Invest in AgFeed Industries? When Pigs Fly!

Before you go, we thought you'd like these...
Before you go close icon

Even though China is the world's biggest market for pork in terms of production as well as consumption, Chinese pork processor AgFeed Industries (NAS: FEED) is attempting to swing to Western-style hog farming practices to make its operations more efficient. But between overly exuberant expansion and an inability of its customers to pay their bills, the pork processor is running into some lean times.

Pig in a poke
AgFeed, like other pork processors and hog farmers such as Zhongpin (NAS: HOGS) , should be benefiting from sky-high pork prices that rose 57% over the past year that ended in June, with even Tyson Foods (NYS: TSN) reporting that pork prices increased 16% over the first nine months of 2011. Seaboard (NYS: SEB) saw first-quarter revenues jump 44% in good part because of higher pork prices.

But input costs have soared at the same time, and that has made it difficult for AgFeed to make a profit. In its most recent preliminary quarterly results, AgFeed expects to post a loss of more than $17 million as it added $5 million in allowances for its bad-debt provision. It will also take a charge of $9.2 million for the collection of outstanding accounts receivable in its animal-nutrition business.

Increased competition and subsidies threaten to bring down pork prices by boosting supply.

Real "pork barrel" politics
The Chinese government is looking to subsidize large-scale pig farmers by paying them a bounty of RMB 100 (a little more than $15) for each sow they raise for breeding and as much as $124 for each pig they cull in order to control epidemics. Back in 2007, "blue ear" disease swept through China's pig population and wiped out large swaths of supply, making the country especially sensitive to illness.

The government also initiated a subsidy program that year to support hog farmers, but it caused prices to crash, and many local hog farms went under. China isn't expecting the current subsidy program to have an impact on prices until early next year, since it takes more than a year for piglets to reach slaughtering age.

Brazil is also attempting to engineer outcomes in strategic industries like meat. It recently approved the creation of Brasil Foods (NYS: BRFS) out of rivals Sadia and Perdigao. While it's the world's largest poultry exporter, Brasil Foods is a big player in pork, too. But now it will be forced to give up a number of assets corresponding to about 13% of revenues in order to avert a government attempt to break up the company.

China accounts for half the world's hog production and is followed distantly by the U.S. with 10%. Yet for all that, the majority of China's pork comes from small family farms that wildly swing from feast to famine. About 60% of China's hog farmers breed fewer than 40 hogs a year.

Slippery as a greased pig
AgFeed bought up 31 hog farms a few years ago in an attempt to make its business more vertical, but that plan was like casting pearls before swine, and it's been writing off the acquisitions for the past few quarters. Its new plan for growth is to buy up independent U.S.-based producers to the point where its U.S. business will be more than half as large as its China-based business by the end of next year.

It bought U.S. pork processor M2P2 last year and just picked up the assets of Kansas City Sausage, a private-label sausage maker. But buying growth won't come so easy, since AgFeed can't tap the equity markets so readily. A planned spinoff of its animal-nutrition business has been canceled because of poor market conditions.

Bringing home the bacon
But if AgFeed is looking to get its ham hocks on the U.S. markets, it's going to have domestic pork processors playing in the pigpen, too. U.S. pork consumption fell 2.2 pounds per person in 2010, but pork producers are looking to boost sales by 10% over the next three years. Exports are expected to rise 23% this year alone.

Analysts like the prospects of pork players, too, raising earnings targets for Smithfield Foods (NYS: SFD) in the process. Hormel (NYS: HRL) is also expecting better growth, though margins will be tighter for many of the same reasons AgFeed is feeling the pinch, such as higher costs.

So far, AgFeed hasn't shown itself adept at managing its domestic hog business or that it can appropriately expand beyond what it has. I'd be leery of jumping from the fire into the frying pan with this stock.

Keep track of all its little piggies by adding AgFeed Industries to your watchlist.

At the time this article was published Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.Fool contributor Rich Duprey has no financial position in any of the stocks mentioned in this article. You can see his holdings. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners