Allan Barber: Buoyant meat market delicately poised

A couple of weekends ago, speaking to the dairy farmers' conference, Tony Egan of AFFCO expressed the view that the meat industry was ticking along nicely, but there was the potential for a Molotov cocktail to be tossed into this comfortable state of affairs. Increased capacity from new plants, fairly static livestock numbers, environmental pressures, growing wage demands and the impact of the exchange rate on market prices are all factors that could light the fuse.

New sheep and lamb processing capacity of up to two million head a year, equivalent to about 6 per cent of the annual kill, chasing the same number of livestock, suggests that life is about to get tougher for processors.

The strength of the dollar has not yet impeded the returns to farmers, which are at similar levels to last year, but an increase in capacity and a sudden drop in the exchange rate will put pressure on processors to increase livestock payments to unprecedented levels.

The traditional response of the meat industry to a period of prosperity is for new investors to add capacity, which will suck up any surplus profits, and this one seems to be little different.

The most significant difference this time around is that most of the new capacity belongs to strong, existing players. AFFCO, in partnership with its major shareholder, Talleys, is about to open a plant in Southland, while ANZCO, owner of Canterbury Meat Packers, has just opened its Rangitikei plant as well as taking an option to buy 50 per cent of a new plant at Rakaia.

These developments come hot on the heels of PPCS's acquisition of Richmond last season and Alliance's purchase two years ago of the Dannevirke plant previously owned by Lake View.

In the lower North Island alone, there are at least 11 sheep meat plants, of which PPCS Richmond has three, AFFCO and Bernard Matthews two, and Alliance, CMP, Progressive and Frasertown have one each. Taylor Preston and Napier Abattoir, meanwhile, process sheep and cattle.

The good news this year is the forecast of 300,000 extra lambs in the North Island, although offset by a drop of 175,000 sheep, and 50,000 more in the South. Cattle numbers are stable in both islands and, at least in the short term, there is no word of more beef-processing capacity planned.

The secret of success in the meat industry is processing efficiency and kill-day loadings. Get those right and you can afford to pay just enough for livestock to gain the required market share and guarantee plant throughput, without under-recovering fixed and variable costs.

Past seachanges in the industry's competitive balance have arisen because processor shareholders have either under-invested in facility upgrades - Waitaki, Weddel and AFFCO in the late 80s and early 90s - or over-invested, as in the case of Fortex. As a result, plant throughput fell to uneconomic levels and competitors grabbed market share.

The failure of owners and shareholders to provide equity to ensure that their plants had an appropriate fixed cost structure, coupled with prohibitive labour agreements, led in each of these cases to the collapse of the company or the need for substantial debt write-off and recapitalisation to ensure survival.

The cost pressures today from environmental compliance and occupational safety and health, in particular, make it even more critical to keep processing facilities up to scratch. Two companies that survived that period are Alliance and AFFCO, whose main competitors are PPCS and ANZCO.

The next couple of seasons will show just which ones have invested to lock in gains that will help them survive the next inevitable belt-tightening.

* Allan Barber is a freelance writer, business consultant and former chief operating officer at AFFCO.