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Global Beef Primer
SECTOR REVIEW
Why Brazil Still Has the Upper Hand
While the U.S. and Brazilian beef industries don't compete directly against each
other in the global beef market yet, we think the fates of both markets are
beginning to converge. Brazilian beef processor JBS has taken a leadership
position in the U.S. industry through aggressive acquisitions, so Tyson’s fate is
increasingly in JBS’s hands. Brazilian beef has near-term challenges, but in this
report, we explain why it presents better investment opportunities than U.S. beef.
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Brazil has cheaper land, lower cost labor, cheaper feed, and more
opportunities for growth and reinvestment domestically than does the U.S.
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Fast-growing export markets such as Russia and the Middle East either
have a preference for the taste of grass-fed beef from Brazil or they just
have a bias against the U.S. for political reasons or concerns regarding the
U.S. practice of using hormones and/or antibiotics. Either way, the biases
do not go away quickly.
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Brazil is in the process of diversifying into grain-fed beef, which could make
it more competitive in Asian markets too. China’s budding demand for beef
imports represents an opportunity for both the U.S. and Brazil, and Brazil
currently has the upper hand.
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A key limiting factor for U.S. beef is that the domestic cattle supply is likely to
contract over the next three years owing to higher feed costs and the
reluctance of ranchers to expand. This could drive beef prices measurably
higher, which could then hurt consumer demand. Consumer demand has
been surprisingly strong this year in the face of a weak economy, but
deterioration in demand in 2009 would present a significant challenge to U.S.
processors. Exports have rebounded this year, but may be compromised
next year with a stronger U.S. dollar.
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Capacity utilization is the most important driver of profitability in beef
processing and there is still overcapacity of 5-9%. The conditions for
undisciplined behavior (such as chasing after market share and overpaying
for cattle) will continue to exist until more capacity comes out of the market.
JBS claims that it will not close capacity once it completes its acquisition of
National Beef and Smithfield Beef.
Conclusion. We favor Brazilian-based Marfrig because its geographic distribution reduces
dependence on specific markets and because its solid growth-strategy toward food service
reduces its exposure to commodity products. Marfrig also has large-scale operations in
low-cost-producing regions such as Uruguay. Marfirg is currently trading at 5.6x
EV/EBITDA on a 2009 basis, which is a 20% discount to local peers and an 8% discount
to Tyson (see Exhibit 1). We are negative on U.S. processor Tyson. While we expect
very strong beef results from Tyson over the next six months, the situation could turn
radically negative in 2009 given the continued weakness in chicken, the trend toward
cattle and hog supply reductions, and the risk of trade disruption from political bias or a
stronger U.S. dollar. Tyson has been reducing its commitment to U.S. beef through plant
closures and divestitures while JBS is expanding. As a result, Tyson’s fate is increasingly
in the hands of factors outside of its control.
Where We Could Be Wrong. Tyson stock is trading at the low end of its traditional range
on a price-to-book basis (at 1.1x compared with a range of 1.0-1.5x), so a lot of the bad
news might already be in the stock. Indeed, Tyson still stands to benefit this year from
incrementally better conditions in U.S. beef thanks to the industry capacity reductions,
improving export volume, and increased discipline by JBS.
External events that could help Tyson further would be if JBS cuts beef processing
capacity or adds further discipline to the U.S. beef industry following the close of its
acquisitions of National Beef and Smithfield Beef in the fourth quarter. U.S. government
policy changes on corn-for-ethanol or beef trade agreements with Japan would be
positives as well.
Table of Contents
Brazil’s Competitive Advantage 4
Recent Challenges In Brazil 8
Marfrig 11
Minerva 13
Implications for the U.S. 15
U.S. Protectionism 16
Why We Think the U.S. Cattle Supply Will Decline 19
Why We Remain Bearish on U.S. Beef 28
U.S. Demand 29
U.S. Ranchers 32
Threat of Cellulosic Advancement? 35
Vertical Integration? 35
Cattle Feeding 37
Capacity Rationalization and Commoditization 42
Beef Packing 44
Labor Challenges 45
Disease and Contamination Challenges 46
Packing Margins 47
Beef Processing Capacity Utilization 48
Beef Packing Industry Consolidation 52
Tyson 57
Cargill 58
JBS Background 58
Global Beef Market Background 60
Why Protein Exports Are Fickle 66
Growing Traceability Requirements 67
Australia 67
Uruguay 72
Argentina 72
India 72
United States 73
Russia 76
Japan 77
European Union 78
Mexico 79
Korea 79
Egypt 80
China 81
Tyson Earnings Model 84
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