaughter as percent of breeding herd

Reductions, though, are picking up steam. Goldsboro Milling's announcement two weeks ago that they would wind down their 54,000-sow operation was shocking. It is the largest liquidation of a hog enterprise on record. It may say more about pricing systems than about anything else, but regardless it means a substantial reduction in the nation's productive capacity.

Since that time, the Kerns and Associates staff has talked to many industry sources to determine that roughly 50,000 sows have already been taken out of production since March 1 and another 150,000 will be taken out by the end of the year. Should the reductions occur in the time periods we have gathered, they would result in quarterly year-on-year declines of 2.6% in the September report and 4.1% and 3% in the December and March reports, respectively. Reductions yes. Dramatic reductions? We don't think so.

And then there are these two final factors.

Productivity will resume its inexorable growth when these herds are removed. Exiting the pork industry right now certainly doesn't mean you are an inefficient producer, but we know that the ones remaining will likely be at the top end of efficiency and herd health, and likely price determination method. Tack 1.5% to 2% onto litter sizes and you offset a huge part of the sow herd reduction.

The 2021 futures contracts for lean hogs, corn and soybean meal are still offering profits for average producers and strong profits for the lowest-cost producers. The average of all 2021 lean hog contracts on the board the morning of Aug. 17 was $68.37. Our cost model would suggest that average producers can produce pigs for around $64 per hundredweight in 2021 and that the best 25% or so will be below $60 per hundredweight assuming good herd health. Large negative hog basis for those tied to negotiated markets will eat up a good chunk of those lean hog futures so 2021 is not too enticing for those tied to such prices.

But a good chunk of the industry is looking at profits. So the incentive to sell sows or close down units is certainly not universal. Is it large enough to get a significant reduction in output? Maybe, but we will not likely see it in 2021. It may well take longer.

Source: Steve Meyer, who is solely responsible for the information provided, and wholly owns the information. Informa Business Media and all its subsidiaries are not responsible for any of the content contained in this information asset. The opinions of this writer are not necessarily those of Farm Progress/Informa.
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