Problem Areas Credit Risk - IBISWorld

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Table 1 Industry Purchase Costs (% of total revenue) Profit Rate (% of revenue) Price-shock Vulnerability Checklist Implied Input Price Rise 'Buffer' Industry Life- Cycle Stage Average Size of Industry Company ($) IBISWorld Industry Health Index Beef Cattle Production 48.8 15.0 30.7 Mature 73,365 106.1 Milk Production & Dairy Cattle 51.9 13.0 25.0 Mature 502,688 99.3 Hog & Pig Farming 50.0 14.0 28.0 Decline 481,334 103.7 Chicken Production 52.2 18.5 35.4 Mature 968,033 119.2 Turkey Production 44.0 14.1 32.0 Mature 1,176,110 123.6 Animal Food Production 61.0 19.6 32.1 Mature 21,721,465 110.8 Egg & Poultry Wholesale 83.0 4.0 4.8 Decline 10,859,586 79.1 Beef & Pork Wholesale 83.6 2.5 3.0 Decline 9,760,094 77.6 industry might bear a short-term increase in input costs of only 3% before considering passing on prices or threatening default. These pressures are likely to accelerate the general move toward wholesale function bypass and play to the strengths of vertically integrated agribusinesses that grow, process, wholesale, and even retail goods. The saving grace of the wholesale sector is the large average size of an industry operator. Buying power is a key pressure point along any supply chain. In comparison to most farmers, wholesale firms have a high degree of bargaining power in the supply chain. Firms at or larger than the benchmarks noted can use economies of scale in purchasing, storage, and distribution that a smaller company would find more difficult. The discrepancy in establishment size is a fair indication of one company’s power compared with another. Evidence of the way supply-chain dynamics operate is calculable. According to the U.S. Department of Agriculture (USDA), the retail price of beef increased 16.6% between 2002 and 2007, and all of this occurred between wholesalers and retailers. A comparison of the farm gate price of beef and the wholesale price shows a fall of 6.2% over the same period. Clearly, the discrepancy between average farm size and average wholesaler and manufacturer is vital. Supply-chain credit risk is mitigated by reasonably high average profit margins, which operators can use as a shortterm buffer against price shocks before passing the price to consumers (or further down the supply chain) or, in the worst-case scenario, before credit default. The animal food production industry is particularly well sheltered with a significant average establishment size (manufacturing is reliant on economies of scale that reduce unit prices) and a profit margin touching 20% of revenue. The buffer in this industry’s cost structure is 32.1%. Although purchase costs are reasonably high, they are spread across crop and noncrop industries. Moreover, the mature stage of the industry life cycle allows the best companies to segment their product offerings. Higher-quality goods will probably be marked up in price at the retail level (pet food accounts for around 30% of industry revenue), while lower-end goods (such as cattle feed) will benefit from some near-term price crosssubsidization. The IBISWorld Industry Health Index shows an average score across all industries in the chain of 102.4—ranging from a very healthy 123.6 points for turkey production to a low of 77.6 points in the beef and pork wholesale industry. Turkey producers are aided by the fact that purchase costs account for only 44% of total revenue (the lowest in this supply chain). Of that total, only about 15 percentage points come from crops (as used for feed). Further along the turkey production supply chain, operators are helped by the high price of turkey livestock, a low incidence of disease, and changing consumer consumption habits favoring white meat. Three industries fall below the baseline 100 level, suggesting relatively poor health. In the case of the milk production and dairy cattle industry, problems stem from the industry operators’ reliance on crops as feed. IBISWorld estimates that crops account for about 20 percentage points of purchase costs (which total 51.9% of revenue). The industry also suffers from a weakening supply chain of its own. Key buyers, such as the dairy product manufacturing industry, which accounts for about 30% of total demand, will grow only 0.6% in 2009. Another key buyer, the ice cream manufacturing industry, will decline 0.9%. Agriculture and the Food Production Chain The benchmark checklist for industries in the food production supply chain (Table 2) has two industries in the growth stage of their life cycles: the tortilla production industry and corn, wheat, and soybean wholesaling. On closer inspection of the latter, we find that expansion is concentrated in the corn segment, especially sales to producers of ethanol and other biofuels. Expansion in this The RMA Journal October 2008 45
Table 2 Industry Purchase Costs (% of total revenue) Industries in Food Production Supply Chain Profit Rate (% of revenue) Implied Input Price Rise ’Buffer’ Industry Life- Cycle Stage Average Size of Industry Company ($) IBISWorld Industry Health Index Flour Milling 73.0 15.0 20.5 Mature 36,196,730 71.8 Margarine & Cooking Oil Processing 70.2 15.0 21.4 Mature 124,543,827 70.7 Cereal Production 32.4 43.5 134.3 Mature 180,525,000 114.3 Bread Production 36.1 19.0 52.6 Mature 3,931,639 100.1 Cookie, Cracker & Pasta Production 40.4 21.7 53.7 Mature 28,534,268 108.3 Tortilla Production 43.8 18.8 42.9 Growth 7,531,546 114.5 Syrup & Flavoring Production 27.7 26.1 94.2 Decline 57,388,966 105.1 Corn, Wheat & Soybean Wholesaling 89.3 5.0 5.6 Growth 37,309,661 83.2 product line has been significant enough to push up the industry’s profit margin to 5% of revenue, which is beyond the sliver normally associated with wholesaling. Moreover, the industry’s average company size, $37 million, reflects strong buying power. Data from the USDA shows that major wholesalers (and, by extension, manufacturers to which they sell) and retailers have successfully “out-bargained” farmers. For instance, the value of cereal and bakery products returned to the farmer fell from 14% in 1980 to 6% in 2006. Over the same period, the retail cost of cereal and bakery products increased 153%. The source of power in this chain clearly is not with farmers. Profit margins across the whole food production supply chain are relatively high, which provides a short-term buffer against default. Indeed, three industries return a buffer level greater than 50%, with a typical operator in the cereal production industry able to bear a short-term price rise of 134% before taking ameliorative action. Profit margins are buoyed by the relatively low cost of labor in this chain. Wage costs are an average of 4.8% of revenue compared to 6.2% for those in the animal food supply chain. Wage costs have been eroded by the extensive use of machinery and large-scale manufacturing plants. Reasonably benign purchase prices over the past five to 10 years have fed directly into profit ratios, with minimal leakage into depreciable investment spending on newer machinery. The IBISWorld Industry Health Index scores for the industries in the food production segment average out at 96 points, meaning the supply chain as a whole is in a slightly riskier position than the baseline measurement in 2005. The riskiest are the margarine and cooking oil processing industry (with a score of 70.7 points) and the flour milling industry (71.8 points). These two industries have very high purchase costs at 70.2% and 73% of revenue, respectively. More importantly, these purchases are concentrated in the three industries that have experienced the highest rise in agricultural prices. On average, wheat purchases account for around 30% of total revenue for a typical flour miller. Meanwhile, oilseed crops account for 35% of revenue in the margarine and cooking oil processing industry and corn accounts for another 10%, making the rise in agricultural prices a cause for concern. Some Companies Are Stronger Than Others With the purchase cost of agricultural goods high and rising, the average profit margins of industries in a number of supply chains are likely to be eroded. The best enterprises will weather the storm over the short term without threat of credit default or passing on price increases to consumers (and dissuading people from buying the good). Some weaker enterprises, especially those in industries susceptible to supply-chain price shocks, will suffer. Consequently, credit risk will increase. A number of key indicators have been determined and quantified in this article to help determine the robustness of an industry as it deals with price increases from suppliers. An industry’s life-cycle stage accounts for a number of industry fundamentals and will prove a solid guide to the industry’s long-term viability. In the short term, an industry’s purchase costs, the distribution or concentration of those costs, and the average profit margin are central to judging changes to the credit risk environment. This article established some benchmarks figures for 16 key industries. The third and final article in this series will focus on stress-test modeling. In this way, we can hypothesize further agricultural price rises (and falls) and other macroeconomic shocks that help pinpoint weaknesses along the agribusiness supply chain. v •• Gavin Smith is a senior economic analyst at IBISWorld Inc., a Los Angeles-based industry intelligence firm. Contact him by e-mail at gavins@ibisworld.com. 46 October 2008 The RMA Journal
Page 1 and 2: Economic Environment Agriflation Id
Page 3: Figure 2 Agriculture and Food Produ

Problem Areas Credit Risk - IBISWorld

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