s-p industry surveys - agribusiness - 2007

8/2/2019 S-P Industry Surveys - Agribusiness - 2007

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May 31, 2007

Industry SurveysAgribusiness

THIS ISSUE REPLACES THE ONE DATED DECEMBER 14 , 2006 .

THE NEXT UPDATE OF THIS SURVEY IS SCHEDULED FOR NOVEMBER 2007 .

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CURRENT ENVIRONMENT..................................................................1

Cashing in on biofuelBoom and bust?Grains: harvest update and forecastGovernment paymentsLivestock updateS&P Ratings Services View:

Outlook for agribusiness credit quality is stable

INDUSTRY PROFILE.............................................................................11Economics of food production

Agricultural producersAgriprocessors

INDUSTRY TRENDS ...............................................................................13Going globalConsolidation trend continuesGlobal food safety issuesThe rise of organic farmingGenetic engineering: expansion and controversy

HOW THE INDUSTRY OPERATES .............................................................20The role of the crop processorHow grains are processedDistribution: spreading the bountyIt all starts at the farmThe main food groupsWorld trade: moving toward freer markets

KEY INDUSTRY RATIOS AND STATISTICS ...................................................27HOW TO ANALYZE AN AGRIBUSINESS COMPANY ......................................28

External factorsLooking at the income statementS&P Ratings Services View:

Assessing the creditworthiness of an agribusiness companyEvaluating the balance sheet

GLOSSARY .............................................................................................34

INDUSTRY REFERENCES.....................................................................35

COMPARATIVE COMPANY ANALYSIS ..............................................37


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VOLUME 175, NO. 22, SECTION 1

THIS ISSUE OF INDUSTRY SURVEYS INCLUDES 3 SECTIONS.

Standard & Poors Industry Surveys


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Ethanol producers have been scrambling to getin on the latest US gold rush, mining what theyhope become deep lodes of demand for thegrain-based fuel. Their dreams of future richeswere further excited by President George W.Bush, whose 2007 State of the Union speechtossed a large nugget to agriprocessors by call-ing for the nation to produce 35 billion gallonsper year within 10 years a figure some skep-tics consider too ambitious.

Right now, ethanol demand is enlargingthe market for corn, and, in the long term, itis expected to alter the supply/demand equa-tion as well as prices. In 2006, an estimatedfive billion gallons of ethanol were produced,utilizing about a fifth of the nations corncrop. The nations 115 ethanol plants arenow capable of making 5.8 billion gallonsper year. Capacity is up from roughly fourbillion gallons in 2005 and 5.4 billion gal-lons in 2006, according to the RenewableFuels Association. Another 86 plants, with

capacity of 6.4 million gallons per year, areunder construction.

In the United States, leading ethanol pro-ducer Archer Daniels Midland believes thatcurrent capacity is far outstripped by poten-tial demand of roughly 14 billion gallons peryear (based on 10% of the gasoline usage onexisting automobiles). In 2006, the companyannounced that it would expand its US

ethanol capacity to 1.65 billion gallons peryear. In a distant second place, US BioEnergyhas a capacity of 250 million gallons per yearwith five more plants under construction. Thecompanys CEO, Gordon Omen, sees consoli-dation ahead in the industry, and said hisfirm would like to make acquisitions.

As an indication of ethanols profitabilityfor processors, ADM reports that in thequarter ended Dec. 31, 2006, operating prof-

it for the Bioproducts unit rose 121% over2005, to $366.9 million. Ethanol now repre-sents 30.5% of the companys operatingprofit, up from 21.3% a year earlier.

The limits to corn ethanol production,however, may be met sooner rather than lat-er. By mid-2008, the nation will produce11.4 billion gallons of the fuel, according tothe ethanol association. Doing so will require4.2 billion bushels of corn, or roughly a thirdof the forecast 2007 crop. If the entire UScorn harvest were allotted to this one prod-

uct, it would yield 34 billion gallons per year(based on the projected 2007 crop), fallingjust short of the presidents goal for 2017.

Another question is, will the market con-sume the growing ethanol production? ADMreports that demand from gasoline refinershas boosted prices, although sales volumesfor the quarter ended December 2006 werebelow the comparable year-ago period, whensales exceeded production, and the companysold ethanol out of inventory.

The Economic Research Service (ERS), an

economic research division within the US De-partment of Agriculture (USDA), estimatesthat corn-based ethanol volumes will exceedthe goals established by the 2005 Energy Pol-icy Act by nearly four billion gallons byaround 2010, based on the USDAs 2007projections. The question, then, is: Who willbuy this ethanol?

Boom and bust?

Petroleum remains the primary fuel source

for transportation, and will not be dislodged

CURRENT ENVIRONMENT

Cashing in on biofuel

CORN USED IN ETHANOL PRODUCTION(Millions of bushels)

E-Estimated.

Source: US Economic Research Service.

4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

01992 1994 1996 1998 2000 2002 2004 E2006 E2008


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anytime soon. The United States consumedroughly 138 billion gallons of gasoline in2004, according to EIA statistics. Ethanol

represented just 3.5% of gasoline consumed,according to the ERS.

Nonetheless, use of alternative fuels islikely to increase. Financial incentives fromthe US government, restrictions on use ofgasoline additives, and public concern overemissions of greenhouse gases are helping tostimulate demand.

Although it has been produced for decadesin the US, ethanol got a boost from the Ener-gy Policy Act of 2005, signed into law byPresident Bush in August 2005. The law re-

quires refiners to use 7.5 billion gallons ofethanol in gasoline annually by 2012. Beforethe 2005 mandate, ethanol usage had beenspurred by high oil prices and growing con-cerns about the health hazards of methyl ter-tiary butyl ether (MTBE), a fuel oxygenate forwhich ethanol is a common replacement.

The Energy Security Act of 1979 created atax incentive for ethanol to encourage gasmarketers to mix the fuel with their gasoline.The program, through which gas marketersor blenders may claim a tax credit of 51

cents per gallon of ethanol blended, was ex-tended through 2010 by the VolumetricEthanol Excise Tax Credit, part of the Amer-ican Jobs Creation Act.

Along with the US, Brazil is the othermain producer of ethanol. Both nations pro-duced about the same levels of ethanol in2005, and together accounted for about 90%of the world total, according to the USDA.

Biodiesel, made from soybeans, remains adistant second as an alternative fuel. Still, ifbiodiesel gains traction as a lubricity additive

in diesel fuel, annual US demand could reach

470 million gallons in 2010 and 630 milliongallons in 2020, according to the EIA.

Impact on market, food and feed costsIn late May 2006, ethanol futures

fetched as much as $4.20 a gallon, up from

roughly $1.20 a year earlier. This jump wassparked by rising oil prices and increaseddemand for ethanol as a gasoline additiveto replace MTBE, believed to contaminategroundwater. But ethanol prices nosedivedjust as quickly. As of October 4, Novemberethanol futures were selling for $1.68 pergallon on the Chicago Board of Trade. Asof March 2007, the price had risen to the$2.20 area.

An estimated 1.9 billion bushels of cornwere used in ethanol production in 2006, up

from 1.6 billion in 2005 and 628 millionbushels in 2000, according to the USDA. Theagency projects that ethanol will consume2.15 billion bushels in 2007.

Volatility in grain futures is generally lim-ited, staying within certain bands for eachcrop. But that may not turn out to be thecase for ethanol. The boost in production ca-pacity now underway could further exacer-bate price volatility. Rising input costs couldalso squeeze margins and reduce producersappetite for ethanol, whose commercial via-

bility is, for now, dependent on subsidies.These added costs may not be recouped byraising prices; according to ADM, ethanolselling prices bear no direct relationship toinput costs.

A sustained rise in food costs worldwidecould spark inflation. The greatest risk ofthis occurring is in developing nations, wherefood represents a much higher percentage ofthe consumer price index as high as 50%in the Philippines compared with 15% in theUS, according to the Wall Street Journal.

Temporary spikes in food prices have set offrecessions in combination with other factors.But a sustained increase in demand for corncould be sufficient to permanently raise foodcosts, according to the Earth Policy Institute,a Washington, DCbased environmentalgroup.

The demand has also led some experts toworry that fuel production will cause foodshortages for humans and livestock. Con-cerned that it will not be able to meet do-mestic demand for corn-based food and

animal feed, China has limited construction

US CORN USAGE BY SEGMENT(In percent)

CHANGECOMMODITY 2005 R2006 IN SHARE

Feed/residual 54.5 50.3 (4.2)

Export 19.1 19.3 0.3

Ethanol 14.2 18.5 4.3

High fructose corn syrup 4.7 4.4 (0.3)

Starch 2.4 2.4 0.0

Sweeteners 2.0 2.1 0.0

Cereal/other 1.7 1.6 0.0

Beverage/industrial alcohol 1.2 1.2 0.0

Seed 0.2 0.2 0.0

Figures may not add due to rounding. R-Revised.Source: US Department of Agriculture.


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of corn-derived ethanol plants, the WallStreet Journalreported.

Ethanol, made primarily from field (notsweet) corn, as well as from grain and otherbiomass sources, is used as a gasoline octaneenhancer and oxygenate. Ethanol production

uses only the corn kernels starch, leaving thevitamins, minerals, protein, and fiber as abyproduct that can be sold for use in high-value animal feed. Thus, US corn demandfrom feed processors still can be satisfied, de-spite greater volumes going to ethanol pro-ducers, according to the Corn GrowersAssociation. Corn prices, however, will feelthe increased pressure.

Through 2011, the USDA sees the ethanoltrend restricting US corn exports. The de-partment projects that, should the reduction

stimulate a boost in corn prices, it will notlikely affect Japan and Taiwan, the largestcustomers for US corn, due to their high percapita income levels. Canada might be ex-pected to produce more corn for its own use,just as Argentina and Brazil could take upsome of the slack by boosting their produc-tion and exports. China is likely to producemore corn for its livestock, though it will re-main a net importer. Among lower-incomecountries, however, a price rise could cutconsumption in Egypt, Central America, and

the Caribbean nations, or force them to seeksubstitutes.

In the US, the largest use for corn remainsas livestock feed, but ethanol is gaining rapid-ly. Feed accounted for 51.3% of corn con-sumed during 2006, down 3.2% from 2005,when it held a 54.5% share, according to theUSDA. Meanwhile, ethanols share jumped to18.1% in 2006 from 14.2% in 2005, close toovertaking corn exports, whose share fellmarginally to 18.9% from 19.1%.

The National Corn Growers Association

disputes that ethanol will detract from foodsupply. In a November 2006 paper, the tradegroup projects that corn yields per acre willcontinue to grow over the next decade. (Thehistorical average for 19962005 was, asnoted, 138 bushels per acre; in 2006, the av-erage was 149 bushels.) The trade group seescorn yielding 180 bushels per acre by 2015.At that level, the harvest would exceed the19962005 average yield by 42 bushels peracre, producing an additional 8.8 billion gal-lons of ethanol. (This rough estimate is based

on 78 million acres under cultivation in 2006

and 2.7 gallons per bushel; it doesnt takeinto consideration rising yield in ethanol pro-duction or future changes in corn acreage.)With other demands expected to grow slowly(demand for livestock feed and industrial[nonethanol] uses have remained relatively

flat for the past decade), the trade groupconcludes that the increased corn yield willbe available for ethanol production.

Corns criticsCritics of the nations sudden rush to

corn-based ethanol are sprouting at bothends of the political spectrum, from environ-mentalists to free marketeers, as well as, nat-urally, consumers of grains like livestockproducers. At present, the anti-corn crowddoes not wield significant influence, although

it is gaining momentum, according to Busi-nessWeek magazine (published by McGraw-Hill Cos., parent of Standard & Poors).

While the newfound activity seems topromise economic revival in struggling ruraland farm communities, residents across theCorn Belt are organizing to oppose construc-tion of ethanol plants. Complaints about thecorn-based plants target the smell, air pollutionfrom truck traffic, and their large consumptionof water, plus concerns about fire hazards.

Some environmentalists object to heavy

reliance on corn ethanol due to the high re-quirements for water, fuel, natural gas, andfertilizer needed to grow and convert it intoautomotive fuel. Opponents have also arguedagainst the diversion of food crops for gaso-line use, pointing out that rising prices are al-ready hurting the worlds poor.

With one bushel of corn yielding at least2.7 gallons of ethanol, an acre of corn couldtheoretically yield 373 gallons, based onUSDA data. The Corn Growers Association,however, cites 300 gallons per acre as a

standard.Some scientific researchers are also poking

holes in lofty expectations for ethanol. Cornethanol yields 25% more energy than its pro-duction consumes; for soy-based biodiesel, theyield is 93%, according to a study led by theUniversity of Minnesota and published in July2006 by the National Academy of Sciences.

From the perspective of emissions, cornethanol performs worse than biodiesel, ac-cording to the study. Compared withpetroleum-based diesel, ethanol reduces car-

bon dioxide emissions by only 12%, but


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biodiesel cuts them by 41%. As a 10% addi-tive in gasoline, ethanol can reduce CO2,volatile organic compounds, and fine partic-ulate matter. But more of these pollutants,and more sulfur and nitrogen oxides, are re-leased in the production and transport of

E85 (85% ethanol and 15% gasoline) thanwith gasoline. Biodiesel blended with dieselfuel, however, does reduce emissions duringcombustion and over the entire productioncycle, the University of Minnesota studyfound.

In the end, the longevity of this burgeon-ing industry will mostly hinge on its econom-ics. Corn ethanol is profitable now, but forhow long? Some experts see the fuel as onlya first step in an evolving biofuel market,whose future contours and profitability for

farmers and processors is not yet known.

Just the first step?In a follow-up to the 2005 University of

Minnesota study that was published in De-cember 2006 by Science, one of the studysauthors describes both corn and soy fuels assuccessful first-generation biofuels, eventu-ally to be replaced by less resource-intensiveinputs. This study indicates that cellulosic al-ternatives offer the most promising sourcefor alternative fuels. They do not have to

take productive agricultural land out of culti-vation for food sources, they use less waterand other resources, and cause less damageto environment and animal habitat. A re-search scientist with the Minnesota PollutionControl Agency told the journal Environ-mental Health Perspectives that, given its en-vironmental costs, the most sensible use ofcorn ethanol will remain as an oxygenate toreplace MTBE or as a 10%20% additive togasoline.

Cellulosic ethanol: the alternative toalternative fuels

Pilot projects are currently underway toderive cellulosic ethanol from plant wastes,an alternative to corn-based ethanol. Plantwastes such as switch grass and corn cobsare cheaper, more plentiful, and less water-intensive than grain corn. The fuel couldyield three to six times the energy that isneeded to produce it.

For farmers, this development could pro-vide a new market for their agricultural

wastes. For companies that process biofuels,

the technology could represent a source oflow-cost supplies. Finding a way to economi-cally transport the bulky volumes of wasteswould pose a challenge, however. One acreof corn produces about 5,500 dry pounds ofstover (corn stalks, leaves, and cobs), which

will produce roughly 180 gallons of ethanol,the USDA reports.

The US Department of Energy estimatesthat 30% of US oil consumption could comefrom cellulosic ethanol, produced from agri-cultural wastes, switchgrass, wood chips, andother low-intensity agricultural products, ofwhich the US could produce more than onebillion tons per year. But this feedstock iscurrently more expensive to process into fuelthan corn and not commercially viable.

Six facilities are scheduled to receive $385

million in grants from the Department of En-ergy, which announced the grants on Febru-ary 28, contingent upon the plants achievingcertain goals. Projects include demonstrationplants capable of producing ethanol fromwheat straw, corn cobs and stalks, wood-based products, and switchgrass. Includinginvestment from the projects sponsors, thefacilities funding will be $1.2 billion. Theyare expected to yield more than 130 milliongallons of cellulosic ethanol per year, accord-ing to the DOE.

This new technology could be 10 to 15years away from being competitive with cur-rent corn ethanol technology, however.Among the technical hurdles to be clearedare developing enzymes to facilitate consis-tent and economical conversion into ethanol,and finding an efficient means of handlinglarge volumes of bulky materials.

In February, the University of Illinois an-nounced that it had been selected to partici-pate in a new research partnership with theUniversity of California at Berkeley and the

Lawrence Berkeley National Laboratory tostudy renewable fuel sources. The EnergyBiosciences Institute will be funded by a10-year, $500 million grant from oil firm BPplc. The universitys first research projectswill involve stover and fast-growing, high-yield perennial grasses like miscanthus.

Biodiesel, made from soybean (or other)vegetable oil, is another nonfossil fuel whosestar is rising. Its demand may create a broad-er market for soybeans and ultimately boosttheir price. Demand for 50 million gallons of

soybean oil per year could increase the oils


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price by 15% in 200607 and by 20% in201213, according to projections issued in2004 by the Energy Information Administra-tion (EIA), the statistical agency of the USDepartment of Energy.

Archer Daniels Midland is seeking to sub-

stantially raise its stake in the growingbiodiesel market. The company announcedthat, as of mid-2007, it will have capacity toproduce 135 million gallons of biodieselfrom soybean and canola oil in the UnitedStates, as well as a combined 450 milliongallons in Europe, Brazil, and Indonesia.

US processors should be able to serveboth domestic and foreign markets. USbiodiesel capacity was about 400 million gal-lons per year in 2006, according to the Na-tional Biodiesel Board (NBB); that figure is

set to rise to roughly 1.2 billion gallons in2008, based on announced new capacity. Toabsorb the surplus US production, export de-mand could come from the EU, where gov-ernmental targets call for annual productionof nearly 14 million metric tons by 2010, upfrom a target of about six million metric tonsin 2006.

Produced from vegetable oil and methanol(methane derived from natural gas), purebiodiesel can be burned by many gas engineswith little or no alteration. Petroleum-based

blends with up to 20% biodiesel can be usedin almost all diesel engines and require nospecial storage and distribution equipment,which the higher level blends do require.

Efforts to popularize the fuel are comingfrom both the federal government (in theform of tax incentives) and private industry.In addition to big companies like ArcherDaniels Midland, small entrepreneurs aregetting into the act. For example, in Decem-ber 2004, country singer Willie Nelsonformed The Willie Nelson Biodiesel Co. to

promote and sell biodiesel to truckers; theproduct is distributed by publicly tradedEarth Biofuels Inc.

Other uses for biodiesel include homeheating and marine fuel. The US Navy, thebiggest consumer of diesel fuel in theworld, directs its Navy and Marine divi-sions to use a 20% biodiesel mixture innontactical vehicles whenever possible, ac-cording to the NBB.

Research is also underway at a Wisconsinbiotech company regarding the use of soy-

beans in ethanol production, the Milwaukee

Journal Sentinelreported in March. Thecompany is developing enzymes that wouldtrigger ethanol production from soybeans,and that would separately boost yield andsave energy in corn-based ethanol produc-tion. A South Dakota company, Broin Co.,

has invented a way to save energy by pro-ducing ethanol at 90 degrees rather than230250 degrees.

High-priced substitutesThe 2005 University of Minnesota study

found that both corn ethanol and soybiodiesel required subsidies to achieve cost-competitiveness with petroleum fuels. At thetime of the study, corn ethanol cost twocents more per energy equivalent liter (EEL)to produce than gasoline, and biodiesel 11

cents more than diesel. As of February 2007,the cost differentials had grown to 18 centsand 29 cents, according to co-author ErikNelson. The US government provides subsi-dies of 20 cents per liter for ethanol and 29cents for biodiesel.

The growth prospects of soybean-derivedbiodiesel are limited by the relatively highcost of the crop. The EIA projects that, un-less soybean oil falls significantly in price,biodiesel will not become a widespread sub-stitute for petroleum. Its usage will likely be

limited to that of an additive to ultra-low-sulfur fuels, where its useful properties arenot outweighed by the cost disadvantage.

Biodiesel also can be produced atabout half the cost of soybean oil by us-ing recycled restaurant oil, also known asyellow grease. At this cost, biodieselwould come closer to being cost-competitivewith petroleum diesel, according to the EIA.The supply of such oil is limited by its avail-ability from restaurants as well as by de-mand from competing users, who utilize it to

make animal feed additives, as well as soapsand detergents.

Another inherent obstacle to the expan-sion of both corn ethanol and biodiesel is thenatural limit to agricultural land, water, andother resources. Even if the entire US cornand soybean crops were devoted entirely tofuel production, they would replace only12% and 6% of US gasoline and diesel de-mand, according to the 2005 study.

Given that these factors establish the upperlimits of the market in crop-based alternative

fuels, cellulosic ethanol may be more cost-


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competitive with petroleum in the long run. Inthe meantime, farmers and processors stand toprofit from the manufacture and sale of mil-lions of gallons of alternative fuels.

Grains: harvest update and forecast

Prices for the three principal grain cropsincreased in late 2006. Drought in wheat-producing countries (including the US) cutinto supplies, pushing up prices, while ex-pansion of production facilities and demandfor biofuels boosted the price of corn andsoybeans. With prices higher for corn, soy-beans, and hay, farm income will rise $6billion in 2007, to $66.6 billion, accordingto the USDA Economic Research Servicesforecast.

CornIn 2006, farmers planted 78.3 million

acres of corn, down from 81.8 million in2005, due to high costs of inputs such as fer-

tilizer and fuel, according to the USDA. Pro-duction of corn for grain fell to 10.5 billionbushels from 11.1 billion in 2005. Yield roseto 149 bushels per acre, up from 148 bushelsin 2005 but down from 160 in 2004.

In the face of reduced supply and in-

creased demand, the average per-bushel pricerose to $2.48 from $2.05 in 2005. As of thefourth quarter of 2006, the per-bushel priceof corn averaged $3.35.

High corn prices in the first quarter of2007 have encouraged farmers to grow moreof the crop, and the USDA forecasts thatthey will plant 90.5 million acres of corn, up15% from 2006 and 11% from 2005. Itwould be the second-largest corn crop byacreage since 1944, which totaled 95.5 mil-lion acres. Cash receipts from corn will ex-

ceed $30 billion in 2007, the USDA projects.

SoybeansIn 2006, US farmers harvested the largest

soybean crop in the nations history: 3.2 bil-lion bushels, up 4% from 2006, which alsoset a record. Planted acreage was up 5%, to75.5 million acres, though yield per acre fellslightly from 2005, to 42.7 bushels, from43.0. The average price of soybeans fell to$5.74 in 2006, from $5.97 in 2005, but inthe fourth quarter of 2006, prices were

trending upward with an average of $6.15.Since late 2004, soybean futures have lan-

guished in the range of $5.00 to $6.25 perbushel (other than a two-month spike above$7.00 per bushel in mid-2005). Soybeanprices began to tick up in September 2006.The USDA projects a price range of $4.90 to$5.90 per bushel for 200607, notwithstand-ing the robust harvest. The increase wouldpush up total cash receipts for soybeans by$1.2 billion.

Prices could continue to go up for a cou-

ple of reasons. Used as animal feed, soybeansare a cheap alternative to corn, so the highprice of corn could boost soybean sales. Theburgeoning biodiesel market could be anoth-er factor driving prices. AgWeb.com, an agri-cultural news Web site, notes that pricescould also shoot up if farmers decide to re-duce acreage in order to grow more corn,due to the high prices for that crop. Indeed,the USDA projects that acreage will fall 11%in 2007, to 67.1 million acres whichwould be the lowest acreage since 1996, ac-

cording to the USDA.

MAJOR CROPS ACREAGE, SUPPLY, & PRICES

CROP YEAR

CROP 2002/03 2003/04 2004/05 2005/06 E2006/07

WHEAT

Acreage planted (mil.) 60.32 6 2.14 59.67 57.23 57.34

Yield (bushels per acre) 35 44 43 42 39

Production (mil. bushels) 1,606 2 ,345 2,158 2,105 1 ,812Total supply (mil. bushels) 2,460 2,899 2,775 2,727 2,498

Exports (mil. bushels) 850 1,158 1,066 1,009 875

Total consumption (mil. bushels) 1,969 2,353 2,235 2,155 2,026

Farm price ($ per bushel) 3.56 3.40 3.40 3.42 4.20-4.30

Total estimated market value* (bil. $) 8.8 9.9 9.4 9.3 7.6-7.8

CORN



Production (mil. bushels) 8,967 10,089 11,807 11,114 10,535

Total supply (mil. bushels) 10,578 11,190 12,776 13,237 12,512

Exports (mil. bushels) 1,588 1,900 1,818 2,147 2,250


Farm price ($ per bushel) 2.32 2.42 2.06 2.00 3.00-3.40Total estimated market value* (mil. $) 24.5 27.1 26.3 26.5 31.6-35.8

SOYBEANS



Production (mil. bushels) 2,756 2 ,454 3,124 3,063 3 ,188

Total supply (mil. bushels) 2,969 2,638 3,242 3,322 3,642

Exports (mil. bushels) 1,044 887 1,097 947 1,100


Farm price ($ per bushel) 5.53 7.34 5.74 5.66 6.10-6.50

Total estimated market value* (mil. $) 16.4 19.4 18.6 18.8 19.4-20.7

E-Estimated. *Standard & Poor's estimate based on production times farm price.Source: US Department of Agriculture.


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Wheat: prices and acreage upWheat prices, meanwhile, are bolstered by

strong demand following a drought-damagedglobal harvest of other grains. Major wheat-exporter Australia cut its crop by nearly one-third in 2006, boosting prices and giving

American farmers the chance to pick up a lit-tle extra business. The average per-bushelprice for wheat (Kansas City hard red wheat)was $5.11 in 2006, up from $4.11 in 2005.For 2007, the per-bushel wheat price is ex-pected to hold above $4.35, compared withbelow $4.00 for most months in 2006, ac-cording to ERS.

The USDA forecasts that farmers willplant 60.3 million acres in 2007, up 5%from 2006. Cash prices for wheat are fore-cast to reach a record $8.4 billion in 2007,

according to the USDA.The largest exporters of wheat traditional-

ly have been the United States, Australia, theEU, Canada, and Argentina. Black Sea na-tions, such as Kazakhstan and Ukraine, havebeen gaining market share due to their lowproduction costs and ongoing investments inagriculture, and the USDA sees this sharegrowing over the next decade. The regionsextreme weather, however, can cut into yieldsunpredictably, reducing the reliability of theharvest.

Government payments

By the end of the 2006 Congressional ses-sion, Congress had failed to pass 11 appro-priations bills, including agriculture, for the2007 fiscal year. In their place, Congress haspassed a series of resolutions leaving the2007 federal agriculture budget almost un-changed from 2006 levels.

The 2007 agriculture budget proposedby the Bush administration in February

2006 had called for an additional 5% cutin subsidies for all crop programs, whichwould have reduced payments by $4.9 bil-lion. The appropriations bill passed by theHouse of Representatives in May wouldhave not only eliminated those cuts, it alsowould have added roughly $5 billion in dis-aster assistance.

The USDA sees government payments tofarmers dropping dramatically in 2007, to$12.4 billion for the year, down from $16.3billion in 2006. Payments in 2005 totaled

$24.3 million, when low commodity prices

and large crop supplies triggered price sup-port programs such as loan deficiency andcountercyclical payments. The 10-year his-torical average (19962005) is $16.1 billion.

Due to strengthening crop prices, counter-cyclical payments are seen falling to $1.6 bil-

lion from $4.1 billion in 2006, with onlyupland cotton and peanuts receiving funds.Direct payments are established in legislationand do not change based on crop prices.

Livestock update

With the price of corn nearly doubling,from an average of $2.00 per bushel in 2006to a projected $3.00$3.40 average in 2007,and other grains rising in tandem, farmers ofthose crops are rejoicing. But livestock pro-

ducers who must purchase feed grain aresquealing in protest. They have been com-plaining to the media, as well as to Congress,which has held hearings on their situation.The National Chicken Council refers to theethanol situation as a crisis.

ChickenOf the livestock categories, chicken pro-

ducers will feel the least impact from the ris-ing price of corn, according to PilgrimsPride. Producing a pound of chicken meat re-

quires 1.9 pounds of feed, versus 3.5 poundsfor pork and 8.3 pounds for beef, accordingto USDA statistics cited by the poultry pro-ducer. The average price over one year asMarch 2007 was $2.49 per bushel, versus$2.36 over five years and $2.31 over 10years.

In fiscal 2006 (ended September 30,2006), the United States produced 42.2 bil-lion pounds of poultry, down from 45.7 billionpounds in fiscal 2005, according to the USDA.Although production increased slightly in the

first half of 2006, it subsequently declined as

FROZEN CHICKEN IN STORAGE(Millions of pounds)

STOCKS, END OF MONTH

MAR. 2006 MAR. 2007 % CHG.

White meat 181.5 146.8 (19.2)

Dark meat 209.6 90.6 (56.8)

Other parts* 449.5 327.1 (27.2)

Whole chickens 28.7 30.0 4.4

Total 869.4 594.4 (31.6)

*Includes pieces that have both white and dark meat.

Source: US Department of Agriculture.


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a result of a heat wave and flooding in theEast from a tropical storm both of whichkilled chickens over the summer.

Nonetheless, in late October, PilgrimsPride announced plans to reduce chickenprocessing by 5% year-to-year as of January

1, 2007, to try to bring production in linewith demand. By mid-March, slaughter levelswere back to normal.

The USDA reports that a slight decline inmeat yields per bird reduced production in

January 2007, despite a small increase in thenumber of birds slaughtered. Prices for

January-February 2007 were up 16% fromthe low reached in the 2006 period, with the12-city whole broiler price averaging 73.2cents per pound. The rising prices werelikely responsible for a 7% decline in ex-

port shipments in January. The agency pre-dicts that 42.8 billion pounds of chickenwill be produced in 2007.

US consumption of chicken remainsstrong. Annual US per capita consumption ofchicken is projected to rise to 102.1 poundsin 2006 before dipping slightly to 101.9pounds in 2007. In 2005, consumption was99.9 pounds.

Pilgrims Pride pushed aside Tyson as thenations leading poultry producer in January2007, when it completed its acquisition of

Gold Kist. Pilgrims Pride now controls24.8% of market, versus 20.7% prior to theacquisition. Combined revenues for fiscal2006 (September) were $7.4 billion, of whichPilgrims Pride contributed $5.3 billion. At aprice of $21 per share, the transaction to-taled $1.1 billion, plus the assumption ofGold Kist debt valued at nearly $340 million(including prepayment penalties).

Beef

Beef producers have been prompted bylow forage reserves to increase the number ofanimals they send to slaughter. The ERS re-ports that as of March 19, the calf slaughtertotals were up 28% (on a weekly basis) com-pared with the year-ago period. Production,however, was up only 6%.

High feed prices are likely inducing ranch-ers to send more cattle to slaughter, whichraises supplies and causes prices to fall. Theprice range for 2007 is projected to be be-tween $81$87 per cwt.

The USDA projects the average price forchoice steers (Nebraska direct) at $84$89per cwt, compared with $85.41 in 2006.Feeder steers (Ok. City) are expected to aver-age $96$101, from an average of $107.32in 2006. The USDA notes that, when corn is$3.00 per bushel and yearling feeder cattleare $111.00 to 114.50 per cwt, a ranchercan break even when fed cattle fetch $86 to$88 per cwt, compared with an average of85.41 in 2006.

The department forecasts 26.6 million

pounds of beef in 2007, up from 26.2 bil-lion in 2006. Per capita consumption is seendeclining to 66.4 pounds, from 65.8 poundsin 2006.

PorkHigher corn prices are translating into

lower dressed weights for pork a forecastone pound per hog as producers rein intheir feed costs, according to the USDA.

The agency sees pork prices strengthening9% in the first half of 2007 over the 2006

period, as high broiler prices encourage con-

US MILK PRODUCTION

F-Forecast.Source: US Department of Agriculture.

185

180

175

170

165

160

155

150

18

17

16

15

14

13

12

111996 97 98 99 00 01 02 03 04 05 06 F2007

Average milk price, $ perhundred pounds (right scale)

Billions of pounds(left scale)

POULTRY PRICE

(Leg quarters, Georgia dock price, cents per pound)

Source: Georgia Department of Agriculture.

50

40

30

20

10

02003 2004 2005 2006 2007


11/41

sumers to buy more pork as a substitute. Inthe second half, however, broiler pricesshould fall, taking pork down as well. For

the full year, the agency forecasts $46$47per cwt for 51%52% lean hogs.

In 2006, the US produced 21.1 billionpounds of pork, which fetched an averageprice of $42.63 per cwt (barrows and gilts,N. base, l.e.), down from $50.05 per cwt in2005, according to USDA forecasts.

Standard & Poors expects US pork ex-ports to remain strong. Demand from SouthKorea and Russia (which has restrictedBrazilian pork imports) will contribute tothat strength, as will weakness in the dollar,

which compensates somewhat for high USpork prices. US pork exports reached 3.0million pounds in 2006, up 11% from2.7 million pounds in 2005. US pork pro-ducers held a 25.5% share of the global mar-ket as of 2006, up from 18.3% in 2003,according to the USDA.

US MEAT SUPPLY & PRICES

PRODUCT 2003 2004 R2005 R2006 F2007

BEEF

Production (mil . lbs.) 26,339 24,650 2 4,787 26,258 26,680

Total supply (mil. lbs. ) 30,036 28,847 29,023 29,814 30,590

Exports (mil. lbs.) 2,518 460 698 1,153 1,345

Total consumption (mil. lbs.) 27,000 27,750 27,754 28,131 28,645

Avg. market price ($ per 100 lbs.) 84.69 84.75 87.28 85.41 84-89

Total estimated market value* (bil.$) 22.3 20.9 21.6 22.4 22.7-22.9

PORK



Exports (mil. lbs.) 1,717 2,181 2,665 2,997 3,150




BROILERS



Exports (mil. lbs.) 4,920 4,784 5,203 5,272 5,405




R-Revised. F-Forecast. *Standard & Poors estimate based on production times marketprice.



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Outlook for agribusiness creditquality is stable

We expect another busy year for the agribusiness

sector as we enter the spring planting season and as

the drumbeat continues for greater bioenergy initia-

tives, especially ethanol and biodiesel. Yet the over-

all credit quality of the US agribusiness companies

we rate should remain relatively stable.

The demand for agri-based energy sources had

US farmers indicating at the end of March 2007 that

they intend to plant 15% more corn acreage in 2007,

for a total of about 90.5 million acres, the most since

1944. The immediate response to this news was a

drop of about 5% in the price of corn on the ChicagoBoard of Trade. However, corn prices are still rela-

tively high, in the $3.50 to $4.00 a bushel range, and

well above their historical level of about $2.00 a

bushel. If the US produces a bumper corn crop this

year a very big if it is possible that corn

prices will decline in the fall. Nevertheless, we still

expect prices to remain above historical levels in the

near term.

Furthermore, farmers may change their minds

and plant less corn. The most critical factor between

mid-April and the end of May will be the weather. As

of late April/early May, corn planting in the Southwas on track, but planting in the Midwest was lag-

ging by about a week. (Figures on actual planted

acreage will not be available until the end of June.)

In addition, since acreage available for planting is

limited, an increase in corn acreage would likely

come at the expense of soybean acreage, which is

predicted to fall to its lowest level in 10 years. But

some farmers may switch back to soybeans, a crop

with a longer planting season, if poor weather ham-

pers corn planting or if they believe a large corn har-

vest will depress prices in the fall.

While oil prices seem to have taken a temporarybreather from their upward spiral, dampening near-

term exuberance for ethanol, the need for alternative

fuels remains a global priority. In our view, the co-

nundrum of whether to use crops for food or fuel will

have reverberations for some time in the agribusi-

ness, meat processing, dairy, packaged food, and

beverage sectors, and ultimately for the consumer.

Unless the US develops cellulosic biomass (wood

fibers and crop residue) as an economic alternativefeedstock for ethanol, adjustments will eventually be

required in the corn market to meet demand. This

could be further exacerbated if US harvests are dis-

appointing, as was the case in 2003, which resulted

in commodity prices hitting record highs in the spring

of 2004 and remaining there until the fall harvest.

Evolving industry dynamics seemfavorable...for now

Still, weather, disease, input prices, government

policies, and trade agreements can change quickly. A

new US farm bill, which could be affected by the pos-sible resumption of the WTOs stalled Doha Round of

trade negotiations dealing with export subsidies,

market access, and domestic support, will be a hot

topic throughout much of 2007.

Other factors that will continue to influence the

marketplace this year include increased volatility in

the commodity markets resulting from greater Asian

and Chinese demand, and a shift to greater agricul-

tural production in South America, especially in

Brazil and Argentina. Also important are the continu-

ing debate over genetically modified crops, the

growth of organic farming to meet rising demand forhealthy food choices, and consumers growing con-

cerns about food safety.

Despite the sectors changing landscape and near-

term challenges, we expect stability overall in our

agribusiness ratings. Nevertheless, many of these

companies will face higher working capital needs and

increased short-term debt usage because of higher

agricultural commodity prices, which could squeeze

already thin margins. Additionally, some rated com-

panies are making sizeable capital investments into

bioenergy projects to add to their existing market po-

sition or to hop on the bioenergy bandwagon, whichhas resulted in a near-term decline in free operating

cash flow. However, as we have seen over the years,

the agribusiness companies we rate have shown re-

silience in a volatile and ever changing market.

Jayne Ross

Agribusiness Credit Analyst

S&P Ratings Services View:


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INDUSTRY PROFILE

The United States is the worlds largest pro-ducer of food and agricultural products, andUS agriprocessors export their productsaround the globe. Total domestic farm sectorreceipts from the sale of agricultural com-modities are projected to total $242.7 billionin 2006, according to the US Department ofAgriculture (USDA). This sum, up from$238.9 billion in 2005, consisted of $121.2billion in livestock receipts and $121.6 bil-

lion for crops. The agency forecasts cash re-ceipts of $258.7 billion for 2007, based onprojected sales of $125.2 billion in livestockand $133.5 billion in crops.

The leading commodities, based on cashreceipts, were poultry, cattle, dairy products,and corn. Net farm income in 2007 is esti-mated at $66.6 billion, up from $60.6 billionin 2006 but below the $72.6 billion farmersearned in 2005. Nonetheless, it is $9 billion(16.2%) above the sectors 10-year averageof $57.4 billion. The USDA sees government

payments to farmers dropping dramaticallyin 2007, to $12.4 billion for the year, downfrom $16.3 billion in 2006 and from therecord $24.3 billion received in 2005. The10-year historical average (19962005) is$16.1 billion.

The agribusiness industry includes pro-ducers, agriprocessors, and packagers. ThisSurvey covers the producing and processingsectors largely, the public corporations forwhich data are available. Food packagingcompanies that is, public and private

companies engaged in later stages of con-sumer food production, such as Kellogg Co.or H.J. Heinz Co. are covered in theFoods & Nonalcoholic Beverages issue ofIn-dustry Surveys.

According to the USDA, 2.1 million peopleworked in the US farm sector as of 2002 (lat-est available), and 23.9 million worked in thefood and fiber sectors. Agriculture represented0.8% of US gross domestic product of $12.5

trillion in 2005 (latest available); agricultureand related industries (including value-addedoutputs of farms, forestry, fishing, hunting,processed food, beverage, and tobacco prod-ucts, textile and leather apparel, restaurantsand drinking establishments) were 4.5%.

Agricultural producers

Agricultural producers include individualsand organizations farmers and ranchers,farmers cooperatives, and public and private

corporations that are involved in the earlystages of making food products. Their func-tions include planting, raising, and harvest-ing crops and breeding and raising livestock.

The consolidation of US meat productionhas increased substantially over the past 15years. While the process is ongoing, compa-nies will be prevented by antitrust regulationfrom gaining more than about 30% of anysegment.

The four largest beef packing firms, in or-der, are Tyson Foods Inc. (25% of the US

Economics of food production

CHICKEN, BEEF, AND PORK PRODUCTION MARKET SHARE, BY COMPANY 2006

CHICKEN MKT. BEEF MKT. PORK MKT.

PROCESSORS SHARE (%) PROCESSORS SHARE (%) PROCESSORS SHARE (%)

Pilgrim's Pride 25 Tyson Foods 25 Smithfield Foods 25

Tyson Foods 21 Excel* 22 Tyson Foods 18

Perdue Farms 8 Swift & Co. 14 Swift & Co. 11

Wayne Farms 5 National Beef 10 Excel* 9

Sanderson Farms 5 Smithfield Foods 6 Hormel 7

Others 37 Others 23 Others 30

*Unit of Cargill Inc.Sources: Tyson Foods Inc.: Pilgrim's Pride Corp.


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commercial cattle slaughter), Excel (a unit ofprivately held Cargill Inc.; 22%), privatelyheld Swift & Co. (14%), and National BeefPacking Co. LLC (majority owned by USPremium Beef LLC; 10%). Collectively, theyaccounted for 71% of beef production in theUnited States as of October 2006, accordingto trade publication Cattle Buyers Weekly.

The four leading pork packers Smith-field Foods Inc. (with 25% of US commercial

hog slaughter), Tyson Foods (18%), Swift(11%), and Excel (9%) accounted for65% of the segment total in October 2006,according to Cattle Buyers Weekly. This totalcompares with only 40% in 1990, accordingto a study by the University of Missouri.

Meanwhile, in the wake of its takeover ofGold Kist Inc. in January 2007, PilgrimsPrides has taken the lead among poultryproducers, with 24.8% of US production asof February 2007, according to Watt PoultryUSA. Tyson Foods holds 20.7% of the mar-

ket, and privately held Perdue Farms Inc.claimed 7.7%. Together the three companiesproduce 53.2% of the countrys chicken,compared with 44% in 1990.

Dairy Farmers of America (DFA) is thelargest US dairy cooperative, with 20,631members in 49 states in 2005. The groupgenerated nearly $8.9 billion in sales andprocessed 34% of the US milk supply in2005 (latest available), compared with $8.5billion in sales and 33% of the US milk sup-ply in 2004. DFA was formed by the mid-

1998 merger of four large dairy cooperatives:

Mid-American Dairymen Inc., Milk Market-ing Inc., the southern region of AssociatedMilk Producers Inc., and Western DairymenCooperative Inc.

The leading processor and distributor offluid milk and dairy products in the UnitedStates (and a major customer of DFA) isDean Foods Co., which recorded $10.1 bil-lion in sales in fiscal 2006 (ended December31, 2006). Other competitors include Land

OLakes Inc. ($7.3 billion in fiscal 2006,ended December 2006) and Darigold Inc.(formerly known as WestFarm Foods), theprocessing and marketing subsidiary of theNorthwest Dairy Association, a cooperativewith about $1.3 billion in annual revenues in2004, according to the USDA.

Agriprocessors

Agriprocessors are public and privatecompanies involved in the early to middle

stages of food processing. Their operationsinclude the harvesting, milling, or processingof raw agricultural commodities. While theyalso may plant and raise crops themselves,they generally purchase those commoditiesfrom farmers.

Among processors, the largest user ofcrops is Cargill, with sales of $75.2 billion inits fiscal year ended May 2006. Publiclytraded Archer Daniels Midland Co. is thesecond largest US agribusiness firm, with$35.6 billion in sales for its fiscal year ended

June 2006. Other major crop processors are

LEADING AGRIBUSINESS COMPANIES(Ranked by 2006 revenues)

FISCALREVENUES (MIL $)

COMPANY YEAR END 2003 2004 2005 2006

Cargill May '06 54,390 62,907 71,066 75,208

Archer Daniels Midland Jun '06 30,708 36,151 35,944 36,596

Bunge Ltd. Dec '06 22,165 25,168 24,275 26,274

Tyson Foods Sep '06 24,549 26,441 26,014 25,559

CHS Inc. Aug '06 9,299 10,952 11,907 14,355

ConAgra Foods May '06 19,839 14,522 14,567 11,579

Smithfield Foods Apr '06 7,905 9,267 11,354 11,404

Dean Foods Dec '06 9,185 10,822 10,506 10,099

Land O'Lakes Dec '06 6,320 7,497 7,336 7,102

Hormel Foods Oct '06 4,200 4,780 5,414 5,745

Pilgrim's Pride Sep '06 2,619 5,364 5,666 5,236

Corn Products International Dec '06 2,102 2,283 2,360 2,621

Gold Kist* Jun '06 1,855 2,261 2,304 2,127

*Acquired by Pilgrim's Pride in January 2007.

Sources: Standard & Poor's Compustat Global Data; Company reports.


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leading soybean processor Bunge Ltd. ($26.8billion in the fiscal year ended December2006), and Corn Products International Inc.($2.6 billion in the fiscal year ended Decem-ber 2006).

A large part of agriprocessors business in-

volves exporting commodities (such as corn,wheat, soybeans, livestock, and dairy prod-ucts) and processed products (such asethanol, high fructose corn syrup, and soy-bean meal).

INDUSTRY TRENDS

US agriprocessors have pursued globalexpansion plans in recent years. While thedomestic market is relatively mature and

likely to exhibit consistent but only modestgrowth in the future, developing marketsdemand for protein-rich foods is growingrapidly. In markets such as China and India,disposable income is increasing because ofeconomic growth and industrialization, butagricultural output is growing less rapidlythan consumption. Consequently, the USagribusiness industry is well positioned totake advantage of future increases in world-wide food demand.

These opportunities also present new chal-

lenges. To meet demand in these markets,agriprocessors must be attuned to culturaldifferences, changing trade agreements, andvarying food safety standards.

Going global

A growing percentage of US agribusinessindustry revenues are coming from overseasmarkets. US annual agricultural exports rose18.4% from fiscal 2001 (ended September30, 2001) to $62.4 billion in fiscal 2005, ac-

cording to the US Department of Agriculture(USDA). The rapid economic expansion ofChina, Southeast Asia, and Eastern Europe,along with the acceptance of more liberaltrade agreements, is opening new markets forfood processors.

Leading US pork processor SmithfieldFoods Inc. has controlling interests in pro-cessing operations in Poland, France, Roma-nia, and the United Kingdom, as well as jointventures in China, Romania, Mexico, andSpain. International operations accounted for

10% of sales in the companys fiscal 2006

(ended April 30, 2006), up from 7.7% in theprior year, despite losses from the temporaryshutdown of the companys Polish facility inits first quarter. About 8% of the companyspork and 4% of its beef that were domesti-cally processed were exported to other coun-

tries in fiscal 2006.Corn Products International Inc. markets

refined corn products, including sweeteners,starches, and corn oils, in 70 countries. In itsfiscal year ended December 31, 2006, NorthAmerica accounted for 60.6% of net sales,compared with 60.3% in 2005. The compa-ny is the top seller of refined corn productsin Canada, Mexico, and South America,while ranking only fourth in its home mar-ket, the United States.

With the worlds gross domestic product

expected to rise more than 3% annually be-tween 2005 and 2014, according to USDAprojections, there is ample reason to expectever-growing demands on the worlds agri-culture. When incomes begin to rise, peopleoften upgrade their diets, consuming morefood grains, meat, sweeteners, and vegetableoils. This trend should benefit the US agricul-tural industry, which traditionally exports alarge percentage of high-value products, in-cluding packaged meat and processed foods.

A greater reliance on foreign markets is

also likely to increase the volatility of USfirms sales and profits. When the US dollarrises against foreign currencies, it can raisethe price of US agricultural exports in othermarkets, and thus lower sales as consumersbuy cheaper goods from other countries; atthe same time, it reduces income from for-eign operations when those receipts areconverted into dollars. As a result, manycompanies hedge their risks by enteringinto foreign currency forward contracts tominimize income shifts produced by curren-

cy fluctuations.Changing oil prices cause an agricultural

firms transport costs to rise or fall. As fuelprices increased through mid-2006, prices forforeign-produced food rose against locallyproduced goods. Companies may minimizethe impact of fuel costs by operating process-ing plants around the globe.

US agribusiness firms must also conformto changing trade agreements. They can tapnew markets when tariffs fall, but may losesales when a market enacts new tariffs or

nontariff barriers.


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For food processors that import ingredi-

ents, the long and circuitous trail from pro-ducer to manufacturer creates new hazardsfor adulteration and liability. In April 2007,wheat gluten imported from eastern Chinaand manufactured into pet food in the USwas found to contain melamine, a potentiallytoxic substance. Fifteen pets died from eatingthe food, the FDA confirmed, although thetoll may be in the hundreds, according to theAP. One hundred pet food brands werepulled off the shelves. The gluten was pur-chased by the exporting firm, Xuzhou Any-

ing Biologic Technology Development Co.,from regional producers, then shipped toChem Nutra in Las Vegas, which distributedit to pet food manufacturers.

Imports and exportsAgricultural products are a leading US ex-

port. Key products include soybeans, corn,

and livestock. In the 12 months ended Au-gust 31, 2006, US agricultural exports were$63.4 billion, up from $57.9 billion in thesame period in 2005.

The nations largest agricultural tradingpartners are Canada, Japan, Mexico, China,

and the European Union. Asian countriespurchased 36.1% of US agricultural exportsin 2005, followed by Canada and Mexico(31.2%) and the European Union (11.1%).

Exports to China are increasing at a rapidrate. With the expansion of that nationseconomy and middle class, Chinese are de-manding more protein in their diet, increas-ing their reliance on Western beef andprocessed meats.

US food imports totaled an estimated $59billion in agricultural products in the 12

months ended August 31, 2006, up from $53billion in 2005, with most products comingfrom Canada and Mexico. Key imports in-clude coffee, tea, cocoa, spices, meats, andoilseeds. The biggest growth in imports iscoming from fruits and vegetables.

Partly because the United States exportsmore high-value products (including processedpork and beef goods and dairy products) thanit imports, the nation had an agriculture tradesurplus of $4.7 billion in 2005, comparedwith $17.6 billion in 1990.

Japan, Korea reopen doors to US beefIn July 2006, Japan once again lifted its

ban against US beef imports. Japan previ-ously the largest export market for US beef had banned the goods beginning in December2003, after a Canadian cow in WashingtonState was discovered to have had bovinespongiform encephalopathy (BSE), commonlycalled mad cow disease. That ban was liftedafter two years but was imposed again sixweeks later, in January 2006, after spinal

bones, which carry the risk of contaminationand were prohibited from import, were foundin a shipment of US veal to Japan.

Significant pressure from the UnitedStates, along with assurances as to productsafety, were behind the change. To help as-suage concerns about US beef, the USDAplans to inspect 40,000 animals per year in aBSE surveillance program. The agriculturalappropriations bill passed by the House ofRepresentatives in May 2006 would provide$90 million for BSE detection and prevention

activities.

LEADING DESTINATIONS FOR US AGRICULTURAL EXPORTS(Ranked by exports for fiscal 2006, in millions of dollars)

% CHG.

COUNTRY 2002 2003 2004 2005 2006 200206

Canada 8,660 9,300 9,741 10,570 11,930 37.8

Mexico 7,226 7,917 8,494 9,362 10,896 50.8

Japan 8,382 8,935 8,139 7,874 8,422 0.5

European Union 6,145 6,454 6,784 6,834 7,290 18.6

China 2,067 4,992 5,541 5,225 6,724 225.2

South Korea 2,672 2 ,853 2,488 2,226 2,851 6.7

Taiwan 1,966 2,036 2,064 2,300 2,479 26.1

Indonesia 810 984 925 957 1,102 36.2

Turkey 675 901 943 1,079 1,030 52.7

Egypt 862 1,001 935 837 993 15.1


US AGRICULTURAL TRADE(In billions of US dollars)

F-Forecast.


90

80

70

60

50

40

30

20

10

0

2001 2002 2003 2004 2005 2006 F2007

Exports Imports


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The agreement with Japan requires thatUS-slaughtered cattle sent to that country notbe older than 20 months. Body parts such asbrains and spinal cords must be removed,and the meat must come from authorizedprocessing plants. The new agreement thus

excludes most US beef, which is older than20 months.

The US trade initiative succeeded despiteJapans discovery of its 25th case of a BSE-infected animal in April 2006, according tothe Associated Press. In August, the JapanTimes reported that the Japanese public re-mains suspicious of American beef. TheUSDA does not foresee exports to Japanreaching the levels seen before the ban, whenexports of US beef to Japan generated annualrevenues of about $1.4 billion. As of April

2007, the US share of the global beef marketwas 7.7%, up from 7.2% in 2006, but downfrom 18% in 2002.

Korea lifted its ban on American beef inJanuary 2006, though with restrictions: thecattle have to be younger than 30 months atthe time of slaughter, and the meat must beboneless. However, Korea did not accept itsfirst shipment until late October, due to ongo-ing safety concerns, according to the NationalCorn Growers Association, a trade groupwhose members supply corn as cattle feed.

Koreas ban, like Japans, was first imposed inDecember 2003. At that time, Korea was im-porting more than 551.2 million pounds ofUS beef a year, worth $893 million.

For US beef producers, growing domesticdemand has partly offset the declines fromlower exports. US consumption of beef isprojected to rise to 66.9 pounds per capita in2006, from 64.9 pounds in 2003. A ban onCanadian imports through mid-2005 keptsupplies tight and limited inventories, whichprevented a major decline in beef prices.

(The United States had banned imports ofCanadian beef and cattle in May 2003, fol-lowing the discovery of a case of BSE in Al-berta; that ban was lifted in July 2005.)

In March 2007, the ERS forecast that USbeef exports would rise in 2007 over 2006.Slow growth in exports to Asia, however,had prompted the agency to slightly lower itsforecast for the year. The USDAs ForeignAgricultural Service sees exports to SouthKorea as remaining small, while the 20-month age limit for cattle, and the need to

verify the age, will slow shipments to Japan.

CAFTA callingIn August 2005, President George W. Bush

signed the Central American Free TradeAgreement (CAFTA) into law. The accord isexpected to end most tariffs on $33 billion ingoods traded annually between the United

States and Central America. The NationalCorn Growers Association, a US trade associ-ation, estimates that the accord will boost USagricultural exports in its first year by asmuch as $900 million, with particular growthfor corn, soybeans, and dairy products.

As of July 1, 2006, five countries had im-plemented the treaty: the United States, ElSalvador, Honduras, Nicaragua, andGuatemala. The Dominican Republic hadratified the treaty but not passed legislationto put it into force. Costa Rica has delayed

approval of the trade agreement.

North American partnersNotwithstanding trade agreements, mar-

kets can close as well as open. In December2005, to protest rising government subsidiesfor US corn producers, Canada imposed aprovisional antidumping duty (US$1.65 perbushel) on corn imported from the UnitedStates; Canada believed that US farmers weredumping corn into the country at below-market prices. The Canadian International

Trade Tribunal voted in April 2006 to lift theprovisional duty and to refund collectedmonies.

In 2002, Mexico enacted a 20% tax onsoft drinks containing high fructose cornsyrup (HFCS), essentially forcing soft drinkproducers to use Mexican sugar cane. Thetax blocked more than $900 million per yearof US corn syrup exports, according to theKiplinger Agriculture Letter, a trade publica-tion. The World Trade Organization (WTO)ruled in the summer of 2005 that the tax vio-

lated the spirit of the North American FreeTrade Agreement (NAFTA). Mexico appealedthe ruling, which was upheld in March 2006.Corn Products International noted that itsMexican sales of HFCS returned to pre-2002levels following the ruling.

Consolidation trend continues

The broader agricultural market was oncecharacterized by large numbers of buyers andsellers trading homogeneous commodities on

the open market. Within this market, spot


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prices coordinated the flow of products fromsellers to buyers, with low-cost producersusually the most successful.

Over the past 30 years, consolidation hasdramatically altered the agribusiness indus-try, driven recently by global expansion and

vertical integration. It has reduced coststhrough economies of scale, encouragingfarms, like factories, to become larger andmore specialized.

Processors, too, have followed suit. Sincethe 1970s, meat processors have consolidatedat the slaughter capacity level, leading to few-er but larger plants. Recently, companies havefocused on expanding their high-margin,value-added offerings, including prepackagedmeats and ready-to-serve meals, which alsolowers their exposure to commodity price

fluctuations. Tyson Foods Inc. expanded itsvalue-added products to 43% of its totalproduct mix in 2005, or $11.3 billion, upfrom 38% in 2004; the company projectsthat value-added product sales will rise an-other $900 million in 2006. Tyson said thatits goal is to reach 50% of sales from value-added products by 2009.

Acquisitions can increase the proportionof value-added products a company offers.Smithfield Foods, the worlds largest hogproducer and pork processor, acquired Farm-

land Foods, the pork production and pro-cessing business of Farmland Industries Inc.,for approximately $363.5 million in 2003.The deal significantly expanded Smithfieldsvalue-added processed meat brand names.According to the company, it also substan-tially expanded retail market share in bacon,lunchmeats, and breakfast sausage.

Mergers and acquisitions can strengthen acompanys pricing power within a segment.Having fewer competitors makes it is easierfor remaining firms to set and hold prices,

enabling stronger and more consistent profitmargins. Pilgrims Pride Corp., one of thelargest US producers of chicken, acquired thechicken division of ConAgra Foods Inc. foran estimated $547 million in 2003, to ex-pand market share. In January 2007, thecompany completed its acquisition of GoldKist Inc., becoming the nations largest poul-try producer.

Acquisitions can increase distribution ca-pabilities, making global expansion easier.A company can enter a new market by ac-

quiring another company based or doing

business in that market. For instance, lead-ing soybean processor Bunge Ltd. pur-chased a soybean refining plant in China in2005, increasing its exposure to that rapid-ly growing market.

Advocates of consolidation believe that

the process will lead agricultural producerstoward more efficiency, less dependence ongovernment assistance, and greater globalcompetitiveness. As producers expand andspecialize, they can reduce production coststhrough economies of scale. Opponents ar-gue that, in a highly concentrated market, asmall number of sellers may gain too muchpower. In a less competitive marketplace,companies may raise prices substantially andforce down the prices that they pay forcrops, to the detriment of farmers.

Global food safety issues

In recent years, consumer fears of madcow disease and avian flu have created majorproblems for US meat processors in interna-tional markets. Leading firms that havegreatly expanded international sales, includ-ing Tyson Foods and Smithfield Foods, areexposed to considerable revenue and earn-ings fluctuations as eating habits change inimportant foreign markets.

In the United States, neither mad cow dis-ease nor the avian flu has yielded fatalities,and US consumption patterns remain virtual-ly unchanged. Nonetheless, companies havereported lower earnings because of foreignconcerns about these maladies.

Mad cow diseaseTransmissible spongiform encephalopathy

(TSE) causes microscopic holes in the brain,giving it a sponge-like appearance under amicroscope. TSEs affect both humans and

animals and are always fatal. Bovine spongi-form encephalopathy is the kind of TSE thatoccurs in cattle. Scientists believe that cattleare infected with BSE when they eat feedcontaining remnants of infected animals.

In 1997, to prevent the spread of BSE, theUS Food and Drug Administration (FDA)prohibited the use of most mammalian pro-teins as feed for ruminants (i.e., animals thatchew their cud, such as cattle, sheep, andgoats). The FDA, in conjunction with stateregulatory and health agencies, began inspec-

tions at feed mills, protein blenders, feed


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haulers, and farms in 1998. Before decidingto lift the ban on Canadian cattle in 2005,US officials conducted a similar review ofCanadian policies and safeguards, determin-ing that they were in line with US standards.

US beef exports must meet more strin-

gent regulations in order to gain re-entry tocertain foreign markets, including Japanand South Korea. The new rules limit theage of the cattle that can be shipped and theparts that can be included. BSE was detect-ed in cattle in the United States in December2003 (in Washington State), in June 2005(Texas), and in March 2006 (Alabama). Thedetection of BSE in December 2003 led tothe closure of many foreign markets to USbeef. Before the ban, exports of US beef to

Japan generated annual revenues of about

$1.4 billion.The first cases of BSE in cows were dis-

covered in the United Kingdom in 1986. TheUK epidemic reached a peak in early 1993,when almost 1,000 new cases were discov-ered each week.

Humans are vulnerable to a fatal diseasesimilar to BSE, Creutzfeldt-Jacob Disease(CJD). A variant form of CJD (vCJD) maybe caused by eating beef products from BSE-affected cattle. As of October 2006, 197 cas-es of vCJD had been reported worldwide,

according to the European and Allied Coun-tries Study Group of CJD.

Avian influenzaHighly pathogenic avian influenza (HPAI)

is an extremely contagious virus that causesmass mortalities of birds in a short period.While flu viruses are common pathogensamong birds, only a few forms, such as theH5N1 virus that first appeared in Korea inDecember 2003, are transmissible acrossspecies (e.g., from birds to humans). Domes-

ticated birds, including chickens, become in-fected with the virus either through directcontact with infected birds or through con-tact with cages or feed that have been conta-minated with the virus.

Human exposure is generally believed tocome from contact with live birds, althoughthe viruss ability to transform into a humanstrain could create a global crisis. Officials ofthe World Health Organization (WHO), aUnited Nations health agency, are concernedthat the influenza could develop into a pan-

demic if it mutates into a virus that spreads

easily through human contact. Governments,international agencies, and individual compa-nies and farmers have pledged resources to-ward ensuring early detection, to save livesas well as stabilize commerce.

At least 172 people have died from ex-

posure to the H5N1 virus since its outbreakin 2003, according to the WHO. The deathtoll may be even higher due to undiagnosedcases in remote areas. The European Union(EU) estimates that the virus may have beenin circulation as early as 1996, and thateconomic losses following the 200304 out-break in Asia cost the regions economiesalmost eight million euros. In an effort tohalt the outbreak, millions of chickens andducks have been slaughtered in SoutheastAsia.

In the United States, between 1997 and2005, there were 16 outbreaks of low patho-genic avian influenza. People who developthis version can typically be treated with an-tiviral medications and fully recover. In Feb-ruary 2004, an outbreak of HPAI wasdetected and reported in a flock of 7,000chickens in Texas. This was the first out-break of HPAI in the United States in 20years. As of October 2006, no human caseshad been detected in the United States, ac-cording to the US Department of Health and

Human Services.The US poultry supply is typically consid-

ered safer than chicken populations in devel-oping countries, as a result of superiorsanitation and safer feeds. The US govern-ment monitors domestic and imported foodproducts; in 2004, it issued a ban on impor-tation of poultry from countries affected byavian influenza viruses. As of March 2006,there was a ban on poultry from China,

Japan, South Korea, Russia, Turkey, andmany Southeast Asian countries.

International focus on bird fluAfter spreading from Southeast Asia into

northern China and Russia in 2005, the vir-ulent H5N1 strain of avian influenza en-tered Turkey in early 2006, infecting somedomestic poultry. In February, wild birds insome European Union (EU) member states,as well as in Bulgaria and the Balkans, werediagnosed with the strain. The outbreakwas contained by the destruction of infectedanimals, the banning of transport of live

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As of April 11, 2007, 16 human cases hadbeen reported in Egypt, with four deaths,and six cases with five deaths in Indonesia.Human deaths were also reported in Laos(2), Cambodia, China, and Nigeria (1 each),according to the WHO.

The outbreaks have threatening implica-tions for US poultry producers, which shipabout 15% of their production overseas eachyear, according to USDA statistics. Publicfears of the disease could potentially reducepoultry consumption, while a quick-spreadinginfection could devastate domestic flocks.

The USDA projects that US broiler ex-ports will rise from 5,203 million pounds in2005 to 5,411 million pounds in 2006, witha further rise to 5,530 million pounds in2007. The global market share of US poultry

producers is estimated at 38% for 2006 level with 2002, according to the USDA.

Since 2002, per capita consumption ofchicken has risen in almost all major mar-kets substantially, in some cases. The ex-ceptions are Thailand, the Philippines, andthe 25 members of the European Union,which saw respective declines of 3.1 pounds,0.4 pounds, and 0.2 pounds.

While the flu has not reduced consump-tion, it has still had an impact on the market,as indicated by poultry prices. Even in the

midst of a health scare, producers can sellnearly anything if they price it low enough.This could be the case for US poultry ex-ports. (Dark meat, which is what leg quar-ters contain, is more popular overseas thanin the United States. As a result, the leg quar-ter is the most commonly exported piece ofchicken.)

Pilgrims Pride reports that US chickenconsumption has risen 81.3%, or 2.2% com-pound annual growth rate (CAGR) since1980, and turkey 63.1%, or 1.8% CAGR,

which beef has fallen 13.3% (0.5%) andpork is down 12.7% (0.5%) in the same pe-riod. In its fiscal 2006 (September), the com-pany reported that concerns over avian fluhad significantly reduced export demandfor its poultry, leading to higher inventoryand lower prices. Chicken sales to Mexico,its primary international market were down6.2% by revenue (while volumes were up,prices were down 9.1%), and turkey salesdropped 36.1%. The company lost $34.2million in 2006, down from net income of

$265.0 in 2005. In the first quarter of fiscal

2007, the company lost $2.9 million, with a$11.4 million loss in US chicken operationspartly offset by a gain in Mexico and inturkey products.

The rise of organic farming

Organic food sales are growing at a rapidrate, opening new opportunities for foodproducers and processors. The OrganicTrade Association (OTA) estimates that $15billion worth of organic products are sold inthe United States each year, up from only $1billion in 1990.

Certain retailers have taken advantage ofthe strong demand for organic products. Forinstance, Whole Foods Market Inc., thelargest US retailer of natural and organic

foods, reported 19.3% sales growth in thefiscal year ended September 24, 2006, downslightly from 21.6% growth in 2005. Same-store sales rose 11.0%. Between 2002 and2006, the company averaged 20.7% annualgrowth. Larger retailers, such as Wal-MartStores Inc., also have been expanding theirorganic food offerings in recent years. Whileretail food sales in the United States havebeen growing at an annual rate of only about1% since 1990, organic food sales are jump-ing more than 20% per year.

The rapid growth is largely the result ofmuch-publicized food scares and public con-cerns about the use of chemicals, growthhormones, antibiotics, and bioengineering inthe food system. Organic farming relies onecological practices that virtually exclude theuse of synthetic chemicals in crop productionand prohibit the use of antibiotics and hor-mones in livestock.

A survey published in February 2006 bythe International Federation of Organic Agri-cultural Movements (IFOAM), which repre-

sents global organic farming interests, foundthat about 3.5 million acres of organic farm-land are under active management in NorthAmerica; more than 76.6 million acres of or-ganic farmland are active worldwide. Thevalue of organic products worldwide was$27.8 billion in 2004 (latest available), withEurope and North America comprising thelargest proportion of sales, according toIFOAM.

Standard & Poors sees the growth of or-ganic foods continuing at a rapid pace as

farmers move into organic production, and


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as more processors and distributors expandtheir product lines to meet increasing con-sumer demand.

The popularity of organic foods maydampen demand for antibiotics and hor-mones. For instance, many US dairies are

considering ending the use of bovine growthhormones in milk cows. This would hurtproducers of animal antibiotics or hormones,such as Monsanto Co.

Without the use of antibiotics and pesti-cides, food producers are more exposed tothe development of potentially serious prob-lems. For instance, organic soybean produc-ers in the United States have few options toprotect themselves from the spread of soy-bean rust, since they do not use traditionalfungicides. However, the growth in organic

dairy and poultry farms has led to increaseddemand for organic soybeans used in animalfeed. Thus, while farmers can demand higherprices for organic crops, they also take ongreater risk.

Genetic engineering: expansion andcontroversy

The development of genetically engineeredcrops has increased farm productivity rapidlysince the 1980s. Scientists use genetic engi-

neering techniques, which involve changingthe genetic makeup of seeds in the laborato-ry, to produce new plant species with desiredcharacteristics.

Most genetically engineered crops are de-signed to reduce the use of pesticides and in-crease crop yields through better control ofinsects, weeds, and disease. For example,Monsanto produces an herbicide calledRoundup, which kills all plants except thosethat have been modified to resist it theseeds that Monsanto sells as Roundup

Ready include varieties of corn and soy-beans. According to the company, the net re-sult is a reduction in chemicals and tillageneeded for crop production.

In 2005, genetically engineered cropswere planted on 222.4 million acres in 21countries, up from 27.2 million acres in1997, according to the International Servicefor the Acquisition of Agri-biotech Applica-tions, an advocacy group promoting agricul-tural development and poverty alleviation.Soybeans account for more than 60% of the

plantings, followed by corn (about 24%)

and cotton (less than 11%). The UnitedStates generates about 55% of global bio-engineered production.

In 2006, 61% of US corn crop byacreage was planted with biotech seed, upfrom 52% in 2005, according to the USDA

Economic Research Service (ERS). The ris-ing use of genetically modified seed, haspushed seed prices up 74% between 1999and 2007, according to ERS. While theseseeds are more expensive to produce andpurchase than other varieties, farmers de-sire the traits they offer and are willing topay more.

The swift acceptance of this technology inthe United States has substantially boostedrevenues for companies focused on geneti-cally engineered crops, such as Monsanto,

but challenges remain in other countries.Concerns exist about the unintended cross-breeding of genetically modified crops withnaturally occurring plants and the potentialfor people to experience allergic reactions tofoods with unexpected characteristics. Someforeign governments have attempted to re-strict the usage of genetically modified or-ganisms (GMOs).

The United States filed a lawsuit with theWTO in March 2003 against a moratoriumon genetically modified foods that the EU

put in place in 1998. US farm groupsclaimed that it was costing them $300 mil-lion in lost export sales annually. The EU of-ficially removed the moratorium in 2004, butit continued to delay approval of new geneti-cally modified variants.

In 2006, the WTO ruled that the EUs banon biotech foods had violated WTO obliga-tions. The decision is expected to increase USagricultural exports to the EU and shouldbenefit companies involved in the develop-ment of genetically engineered seeds, includ-

ing Monsanto.In France, the number of acres planted

with GMO corn in 2006 rose tenfold over thenumber in 2005, to 12,350 acres, accordingto the Wall Street Journal. GMO Compass, anews site supported by the EU, reports that,in 2005, GMO corn was grown on 135.9 mil-lion acres in Spain, France, Portugal, theCzech Republic, and Germany, representing0.5% of the EUs total corn crop.

While these figures are a tiny proportionof EU cropland, they may indicate the open-

ing of a much larger market. The EU pur-


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chases about 15% of seeds sold globally a$30 billion market, according to the WallStreet Journal.

HOW THE INDUSTRY OPERATES

Agribusiness companies function in themiddle stages of the food production process.Crop processor operations include the har-vesting or milling of raw agricultural com-modities; crop processors also may plant andraise crops, although they generally buy thesecommodities from farmers. Crop processorstypically sell their products not to con-sumers, but to processors and food pack-agers, which use the ingredients to makefinished consumer food products.

Companies such as Archer Daniels Mid-land Co., Corn Products International Inc.,and Cargill Inc. process and merchandiseraw grains, including corn, wheat, and soy-beans. Their end products include oils,syrups, starches, and meals used in the foodand feed industries, as well as corn sweeten-ers used in soft drinks.

Meat processors, including Tyson FoodsInc. and Smithfield Foods Inc., slaughter andprocess livestock and chickens for retail sale.Dairy processors, such as Dean Foods Co.,

process raw milk into packaged milk andother related products, such as cheese andbutter.

Companies engaged in the late stages ofproducing consumer food products aregenerally referred to as food manufacturersor packagers. These companies includ-ing Kellogg Co., H.J. Heinz Co., and theHershey Co., among others sell theirfinished goods to retailers, which, in turn,sell the products to consumers. (For moredetail on companies involved in the later

stage processing of foods for consumerconsumption, see the Foods & Nonalco-holic Beverages issue ofIndustry Surveys.)

For the purposes of this Survey, our dis-cussion focuses on the early to middle stagesof the agricultural industry and its majorplayers: the farmers, crop processors, meatprocessors, and dairy product producers.Due to their size and capital resources, thelarger firms in these areas typically havestronger competitive positions, greater diver-sity of businesses, and greater earnings stabil-

ity than do other industry participants, such

as smaller processors or primary producers.Weather disruptions can significantly affectmarkets and prices for all agribusinesses, butthe impact is generally more easily absorbedby the bigger firms.

The role of the crop processor

Crop processors usually modify a raw ma-terial to the level required by processed foodscompanies, which will further enhance theproducts for direct sale to consumers. Forexample, crop processors such as ArcherDaniels Midland or Corn Products Interna-tional buy corn and refine it into high-fructose corn syrup. They sell the syrup tocompanies such as the Coca-Cola Co. orPepsiCo Inc., which use it to manufacture

beverages. Another example of further pro-cessing is the practice of converting grain intodistilled alcohol, which in turn can be used tomake beverages or medicinal products.

Some crop processors have become verti-cally integrated, selling finished products di-rectly to wholesalers, retailers, and consumers.For instance, in addition to its other activities,Archer Daniels Midland makes vitamin E pillsand sells them to retailers. Hormel FoodsCorp. raises and slaughters hogs, while alsomaking value-added consumer products.

Crop processors typically purchase rawmaterials on a daily basis in order to keeptheir production facilities operating at peakefficiency. These raw materials are seasonalproducts, harvested once per year and storedin silos. The availability and price of thesecommodities are subject to wide fluctuations,due to unpredictable factors such as: weatherand plantings; domestic and foreign govern-ment farm programs and policies; changes inglobal demand created by population growthand rising standa

s-p industry surveys - agribusiness - 2007

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