Fitch 2010 U.S. Commodity Food Outlook: Global Demand to Drive Profits; Liquidity Limits Downside

'Although frequently changing import policies by foreign countries cause volatility in export activity, protein exports could increase in 2010 as the global economy continues to improve,' said Carla Norfleet Taylor, Director at Fitch. 'We are also cautiously optimistic regarding domestic foodservice demand due to Fitch's belief that restaurant industry traffic can improve in the second half of 2010. If demand does not recover as anticipated, maintaining ample liquidity and conservative financial strategies should limit downside risk for the industry.'

Liquidity improved significantly for Fitch's universe of high yield commodity food companies in 2009. On a combined basis, Tyson, Smithfield Food, Inc. (Smithfield), JBS, Dole Food Company, Inc. (Dole) and Del Monte Foods Co. (Del Monte) raised $4.2 billion through new U.S. debt issuances and/or equity offerings during the year. Most of these companies are currently generating positive free cash flow, have good revolver availability and are holding above-average cash balances.

Although excess supply caused hog producers, such as Smithfield, to continue to lose money in 2009, the operating environment for other segments of the commodity food industry was relatively stable or improved throughout the year. Better pricing and, to a lesser extent, declining grain cost helped profitability for the U.S. chicken industry, while lower live hog and cattle prices protected margins for pork and beef processors. Some pork processors also benefited from increased demand for value-added packaged pork as consumers dined more at home. Meanwhile, improved product pricing and reduced cost pressures benefited operating income and cash flow for produce companies; such as Dole and Del Monte.

In 2010, Fitch expects higher than normal liquidity and conservative financial policies to support credit profiles, but potential improvement in global demand, given a mixed outlook for costs, could drive profits and cash flow. Modest potential improvement in the restaurant industry would increase foodservice demand for the protein industry. Exports, while volatile, are expected to pick up due to a better outlook for the worldwide economy. Fitch expects protein producers to realize lower average annual grain costs in 2010, due to the absence of losses associated with high-cost corn hedges, despite the fact that corn prices are anticipated to rise from current levels. However, anticipated increases in live hog and cattle prices will result in higher input costs for non-vertically integrated pork and beef processors such as Tyson.

Fitch believes the risk of chicken overproduction and continued excess hog supply, which negatively impacts prices, will be a big concern for the protein industry in 2010. Pilgrim's Pride Corp. (Pilgrim's) is set to emerge from bankruptcy by year end, and expectations that the global economy will continue to recover could encourage chicken producers to increase supply. However, the current prolonged period of losses in hog production, due to weak prices and higher grain costs, should promote inventory reductions by producers in the near term. While the industry is reducing sow herds, an increase in exports and liquidations is also paramount. Fitch expects losses in hog production to moderate as excess industry supply declines and market prices for live hogs increase.

The ratings and Outlooks for Fitch's universe of U.S. commodity food companies are listed below. Excluding Del Monte Foods, Inc., ratings reflect the volatile operating earnings and cash flow stream of the business. Each firm's ability to navigate through an ever-challenging operating environment, characterized by feed cost variability, potential industry overproduction, trade restrictions and food-borne illnesses, will drive future ratings and Outlooks.

--Tyson Foods, Inc. ('BB'; Outlook Stable);

--Smithfield Foods, Inc. ('B-'; Outlook Stable);

--JBS S.A. ('B+'; Watch Positive);

--Dole Food Co. Inc. ('B-'; Watch Positive);

--Del Monte Foods Co. ('BB'; Outlook Positive).

Global Demand and Industry Supply Will Drive Protein Profits - Watching Foodservice Demand and Exports:

During 2009, the closure of several plants by Pilgrim's Pride and reduced production by other chicken producers as the year continued helped keep chicken supply in relative equilibrium with demand. Nonetheless, foodservice demand has become increasingly weak due to growing pressure on quick-service restaurant traffic as consumers dine more at home. Fitch currently expects foodservice demand to remain weak early in 2010 but believes improvement could occur in the later half of the year.

Protein exports are projected to increase modestly in 2010 as the global economy improves but activity could be volatile due to frequently changing import policies by foreign countries. Given this and the current uncertainty regarding foodservice demand, production discipline will be necessary in 2010. Fitch monitors chick placements and egg sets to assess production activity for chicken producers and cold storage data for all proteins to ascertain demand. At Nov. 7, 2009, weekly U.S. chick placements were down 1% and egg sets were down 2% versus the same period in 2008. During the month of September cold storage levels for chicken fell 2% but increased 3% for pork and was flat for beef.

Fitch anticipates trends in sales volume to vary across the proteins depending on global demand. Consolidated sales volume for Tyson grew 1.7% for the nine months ended June 30, 2009, after declining 1.0% during the same period in fiscal 2008, with trends varying across chicken, beef and pork. Sales volume for chicken increased 8.2%, primarily due to inventory reductions, while volumes for beef and pork declined 3.9% and 1.8%, respectively.

Fitch believes chicken has benefited from consumer substitution away from higher priced beef and pork during the economic downturn. However, preference toward chicken could lessen, at least temporarily, if supply reductions by hog producers result in excess pork and lower prices of pork products at retail. Declining retail prices for pork could put downward pressure on selling prices for both chicken and beef if consumers gravitate toward lower priced proteins.

Year-to-date through Nov. 9, 2009, Georgia Dock skinless boneless breast meat chicken prices averaged $1.43 per pound and leg quarter prices averaged 41 cents per pound. Breast meat prices are flat with the average price during the same period last year, reflective of production discipline within the industry, and leg quarter prices are down 15%, given slightly weaker foreign demand during 2009.

In general, consumer prices for proteins are not expected to increase significantly. As of Oct. 23, 2009, the USDA's consumer price index (CPI), which measures consumer inflation, is forecasting retail price increases of 1.0%-2.0% for poultry and beef in 2010 and 0.5%-1.5% increases for pork. The CPI for beef and pork is expected to be higher than the 2009 estimate of flat to negative 1%. The CPI for poultry is expected to be lower than the 2.0-3.0% forecast for 2009. Average selling prices for Tyson declined 0.5% and 5.0% in chicken and beef, respectively, but increased 0.9% for pork during the nine-month period ending June 30, 2009.

As mentioned earlier, Fitch expects on-going volatility with protein exports, despite potential improvement in pounds sold versus 2009. Consequently, continual monitoring of protein export policies for key destinations of U.S. chicken, beef and pork is required. As of Nov. 10, the USDA is forecasting export volume growth of 8% for pork versus export volume declines of 6% for broiler meat. Beef export volume is projected to increase 6%. Weakness in the U.S. dollar and improvement in the global economy should promote increased export activity for each of these proteins in 2010 but periodic trade restrictions, particularly by Russia remain somewhat unpredictable.

Russia, which represented 26% of 2008 exports, is the largest foreign market for U.S. chicken. An expected material decline in the 2010 Russian import quota, as the country aims toward increased self-sufficiency, is not good news for U.S. chicken producers, such as Tyson and Pilgrim's.

China's plans to lift its H1N1-related ban on pork products is very positive for Smithfield and to a lesser extent positive for Tyson, given that it is not vertically integrated in pork and that pork represents a lower percentage of its sales than Smithfield. Sales volumes for pork could improve for both companies but upward pressure on live hog prices will increase input costs for Tyson. Only 9% of U.S. pork was exported to China in 2008 but it has been one of the fastest growing markets for exports.

U.S. beef exporters have benefited from improved access to the South Korean market and should benefit from the recent decision by Taiwan to ease import restrictions. South Korea and Taiwan represented 8% and 5% of U.S. beef exports in 2008, but prior to the discovery of BSE (bovine spongiform encephalopathy) in the U.S. in late 2003, they received significantly more U.S. beef.

Cost Outlook Mixed - Potentially Lower Average Annual Feed Costs to Benefit Producers but Higher Livestock Costs to Strain Processors:

The slower than normal harvest caused by excessive rain and cooler than normal temperatures is expected to place upward pressure on corn and soybean meal prices in 2010. However, annual average corn costs for protein producers could still be below 2009 levels, due to the absence of losses associated with high cost hedges. On Nov. 10, 2009, the USDA revised its corn price forecast up 20 cents to $3.25-$3.85 per bushel during the 2009/2010 marketing year but still projects that the price will be lower than its $4.06 estimate for 2008/2009. The projection for soybean meal was raised 5 cents to $250-$310 per short ton but is also lower than its $331.17 forecast for 2009. Market expectations for corn are currently higher than the USDA's forecast. The futures market expects corn prices to rise above $4.00 in 2010.

Fitch does not believe corn prices will reach 2008 highs but does believe prices could increase from the Nov. 11, 2009 spot price of $3.63. Higher than expected average annual grain costs would pressure margins for protein producers and could test the on-going risk management practices of these firms. The major producers incurred considerable hedging losses after corn prices peaked at just over $7.00 per bushel in June of 2008. During the first nine months of fiscal 2009, Tyson realized $248 million of net losses from its commodity risk management activities related to grain and energy purchases. Smithfield recognized net hedging losses of approximately $100 million in earnings since the beginning of its fiscal 2009 year through the first quarter of fiscal 2010.

Meanwhile, potential increases in live hog and cattle prices could pressure margins of pork and beef processors. As of Nov. 9, 2009, the USDA is forecasting live hog prices of $43-$46 per hundredweight (cwt) for 2010, up an average of 11% from 2009. Choice steers are expected to be $87-$94 per cwt, up an average of 9% from 2009. Broiler prices are forecast to rise only 1% to 75-81 cents per pound. The futures market expects live cattle prices to rise toward $89/cwt by the spring of 2010 and live hog prices to increase to a high of $76/cwt by mid-2010. Fitch believes the futures market is factoring in expectations related to the lifting of China's ban on U.S. pork and a potential increase in pork exports to Russia due to the presence of African Swine Fever in that country's hog supply. Russia represented 9% of U.S. pork exports in 2008. In addition to these factors, more aggressive efforts by hog producers to reduce sow herds and liquidate inventory would also support higher live market prices. At Sept. 1, 2009, the National Agricultural Statistics Service reported a 2% reduction in overall hog inventory and a 3% decline in sow breeding inventory versus the previous year's period.

Hog Production Industry Losses Should Moderate As Live Hog Prices Increase and Production Costs Fall:

The hog production industry began losing money in October 2007 due to the combination of overproduction, which resulted in excess supply when global demand slowed, and rising grain prices. H1N1 (originally referred to as Swine Flu) related consumer fears had a further negative impact on foreign pork demand causing additional strain on the pork industry. Improving global demand will occur as these fears subside. Fitch believes the anticipated removal of China's ban on U.S. pork to be a major step in the right direction. As previously mentioned, the USDA is forecasting pork export volume growth of 8%, after declining an estimated 11% in 2009.

The magnitude of industry losses, which reached a high of about $45/head in late 2008, and the length of the current negative cycle, should promote reductions in hog industry inventories and consequently in supply. In early November, Coharie Hog Farm, which ranked as the 22nd largest pork producer in the country, filed for bankruptcy and is expected to liquidate all of the animals and assets of the company. Given the fragmented nature of the pork production industry and the large number of small farms, Fitch believes the number of bankruptcies would have to increase significantly in order to cause an immediate reduction in U.S. hog supply. Performance of Smithfield's pork processing segment and its packaged meats business has helped partially offset losses in its hog production business. However, the severity of the current downturn along with grain related hedging losses has resulted in significant net losses in recent periods. As mentioned earlier, Fitch expects improved profits for the hog production industry as market prices for live hogs increase and lower average annual grain costs result in lower hog raising costs.

Ample Liquidity Will Help Support Credit Profiles but Debt Levels Remain High:

High cash balances, the generation of positive free cash flow and newly negotiated asset-based lending (ABL) revolvers for Tyson and Smithfield should minimize liquidity concerns in 2010. Current year maturities are fairly immaterial for both companies. Tyson has cash reserved to repay approximately $140 million of 7.95% secured notes due Feb. 1, 2010. These notes were issued by Tyson's wholly owned Tyson Fresh Meats subsidiary prior to the acquisition of IBP, Inc. in 2001. Nevertheless, given volatile earnings and cash flow, Fitch believes debt levels remain too high for larger players in the protein industry. Tyson, Smithfield and JBS each have debt levels in excess of $3 billion.

Beyond 2010, upcoming maturities include Tyson's approximate $800 million of 8 1/4% senior unsecured notes due Oct. 1, 2011 and Smithfield's $600 million of 7% unsecured notes due Aug. 1, 2011. Fitch expects reducing the balances on these notes to be a goal for both companies in the near term, given the accelerated ABL maturity dates if the notes remain outstanding in mid-2011. Tyson's 2011 notes have traded at a hefty premium since May 2009 and as of Nov. 10, traded at a price of 106.5 of par. Smithfield's notes have traded at a discount since November 2007 and at Nov. 11, priced at 98.75 of par, making it more economical for the company to make open-market purchases.

Key Rating Drivers:

Tyson Foods, Inc. - Tyson's Outlook was revised to Stable in February 2009 due to the expectation of improved operating fundamentals in chicken. Tyson should continue to benefit from the diversification provided by its chicken, pork and beef businesses. Given Tyson's goal to expand international production, ratings would be reviewed if the company engages in material debt-financed acquisitions. Leverage, defined as total-debt-operating earnings before interest, taxes, depreciation and amortization (EBITDA), is expected to average 4.0 times (x) over the long term. For the latest 12-month (LTM) period ended June 27, 2009 leverage was 4.4x.

Smithfield Foods, Inc. - On Oct. 19, 2009, Fitch initiated ratings on Smithfield. Ratings reflect expectations that the company's hog production segment, which has sustained significant losses for the last seven quarters can break even within the next 12 months. As previously mentioned, live hog prices are expected to rise as excess supply in the industry is eliminated, and production costs should fall in 2010, given lower realized grain costs. Pork segment restructuring savings should offset any pressure caused by potentially weaker retail selling prices for pork. Fitch anticipates that total debt-to-operating EBITDA can fall below 5.0x by the fiscal year ending April 2011.

JBS S.A. - JBS's ratings were placed on Rating Watch Positive on Sept. 16, 2009 following the company's announcement that it had reached an agreement to buy 64% of Pilgrim's Pride and to merge with Bertin (Brazil's third-largest beef producer). These transactions enhance the company's competitive position in the Brazilian market and further diversify its revenue mix. Both transactions are expected to be entirely funded with a USD2.5 billion equity contribution by a private investor. An upgrade depends on the anticipated marginal leverage improvement from this contribution. In addition, Fitch views JBS's planned $2 billion initial public offering of its U.S. subsidiary in early 2010 positively.

Dole Food Co. Inc. - Dole's ratings were upgraded to 'B-' and were placed on Watch Positive on Sept. 21, 2009 following its successful bond issuances and IPO announcement. The company's ratings are likely to be upgraded by a minimum of one notch once proceeds from its Oct. 26, 2009 IPO are used for debt repayment and a full assessment of operating trends is completed. Leverage is expected to decline materially from 4.8x at the LTM period ending June 20, 2009.

Del Monte Foods Co. - Del Monte's Rating Outlook was revised to Positive on Aug. 19, 2009 due to better than expected operating performance as the company was able to fully offset commodity cost pressures with pricing over the past 18 months. Additionally, Del Monte has remained conservative as it relates to stock repurchases, dividends and acquisitions. Stable debt levels, steady operating performance and the maintenance of market share in pet products is likely to lead to an upgrade in ratings.

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Fitch Ratings
Carla Norfleet Taylor, CFA, +1-312-368-3195 (Chicago)
Wesley Moultrie II, CPA, +1-312-368-3186 (Chicago)
Judi M. Rossetti, CFA, CPA, +1-312-368-2077 (Chicago)
Christopher M. Collins, +1-312-368-3196 (Chicago)
Jose Luis Villanueva, +1-212-908-9158 (New York)
Cindy Stoller, +1-212-908-0526 (New York)
cindy.stoller@fitchratings.com