EDITOR: | May 30th, 2013

Smithfield Deal: Chinese appetite for Pork has investors eying potash

| May 30, 2013 | No Comments

Bacon-ElementIf you were hankering bacon for breakfast and a hot dog for lunch, today, you felt the same craving behind China’s biggest ever acquisition of a US based company – especially if you happened to wonder just what was in that hot dog…. After significant Chinese moves into the North American energy market targeting major resource companies – in 2012 the Canadian government approved CNOOC’s CAD $ 15.1 billion takeover of the Calgary-based oil sands giant Nexen Inc – in the end, US pork proved more appetizing. China’s interest in seeking agricultural and food sector opportunities sends a positive signal to the potash market as well.

Shuanghui International Holdings Ltd – China’s largest meat processor – has made a formal bid for Smithfield Foods Inc. (Smithfield) for about $4.72 billion. Smithfield emphasized, to assure US consumers that the deal is about exporting US pork to China rather than the other way around. Smithfield has accepted Shuanghui’s bid and the deal should close in the second half of 2013 pending US government approval, which is not likely to come easily given a string of  Chinese food safety scandals, some of which involving the very same Shuanghui making the bid. . China is the largest pork consumer in the world and the third largest consumer of pork from the U.S. to Mexico and Japan and for the Asian market is a huge opportunity for Smithfield. Last March some 20,000 dead pigs were found floating in the Huangpu (coincidentally pronounced Huangpoo…) river, which is Shanghai’s main drinking-water source, surrounded by pig farms and pork processing plants. Shuanghui and Smithfield have done business in the recent past and for once, the outsourcing impulse came from China as the Chinese food processor imported thousands of tons of Smithfield pork products.

A growing Chinese middle class has been demanding better environmental and safety standards and Shuanghui’s interest in Smithfield reflects this tendency; a fast rising middle class of Chinese consumers want higher quality food and rather than wait for standards to change in China, major food industry players will be looking to opportunities abroad. Demand for pork in China reflects the fast economic growth and upwardly mobile social transformation, a process that has strained food production as industry has been to haste to meet demand. Two years ago, Shuanghui was found to be using clenbuterol – a banned food additive that is supposed to achieve ‘leaner’ meat in the United States, the EU and China in its pork products.  There is little chance that Smithfield will be importing any food products from China. US investors and workers need not worry about their jobs in this takeover or any other in the food sector, when the buyer is Chinese. Smithfield should continue to operate as usual.

No doubt concerns about bird flu, SARS will impact the US regulators’ position; however, given the well known precedents, the deal may actually herald a period of increased food exports from the United States and the West to an increasingly food safety concerned Chinese market rather than the other way around. Indeed, China is actually struggling to meet its own consumers’ demand for food. Farms are small and cannot keep up and processing is not very sophisticated, marred by massive environmental issues. Meat products are also relatively expensive to produce because of the lack of large scale meat processing plants while agricultural land for animal farming is ever more limited; yet, demand for meat from the growing middle class is soaring. China is the most important export market for European pork products and exports to China from the EU have risen 81% year to year as of last January. Therefore, there is no doubt that the Chinese government is encouraging Chinese companies to seek food and agriculture opportunities abroad with the same vigor as energy or mining.

The potash factor

China’s shortage of arable land, water supply constraints, growing population, infrastructure expansion, urbanization are also driving agricultural process changes. Land must be more productive, yielding more crops per acre. The only way to maximize yield is through mineral fertilizers such as potash, phosphate and urea. China can guarantee its own supplies of the latter two for the time being, but it needs more and more potash from outside sources. One of the main reasons for this is that China is home to almost 15% of the world’s population and all those humans need vitamins, and as incomes rise, they will be demanding ever higher quantities of proteins as well in response to rising incomes. It is no surprise then that a Chinese government owned company, Sichuan Chemical Industry Holding Co, has signed a 10-year agreement to source potash from Prospect Global Resources Inc.(NASDAQ: PGRX). The deal points to two aspects of China’s strategy for sourcing potash. One is that potash is necessary and long term supply agreements are desirable. Nevertheless, Chinese buyers have started to eschew the major suppliers like PotashCorp or Mosaic, which exercise an almost monopolistic approach to the market through such price control mechanisms as Canpotex.

The new Chinese strategy will be increasingly looking toward more independent players in the potash market. Indian buyers have also started to arm-wrestle Canpotex for lower prices. The price disagreements are playing into the hands of junior and emerging plays in the market and the longer Canpotex fails to reach an agreement the better it will be for the juniors; it is also yet another example of how China is reshaping markets and economic patterns. Meanwhile BHP’s potash ambitions and its plans for the Jansen mine in Saskatchewan have not been approved yet by the board. Should BHP complete the Jansen mine – potentially the world’s largest potash mine – it would send a strong signal of confidence in potash prices returning to higher territory – if not the records of 2008-2009. If Jansen goes through, it would affect Canpotex and BPC’s market share significantly.  At that point competitive CAPEX and production costs would be the keys for profitability. To this extent some of the emerging juniors such as IC Potash (TSX: ICP | OCTQX: ICPTF) or Allana Potash (TSX: AAA | OTCQX: ALLRF), which are slated to enter production within the next 24 months, could benefit from the additional competition even if the price of potash drops. Ultimately, more pork means more potash.


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