This could be the year we learn how much price increase consumers will tolerate in beef and the year consolidation hits the packing and feeding sectors.
"We have not identified it yet but there is a limit to what consumers will pay for retail beef," says a new report by Rabobank's Food & Agribusiness Research and Advisory Animal Protein Global Sector Team.
The report says 2012 will be another year of record high cattle and beef prices with diverging impacts for various segments of the industry. Ranchers will benefit from scarce cattle supplies. It says feedlots and packers face these challenges:
- Tight cattle supplies - resulting either from weak rancher margins over the past years or weather-related problems.
- Feedlots and packers should be concerned about higher prices and limited availability of inputs, which exacerbates problems with poor utilization of capacity and causes margin compression.
This same concern was expressed this week by Darrell Peel, Oklahoma State University Extension livestock marketing specialist.
Peel says, "Cattle prices are at record high levels and will push even higher in 2012 and beyond. Retail beef prices are increasing and will push higher but it is uncertain how much and how fast. These conditions ensure that margins for various sectors in between will continue to be squeezed and some sectors of the beef industry will face difficulties in the coming months."
Rabobank analysts concur: "Beef processors' ability to pass through pricing to consumers will be tested in 2012. Global economic growth has been inconsistent, with growth slowing in many markets. In the world's largest consumer markets, Europe and the US, growth has been particularly slow."
Peel explains retailers are always reluctant to increase prices too fast or too much. Therefore, he adds, retail margins are likely to be squeezed in the transition.
Peels says packers have already faced limited margins as fed cattle prices increased faster than boxed beef prices. Packers experienced poor margins much of the fourth quarter of 2011. Packers have the additional challenge of not operating at efficient capacities in the face of declining cattle numbers. Peel says that challenge will increase as feedlot marketings decrease in 2012.
"Feedlots face perhaps the toughest challenge of all," Peel says. "High feeder cattle prices and high feed costs will likely more than offset record fed cattle prices and result in negative operating margins much of the time for the foreseeable future."
He says feeder cattle supplies will continue to tighten and may decrease dramatically if the drought abates and heifer retention accelerates. Feeder supplies will be tighter in 2012 and may not reach the tightest level until 2013 or beyond.
As supplies tighten, competition for feeder cattle and feedstuffs will really push pricing and crimp profitability. This is the "margin compression" to which Rabobank analysts refer.
When they refer to poor utilization of capacity, it's a reference to ongoing "excess capacity" in the packing and feeding segments, compared with the number of cattle moving through the system.
Peel says the U.S. beef industry has had "chronic" excess capacity in the feeding and beef packing sectors for many years. Most of the existing feedlot and packing infrastructure was originally built in the 1970s and 1980s. At that time cattle inventories were 15-25 million head greater than today.
Continued herd liquidation, especially since the mid-1990s has accelerated the pressure to reduce feedlot and packing capacity. Downward adjustments in industry capacity are a slow process and not much has changed yet.
The drought in 2011 temporarily accelerated cattle marketings and postponed the coming crunch of tight feeder supplies but it ensures that the crunch will be even more severe when it happens, Peel predicts.
He says continuing drought could again change the timing of cattle flows to feedlots and packing plants but he expects the squeeze in feeder supplies to reach critical levels in 2012.
Rabobank analysts suggest the ongoing debt crisis in Europe presents another risk for some beef processors: "If the banking system becomes stressed to the point at which it has to withhold credit, cash-strapped beef companies will struggle."
They say: "In conjunction with margin compression, possible credit strains could set the stage for accelerated M&A activity in the beef industry. We began to see signs of this in 2011, with several transactions announced in Europe and in the U.S."Peel says this "war of attrition" on feedlots and packing plants will continue and will accelerate in 2012. Feedlots and packing plants will compete aggressively for ever-declining animal numbers and contribute to even higher input costs until somebody finally exits. It may not happen in 2012 but the pressure will be even greater and it will happen eventually.