Photo: AP Photo/Oleg Nikishin
Russian pork farmers and producers told Prime Minister Dmitry Medvedev last week that government action is stripping them of profitability, as the squeeze between the rising price of feed grain and the falling price of pork is killing the industry’s plan to expand domestic production and replace imports.In anticipation of worsening profit reports, the London stock market has sliced the share prices of the only two listed pork producers in the top-5, RusAgro and Cherkizovo, by 56% and 46% respectively, trimming their market capitalisation to the $800 million level.
A hearing on February 6 at the State Duma’s Agriculture Committee heard testimony that the pork sector was hit with the biggest concessions of any of the farm and foodstuff markets when Russian trade negotiators finalised the accession agreement with the World Trade organisation (WTO) last year.
According to the WTO announcement of the import duty schedule for primary products (their incoming volumes are also subject to quotas), the duty for imported pork in quota is now zero. By comparison, in-quota beef is still subject to a 15% duty and poultry to 25%. The duty on imported meat at volumes above the quota are 55% for beef, 65% for pork, and 80% for poultry.
The purpose of the quotas to enable domestic pork production to replace imports was explicitly set out in July of 2011, one year before WTO accession, by then Prime Minister Vladimir Putin. “In 2011,” he said, “Russia will consume some three million tonnes of pork, and we produce some 2,400,000 tonnes. So this year we will import some 600,000-650,000 tonnes. And next year…we will see a considerable increase in pork production, because we have been launching new livestock production facilities, pig farms. According to a preliminary estimate, we shall produce an additional 300,000 tonnes of pork. That is to say, next year we will import 350,000 tonnes of pork.”
The WTO rules came into effect in August 2012. They also limit the financial support the state budget can provide farmers, such as subsidized interest on bank loans, value-added tax concessions for new equipment, or price-controlled state-stocked fodder. “The total trade distorting agricultural support,” says the WTO, “would not exceed USD 9 billion in 2012 and would be gradually reduced to USD 4.4 billion by 2018. To avoid excessive concentration of support on individual products, from the date of accession to 31 December 2017, the annual agricultural support going to specific products would not exceed 30% of the agriculture support that is not for specific products.”
Energy subsidies to farmers, in the form of gas, fuel or electricity prices, have also been banned.
Finally, the new WTO rules disallow the application of veterinary or phytosantitary measures if they are intended as “technical barriers to trade”. According to the WTO, “except in case of serious risks of animal or human health, Rosselkhoznadzor [RSN], the Federal Service for Veterinary and Phytosanitary Surveillance, would not suspend imports from establishments based on the results of on-site inspection before it had given the exporting country the opportunity to propose corrective measures. Rosselkhoznadzor would send a preliminary report to the competent authority of the exporting country for comments.”
Last month’s RSN ban on imports of frozen and chilled pork and pork offal from the US, allegedly for the use by American farmers of the growth stimulant ractopamine, are being contested by the US Department of Agriculture and by the US pork exporters as a violation of the accession agreement. For a review of this and earlier technical controversies over RSN bans, read this archive.
Under these cross pressures, the Russian pork industry is already slaughtering pigs whom it is loss-making to feed with high-priced domestic fodder. At the same time, the industry is appealing for an immediate budget bailout to reduce the grain price. The Duma Agriculture Committee agreed last week to request an outlay from budget funds of up to Rb10 billion ($323 million) for fodder purchase. The Finance Ministry has responded with an offer of Rb6 billion ($194 million).
On February 7, Agriculture Minister Nikolai Fedorov told Medvedev there should be an emergency increase in this year’s budget for the farm sector by Rb42 billion ($1.4 billion), including Rb15 billion ($500 million) in feed subsidies to meat, milk, and egg producers.
Yury Kovalev, head of the National Union of Pork Producers, said in an interview in a Moscow newspaper last week that the WTO measures have severely damaged the state plan to reduce Russian dependence on meat imports. “We consume 3.2 million tonnes of pork, of which 2.4 million tonnes we produce, and import 800,000 tonnes. Thanks to this protected market the profit margin in pig business is 20% to 25%. It is this rate of return which is the only way producer and farm companies can repay the banks. The plan was to reduce the share of imports to at least 15%.” Kovalev said that because of last season’s poor harvest, the price of feed grain has doubled. At the same time the price of live pigs has been cut by 30% because of the import surge. “As a result, the industry is unprofitable – by minus 15% to 20%. Pork is in a double vise. Therefore, we put the issue to the government that the pig needs help.”
Alexander Kostikov, head of communications and investor relations for Cherkizovo, explains why the price squeeze is hitting so hard on the pork producers’ bottom-line: “we must understand that in Russia pig production is still very young. Most modern pig farms were built in the last five years and they have been built with the assistance of loans. That is, for each kilogramme of pork, in the [retail] sale price at least 10 rubles comprises the cost of [repayment of] credit. So it is clear that for the majority now, production has become unprofitable. The Cherkizovo company, for example, is very big on the one hand; but on the other hand we are also a diversified company – we have also in addition to pork, poultry and meat processing. When there is such [a pork price squeeze] in the market, other segments in general stabilise our business. But the situation with pig production in Russia is very complicated, very difficult. And now pig producers are counting on support from the state very strongly. Various ways are discussed in which the state can stabilise the market. And we hope the situation will return to normal.”
A recent calculation by UralSib Bank analyst Marat Ibragimov indicates how much cash would be added to Cherkizovo’s bottom line if the Kremlin agrees to an emergency outlay for feed. “Russia was forced to reduce import duties on live pigs from 40% to 5%, which led to a massive increase in live pig imports – by 34% YoY last year, according to the National Pork Producers’ Union. This squeezed domestic production by reducing prices, while fodder costs rose, driven by a bad grain harvest… Cherkizovo is Russia’s 3rd largest pork producer with a 5.4% market share in 2011. As such, we estimate that it may receive up to $10.8 million of state money, equivalent to 3.5% of Cherkizovo’s 2013E[estimated] consensus net profit.”
Just how abnormal the current situation is proving to be financially for Miratorg, the largest pork producer in the country, isn’t discussed by Miratorg’s spokesman, Dmitry Lgovskiy. He says this must wait until the annual report for 2012 is released in several weeks. Meantime, according to Miratorg’s financial report for 2011, its earnings (Ebitda) came in at Rb6.6 billion ($220 million), a 65% gain over 2010. The earnings margin also hit a record high of 55.9%; in 2010 the margin on earnings of Rb4 billion ($133 million) was 47.1%.
Based in the Belgorod and Kursk regions of western Russia, Miratorg is owned by the brothers, Alexander and Victor Linnik. They are commercial allies of Ziyavudin Magomedov, backing his takeover of the 50% state shareholding in United Grain Company (UGC, OZK) last May. In return, they received one of the seats on the new UGC board of directors, suggesting they may have contributed some of the Rb5.95 billion ($198 million) Magomedov offered for the winning bid.
Miratorg reports that in 2011 it held a Russian market share of 8.1% and “continues to strengthen its position”. The pork producers union tabulation for the top producers in the same year indicate a slightly lower market share for Miratorg. The new tabulation for 2012 will be released at the end of this month, and significant changes are expected in the wake of the import crisis and margin squeeze.
Nikolai Birulin is the senior expert for market analysis and forecasting at the National Union. He says that by accepting the WTO conditions, the Russian government allowed the mature pork industries of Europe and North America to lock in their capital and cost of production advantages against the revival of the much younger, developing pork industry of Russia.
“Even if we take the playing field, even if we consider that the investment phase is over in Europe and they do not pay off [the Russian level of debt], they can operate at a 2% to 3% profit margin. Even if we set aside the credit position, which today’s [Russian] enterprises need to pay and just focus on comparable operating conditions, we will see that our companies will be less competitive, despite a similar production and performance indicators, in terms of feed conversion, in terms of genetics . Because we have, as it turns out,[bank interest] rates higher than in European countries. Higher costs for the maintenance of pigs, for example, compared with Brazil, because with Brazil’s warm climate, they do not need to spend money on heating, no need to spend money on capital piggeries. Accordingly, their costs are lower. Therefore, if you open the border as emphatically as we are doing it now, we are not competitive in comparison.”
“Taking into account the investment component, the repayment of loans, the [Russian] situation is even worse. Consider the fact that Europe passed the same way after the Second World War and it has also closed its market to raise the price a little. Consider that it too created terms for investment attractiveness, so that investment would go into the industry. Once there was enough for domestic consumption, the surpluses are bought and sold abroad. So from self-sufficiency they moved into export. After that, as prices equalled the world market level, investments in the sector have stopped, and subsidies were paid to the farm enterprises to maintain the profitability necessary for the branch to exist and to reproduce. This is how the whole programme is designed. In North America and in other countries where [state] support of agriculture is big enough, it is very difficult to distinguish which degree of support is precisely available for pork. It is hidden. Lawyers there work very well there, and everything is built in such a way as not to violate the rules of the WTO.”
“Unfortunately, we have been caught in the middle period of the investment phase. If we can pay off the debt we have, then those modern enterprises which now exist will be competitive, taking into account cost of delivery of meat and everything else, albeit on the margin… We have developed a number of proposals, and they are being considered in the government to normalize the situation. If we will be heard, than we hope that the industry will be able to exist in the future. If not, we will see a very significant change in the market.”
In this market squeeze, it’s obvious that everyone loses; but adversity isn’t distributed proportionately. So who within the Russian industry is gaining, and who will benefit most from a Kremlin bailout? Before WTO accession, when he was still president, Medvedev claimed to be boosting competition when in the agro-industrial sector he was doing the opposite. Concentration in oligarch hands, not competitive diversification, was Medvedev’s real purpose.
According to Philip Owen, principal consultant at Volga Trader in Saratov: “The large farms have huge stores at their feed mills to take advantage of harvest prices. It’s the farms without their own feed mills, comprising still as much as 60% of local production, which have suffered most. Backyard farmers get paid in grain by the former collective farm, so [for them] money doesn’t count. Middle- sized producers are the most damaged. The spike in prices is reducing the diversity of competition.”
Russian experts are reluctant to say as much. The current squeeze, responds Birulin of the National Union, “is, first of all, beneficial for importers, because they have the decline of the foreign trade price above and inside the quotas. So, accordingly, they may either put this 15% it into their pockets, or for a 15% discount sell their products while preserving their profitability…We are already seeing a twofold increase in above-quota import volumes in the results of August-December 2012, compared with August-December of 2011.”
Then there is the special advantage Brazil enjoys. “Brazil uses preferential treatment as a developing country. Their coefficient is 0.75 [of the import pricing level for developed countries]; they have even smaller trading fees than the rest of the countries. So [Brazilian meat imports] are the cheapest…They lead in over-quota import volumes; almost 50% of the over-quota imports of pork to Russia are from Brazil.”
Assessing the impact of pork-barrel financing for Russian pork producers, Maria Bovykina, analyst for Alfa Bank, has reported to clients: “We think the news is NEUTRAL for Cherkizovo and Rusagro at this stage, as the proposal has yet to be approved and it is not clear how much each company might receive. However, the proposal to compensate for higher animal feed costs is potentially positive and would support gross margins.”
A European meat trader says: “Putin is keen on pig farmers so this [crisis] is not to be laid at his door.” So why has the president apparently abandoned the industry to the commercial raid of the importers? No one from farm, trade, or investment analysis is willing to answer, though the record of Kremlin-funded bailouts since 2008 clearly shows that state funded benefits favour, not only the process of consolidation of assets, but also those individual proprietors who have run up the largest debts.
Compared to the Russian livestock slaughter of the early 1990s, which then president Boris Yeltsin conceded for the advantage of North American and European Union meat exporters, this means a favour for the dwindling number of Russians who have got their hands on the pig, and aim to keep them there.
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