Livestock Marketing Information Center State Extension Services in Cooperation with USDA. Estimated Feeding Returns in the Broiler Chicken Industry

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1 Analysis & Comments Livestock Marketing Information Center State Extension Services in Cooperation with USDA November 7, 2014 Letter # 45 Estimated Feeding Returns in the Broiler Chicken Industry By J. Ross Pruitt 1 Net ready-to-cook (RTC) broiler chicken production has moderated in recent years from growth rates that frequently exceeded four percent prior to the early 2000s. Increased feed grain prices, excess supply, and the economic recession of have contributed to modest production increases and two years of declines in 2009 and Estimated broiler chicken feeding returns to vertically integrated firms (VIFs) have been quite variable over the past several years but have strengthened since early Tight supplies of competing meats, increased demand and an improving economy have contributed to strong returns and record profits for VIFs that have allowed for consideration of new production facilities to be built and potential acquisition of related business entities. It is unlikely that the broiler chicken industry will experience the type of annual growth it once experienced during the 1980s and 1990s due to entering the mature stage of the product life cycle. Overall U.S. broiler chicken slaughter capacity is little changed in recent years even though a few firms are currently building or considering new facilities. In this Analysis and Comments, discussion is focused on the costs and returns experienced in recent years by VIFs operating in the broiler chicken industry and provide some discussion on outlook for the remainder of this year into early next year. The Cost Side of the Equation The major production expense faced by VIFs growing out broiler chickens are purchased feedstuffs which are largely comprised of corn and soybean meal. As broiler chicken production is largely located in the southeastern U.S., VIFs often face a positive basis (cash prices greater than futures prices) for these two key inputs. The size of the basis varies by VIF facility, but an average basis of $0.60/bushel for corn and $20/ton for soybean meal over the nearby futures price provides an estimate on the price of feedstuffs purchased by VIFs. Assuming a fixed basis does ignore the basis risk faced by VIFs, but basis information is limited in major poultry production areas, especially for soybean meal. Composition of the diet fed to broilers varies by VIF and stage in the production cycle (starter, grower, or finishing ration) similar to cattle and hog diets. For the purpose of estimating a feed cost that the VIF faces monthly, industry contacts have stated that corn comprises 67% of the ration with soybean meal the remaining 33%. This ration assumes a higher proportion of corn than the USDA broiler-feed 1 Pruitt is an associate professor and Extension economist with the LSU AgCenter.

2 $/lb $/cwt LMIC Page 2 ration of 58% corn. A ration containing a lower percentage of soybean meal is assumed for this analysis per discussion with industry contacts and other available information (Waldroup, 2002). Broiler feed efficiency varies by the final weight of the bird at slaughter. Weights at slaughter vary by VIF complex reflecting the marketing agreements within highly coordinated broiler chicken industry. Lighter-weight birds are able to convert 1.65 pounds of feed for one pound of gain while birds weighing nine pounds at slaughter have a feed conversion ratio of approximately 2.2 pounds of feed per pound of gain. Average weekly live weight at slaughter for broiler chickens has averaged near 5.5 pounds since 2001 suggesting a feed conversion ratio of 1.9 pounds of feed per pound of gain. From 2001 until late 2006, ration costs per hundredweight for broiler chickens were largely less than $15/cwt to produce 100 pounds of live weight. Increased demand for ethanol pushed estimated ration costs above $20/cwt in Hedging may temporarily limit the impact of increased feed grain prices since VIFs often source their feedstuff needs a month in advance, but hedged feedstuff positions can lead to losses for VIFs who are unable to take advantage of lower feedstuff prices, as occurred in The losses that occurred partially contributed to production cutbacks that started in 2008 and continued through much of Drought conditions in 2012 resulted in estimated ration costs above $30/cwt. Ration costs have moderated in recent months on the expectation of a large corn and soybean harvest to less than $25/cwt. Figure 1: Estimated Broiler Chicken Ration Cost. Source: Chicago Mercantile Exchange (CME), Compiled by LMIC. *Note nearby prices are from one month prior $0.30 $40.00 $0.25 $35.00 $0.20 $30.00 $0.15 $25.00 $0.10 $20.00 $0.05 $15.00 $- $10.00 Estimated Broiler Chicken Ration Cost ($/cwt) Nearby Soybean Meal Futures ($/lb) Nearby Corn Futures ($/lb)

3 LMIC Page 3 The Revenue Side of the Equation The vertically integrated structure of the broiler chicken industry prevents any pricing information from being available prior to the wholesale level. Contract pricing is heavily used by the industry which varies from the available pricing data from USDA. The available pricing information from USDA reflects overall demand dynamics present in the marketplace, e.g. oversupply, weak demand, and the supply of competing meats. Available pricing data from USDA is likely more variable than the contractual prices, but does provide a glimpse into the strength of chicken demand. Lack of publicly available information on chicken paws and byproducts results in these items not being included in revenues, but can contribute up to an additional 5 cents per pound of revenue to broiler VIFs according to industry sources. Chicken revenues are divided into whole-bird sales and further processing of primary cuts such as breasts, legs, and wings. An estimated 20 percent of revenues come from whole-bird sales. Broilers sold in the whole-bird market tend to weigh approximately 2 ½ to 3 pounds. The Georgia FOB dock price reflects the strength of the whole-bird market according to industry contacts. Revenue from chickens further processed into pieces fill demand from retail outlets for products ranging from chicken nuggets to wings to breast meat to buffalo wings. Leg quarters and line-run breast prices account for nearly 50 percent and 40 percent, respectively, of the weighted average for processed chicken with whole wings comprising the remainder. Pricing information reflects the northeastern wholesale market and may be negotiated in advance of delivery reflecting current retail prices, processors costs, and the overall supply and demand situation for all competing meats. Since 2002, there has been more variability in the estimated revenue for VIFs than in their estimated ration costs. The minimum revenue estimate during this time period was approximately $42.50/cwt while the maximum was $97.16/cwt with an average of approximately $70/cwt. When feed costs begin to rise in late 2006, VIFs were earning approximately $70/cwt revenue. While prices did not completely collapse during the recession of , oversupply did contribute to estimated revenues falling to approximately $61/cwt in November Production cuts that started in 2008 helped estimated revenue climb back into the $70/cwt threshold by the first quarter of Oversupply led to more financial trouble for VIFs in early 2011, contributing to estimated revenues falling back into the $60/cwt range. This decline was short lived as component prices increased helping estimated revenues climb above $70/cwt by August As production cuts began to be felt in the marketplace in late 2011, estimated revenues rose above $80/cwt by January 2012 and above $90/cwt in May Estimated revenues have consistently been above $85/cwt since 2012 except for a temporary decline into the upper $70/cwt range in late 2013 and early 2014.

4 $/lb $/cwt LMIC Page 4 Figure 2: Chicken Prices and Estimated VIF Revenue. Source: USDA AMS, Compiled by LMIC $2.15 $ $90.00 $1.65 $80.00 $1.15 $70.00 $0.65 $60.00 $50.00 $0.15 $40.00 Estimated Revenue Leg Quarters Line Run Breasts Wings GA Dock The Margin Subtracting estimated ration costs from estimated revenues leaves the money available for VIFs to pay labor for processing of chicken, feed mill and hatchery costs, and the contract growers involved in production of broiler chickens. These costs vary by VIF and each of their respective complexes, but the estimated broiler chicken feeding returns provide an indication to the overall financial health of the industry. The calculations estimating broiler chicken margin simplify a complex industry, but can provide insight into the trends for the industry. Estimated monthly returns have averaged approximately $50/cwt since the beginning of From 2002 through 2006, average estimated returns were $45.21/cwt while average returns since 2007 were approximately $8/cwt more at $53.31/cwt. On average, estimated returns are weakest in November and December and strongest in the first two quarters. In both 2009 and 2012 (the last two times that broiler production experienced a year-on-year decline in production), estimated processor returns weakened well before production cutbacks started. Estimated returns began weakening in late 2007 as feedstuff prices increased followed by weakening demand as the recession impacted consumer purchasing habits. Although estimated returns had improved to above $50/cwt by early 2009, production would not see an increase until the following year. Estimated returns fell below the $40/cwt level on higher ration costs and weaker chicken demand in early 2011 resulting in another year-on-year decline in annual chicken production during 2012.

5 LMIC Page 5 Estimated monthly returns for 2014 have improved as the year has progressed. The estimated return for August 2014 set a new record at just over $70/cwt on lower costs even though chicken meat prices are largely lower than a year ago. Seasonally, estimated returns should weaken some in the fourth quarter of this year as consumers turn their attention to traditional holiday items. The Outlook for 2015 VIFs are currently enjoying their lowest estimated ration cost since the 3rd quarter of The current strength of the estimated margin suggests that 2014 production should have been higher than the forecasted 1.6% increase, but that has not occurred. While the number of broiler layers and egg sets has been higher this year, it has not translated into an increase in the number of chicks placed with contract growers. Broiler chicken VIFs have stated in recent months that they expect chicken profits to moderate in 2015 as the industry expands to at least a 3% increase in production relative to this year. Additional processing facilities combined with a larger breeding hen inventory will contribute to that expansion provided the hatchability issues that have hampered the industry this year are resolved. A seasonal decline in the number of layers and egg sets has already began and will continue through early December. The number of layers was 2% higher than a year ago in September 2014 and slightly above the average for Based on historical relationships between the number of pullet placements and the number of breeding layers, the number of broiler breeding layers could be approximately 52.5 million in November and 53 million in December, an increase of 1.5% compared to a year ago. For early 2015, this relationship suggests a breeding layer inventory of over 54 million, an increase of 2% relative to last year early in the quarter and 3% late in the quarter. If that forecast is proven accurate, the number of breeding layers would be just slightly below the average for the first quarter. With total chicken in cold storage at the lowest levels since 2007, there appears to be room for chicken production to increase without negatively impacting current price levels. Given the higher prices consumers have paid for beef and pork so far in 2014 (and still yet to come), consumers may soon switch to cheaper alternatives and result in moderating beef and pork prices.

6 $/cwt Millions of Pounds LMIC Page 6 Figure 3: Estimated Returns to Broiler Chicken VIFs and Ready-To-Cook Young Chicken Production. Source: USDA NASS, USDA AMS, CME; Compiled by LMIC and author s calculations $75.00 $70.00 $65.00 $60.00 $55.00 $50.00 $45.00 $40.00 $35.00 $30.00 Estimated Returns RTC Production 3,600 3,500 3,400 3,300 3,200 3,100 3,000 2,900 2,800 2,700 2,600 References Waldroup, P.W. Soybean Meal in Poultry Nutrition. May Available at: Accessed June 27, 2012.