Steady Growth Ahead for the U.S. Pork Industry

October 2017 Steady Growth Ahead for the U.S. Pork Industry Outlook Hinges on Increased Exports RaboResearch Food & Agribusiness far.rabobank.com Sterling Liddell Senior Analyst - Global Data Analytics +1 314-317-8038 Contents The U.S. Pork Industry in Transition 1 The U.S. Pork Industry in Expansion Mode 2 Slaughter Capacity Catching Up 3 U.S. Pork Exports and Domestic Consumption to Grow 3 Summary More Exports Are Needed 4 Changing Demand for Primal Cuts Increases Market Volatility 4 Justin Sherrard Global Strategist Animal Protein Pablo Sherwell Head of RaboResearch Food & Agribusiness - North America The U.S. pork industry is projected to continue in expansion mode through 2025. Increased production efficiency, through carcass weights and pigs per female, are key drivers of the expansion. An increase in processing capacity removes a bottleneck that periodically limits the flow of pork to consumers. Domestic consumption per capita is expected to grow slightly, but only within historical bounds. U.S. demand for specific primal pork cuts is projected to create periods of high volatility in the short term. Exports are increasingly the most important component of demand for U.S. pork. To remain in a profitable expansion mode through 2025 (and considering supply-and-demand baseline prospects), the U.S. will need to increase pork exports by 400,000 tonnes. By 2025, we anticipate exports to increase by around 100,000 tonnes to China, over 200,000 tonnes to Mexico, and the challenge will be to find an additional 100,000 tonnes of export in the global market. The U.S. Pork Industry in Transition During the last decade, there was an inflexion point in the U.S. hog and pork sector, moving from sluggish production and tight margins to a production recovery phase incentivized by positive margins. Many factors were involved in this dynamic transition: the rise and then fall of feed costs; the Porcine Epidemic Diarrhea virus (PEDv) outbreak, recovery, and aftermath; the improvement of consumption; and the rise in export demand. The result of these substantial changes in both volume and efficiency on the supply side, and product specification and destination on the demand side of the pork industry, is an industry that faces significant change in both the short and long term. Our baseline outlook identifies three key areas that need to be considered in strategic plans over the next ten years. First, the need for intensive risk management systems that include volatility generated by increased reliance on exports and periodic surges in demand for various primal cuts. This is especially true as international completion and geopolitical issues affect the global pork trade. Specifically, U.S. pork meat exports to certain markets such as Mexico and China are likely to face domestic competition as production in those countries is expected to increase. Second, the impact new domestic competition has on the packing industry, and the effect this new packing has on U.S. processing efficiency. Third, changes in U.S. consumption patterns, which include reversion from a primarily lean focus to an enhanced flavor profile, and changes in the distribution channels, such as Amazon. 1/8 RaboResearch Steady Growth Ahead for the U.S. Pork Industry October 2017

The U.S. Pork Industry in Expansion Mode The result of efficiency gains, combined with planned expansion of capacity, is an expected 11 percent (2.8 billion pounds) increase in total pork production, from 2017 through 2025. The baseline dynamic projected for pork production is for faster growth over the next three years and then continued steady increase through 2025, reaching 28.4 billion pounds (13 million tonnes). Key supply-side drivers of this expansion are infrastructure capacity, continued efficiency gains in pounds produced per sow through increased pigs per sow, and steadily increasing carcass weights (see Figure 1). The total U.S. sow herd maintains the long-term downward trend (see Figure 2). The first five years of the baseline show a slower decline in the sow herd, as weights and total number of pigs produced rebalance after the significant peaks of 2014 following the PEDv outbreak. However, the economics of tight profit margins are expected to continue driving more efficiency gains in both key variables, as swine producers seek to optimize returns from feeding and spread fixed costs over more total pounds per female. The key variable that can make these efficiency gains change is a potential movement to more heritage breeds in an attempt to enhance the taste profile of loins and hams through increased marbling. However, the drive for efficiency is projected to continue as a result of the genetic development of taste elements, combined with enhanced production traits. Figure 1: Carcass Weights Grow after Post-PEDv Mean Reversion, 2000-2024f Figure 2: Pigs Per Adjusted Sow Grows while Total Sows Decline, 2000-2024f pounds per carcass 230 220 210 200 190 180 million head 6,400 6,100 5,800 25 20 15 pigs per active sow 01/03/2000 01/05/2002 01/07/2004 01/09/2006 01/11/2008 01/01/2011 01/03/2013 01/05/2015 01/07/2017 01/09/2019 01/11/2021 01/01/2024 5,500 2000 2003 2006 2009 2012 2015 2018 2021 2024 10 Qtr Barrows&Gilts Projection Sow herd Pigs Per Sow Source: USDA, Rabobank 2017 Note: Sow numbers are adjusted to estimated average during the year Source: USDA, Rabobank 2017 Imports of live hogs from Canada are also expected to increase over the baseline period, from nearly 5.7 million head in 2016, to around 6.5 million head by 2025. However, this is currently a wild card as the Canadian industry has not yet ramped up feeder pig production following the dismantling of the U.S. Country of Origin Labeling (mcool) laws. In our baseline, imported feeders will have the biggest effect on the U.S. sow herd since the 2000 season. In the long term, the U.S. sow herd is projected to decrease by 6.3 percent (approximately 400 million head) from 2016 to 2025. This reduction is needed to balance the increased production capacity gained through more pigs per sow, and the 5.5 percent growth in carcass weight. However, in the short term, through 2019, the baseline projection deals with the large population of sows in 2016 that originally developed as a result of PEDv price-related pressure in 2014-15. From 2017 to 2019, the ability of the sow herd to contract by 1 percent to 2 percent will be a critical component driving live-animal production profitability. Alternatively, if sow farrowing does not decline, weights are likely to continue the short-term trend, which started after 2014, of getting lighter or remaining flat through 2019. After the sow herd adjusts, weight per carcass is projected to return to the long-term growth trend, as feeders seek increased revenue to offset overhead costs. 2/8 RaboResearch Steady Growth Ahead for the U.S. Pork Industry October 2017

Slaughter Capacity Catching up Due to processing capacity issues, some periodical bottlenecks in the pork supply channel have developed, particularly at the beginning and end of the calendar year. However, by 2018/19, plants coming online will open up the channel and make supply more available to consumers. By 2025, the baseline projection for total slaughter climbs by 10 percent over 2016 (11.6 million head) to just under 130 million head. Based on the baseline projection for increased production efficiency and future demand levels, additional packing capacity is expected to be needed following 2021 (see Figure 3). Additional capacity expansion is expected as a result of plant upgrades and additional shifts. At this point, these expansions have not been included in the baseline. However, as currently announced processing capacity is added, the industry will need to deal with the potential of over-supplying domestic and international demand, which can have a significant impact on future packer margins. Figure 3: Slaughter Capacity Catches up with More Need after 2020 (2000-2025f) 34,000 million head quarterly 28,000 2015 capacity Wright County, IA 10K h/d Double-Shift Sioux City, IA: 12K h/d Sioux City, IA: 12k h/d and Coldwater, MI: 10k h/d Pleasant Hope, MO: 2.5k h/d and Windom, MN: 4k h/d 22,000 Mar-00 Sep-01 Mar-03 Sep-04 Mar-06 Sep-07 Mar-09 Sep-10 Mar-12 Sep-13 Mar-15 Sep-16 Mar-18 Sep-19 Mar-21 Sep-22 Mar-24 Sep-25 Qtr Barrows&Gilts Projection 2015 Capacity 2016 Capacity 2017 Capacity 2018 Capacity 2019 Capacity Source: USDA, Rabobank 2017 U.S. Pork Exports and Domestic Consumption to Grow The past three years have offered an opportunity for expansion of the U.S. swine herd, while still generating frequent periods of positive profit margins. However, over our baseline projection, the recent herd expansion combines with production efficiency gains to drive the U.S. pork industry back to managing a delicate balance between stable domestic consumption growth, increasing export demand, and supply growth driven by production efficiency gains and infrastructure expansion. Demand will benefit from slight growth in consumption per capita, population growth, and steadily higher exports to trading partners. The long-term trend for pork consumption per capita in the U.S. has generally fluctuated between 49 pounds and 51 pounds this remarkable stability has produced a simple average of 50.1 pounds per capita consumption, adjusted to retail weight (77.6% carcass yield). In 2010, consumption dropped below 49 pounds and did not reemerge until 2015. Over the baseline projection, a slight growth trend is expected to continue until consumption is just above the 51 pound per-capita level in 2024. The 8 percent to 9 percent 3/8 RaboResearch Steady Growth Ahead for the U.S. Pork Industry October 2017

growth rate (over 1.9 billion pounds) in U.S. domestic consumption is expected to marginally outpace population growth, which is at 6 percent over the same time period. Reaching higher consumption growth is challenging as long-term patterns in the U.S. prefer pork in very distinct settings, such as breakfast, and as an addition to supplement other protein types. While this consumption growth is positive for the industry, changes in demand for various primal cuts is also expected to impact volatility in carcass cutout values. Figure 4: Exports Lead the Growth in Pork Consumption, 2000-2025f 35,000 28,000 21,000 14,000 7,000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 million pounds 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Source: USDA, Rabobank 2017 Domestic Consumption Total Pork Exports Ending Stocks More Exports Are Needed The growth of domestic consumption will help the pork industry to stabilize over the next ten years. However, exports will need to continue developing at a steady rate to keep pace with the key production efficiency variables. Through 2025, exports are projected to become the most important growth category of U.S. pork usage (see Figure 4) due to the lack of sufficient growth in domestic use. Total exports grow by nearly 900 billion pounds over the projection period, and increase from representing 22% of total production to reach 23.5% of total production in 2025. The U.S. pork industry s growing reliance on exports has important implications: it introduces volatility to the market and highlights the ongoing need to improve competitive positioning in the key export markets of Mexico and North Asia. Changing Demand for Primal Cuts Increases Market Volatility Demand growth has not been equal among primal pork cuts, which will likely continue to introduce volatility in prices for both carcass and live basis. In the U.S., pork bellies have been demanded more than the relative amount available from the carcass. While the size and weight of bellies varies by genetic breed, in general, the belly is around 14 percent to 16 percent of the average carcass. However, over the past three years, estimated total domestic disappearance of bellies has steadily made up more than approximately 14.8 percent to 17 percent of total usage. Meanwhile, demand for other cuts is less than the usual proportion of the carcass (see Table 1). Small differences between the carcass proportion and the percentage of the carcass demanded has a significant impact on whole-carcass values. Periods of price-rationing are likely to be created when highly demanded cuts become scarce. This will open up opportunities for varying mixes of product imports. Hams, which are just over 24 percent of the carcass, are expected to increasingly find a home in the export market. However, other cuts, such as loins and ribs, have remained stagnant in usage. As long as ham exports to Mexico keep growing, at least in the next 4/8 RaboResearch Steady Growth Ahead for the U.S. Pork Industry October 2017

two to three years, there is no indication that this trend will change the carcass cutout value is likely to remain volatile. Table 1: Disproportionate Domestic Usage of Primal Cuts (2016) Primal Cuts Carcass Proportion Three-Year Average Usage Difference Between Usage and Production in % points Bellies 14-16% 14.8-17.4%.8 to 1.39 Hams 24.8-26% 24.6-24.8% -.2 to -1.2 Loins 25.3-26.8% 25.0-25.3% -.3 to -1.5 Picnic 10.5-11.5% 11.4-11.5% -.1 to 0 Ribs 4-4.7% 4.6% -.1 Boston Butt 10.2% 10.2% -.1 Trim 7.0% 7.0% - Source: Rabobank 2017 Growing for the World Growth in exports over 2017-projected levels of at least 900 million to 1 billion pounds (10 to 15 percent) will be needed to keep the industry in a balanced growth mode. With an ongoing expansion of domestic pork production in two of the top three current export destinations, Mexico and China, the U.S. pork industry will need to increasingly improve the competitiveness of its export products. If production expansion is going to be profitable over the baseline period, exports into current markets will need to grow and new export markets will need to be developed. Figure 5: Change in Export Destinations of Pork Products, 2010-2016 800 thousand tonnes 600 400 200 0 Mexico Japan China Canada Hong Kong Korea, South Aust All Other 2010 2016 Figure 6: Destinations for U.S. Pork, 2016 Australia 3% South Korea 6% Hong Kong 8% Canada 9% China 15% Other 10% Japan 17% Mexico 32% Source: USDA, Rabobank 2017 Source: USDA, Rabobank 2017 While Chinese exports have accounted for 12.1 percent of the 20.8 percent (398,000 tonnes) U.S. export growth from 2010 through 2016 (see Figure 5), the type of product demanded has been mixed. In 2016, over 50 percent of U.S. pork products exported to China were classified as offal, trimmings, feet, or other similar cuts, and over 18 percent of total pork products fell into the ham or shoulder designation. Although China s import demand over the coming years is expected to remain relatively stable, there is scope for the U.S. to increase its share of this trade based on its more competitive cost of production compared with Europe China s major trade partner in pork. Maintaining competitiveness will depend on the whole supply chain, rather than just the exporter, for two reasons. First is that China does not accept the use of ractopamine in pork, requiring the full chain to demonstrate that this implant is not used in the exported product. Second, leading pork exporters continue to invest in product processing, distribution, and marketing in China, along 5/8 RaboResearch Steady Growth Ahead for the U.S. Pork Industry October 2017

with local partners, as a way of locking in their trade flows. This whole chain alignment starts with the right product mix, of a consistent quality and price, being made available for export. If the U.S. pork industry is willing to invest in growing exports to China, and can out-compete other countries exporting to China, it is conceivable that U.S. pork exports to China could grow by a further 100,000 tonnes over the baseline period. This growth is expected to be achieved through capturing market share from other exporters of pork to China, such as Europe. Mexico is expected to import around 1.3 million tonnes of pork by 2025, up from 1 million tonnes in 2017. However, our export scenario could change if Mexico is able to control and eradicate PEDv and control Porcine Reproductive and Respiratory Syndrome (PRRS). Mexico continues to grow its sow inventories and slaughter plants, making it only a matter of time before Mexico boosts domestic production. By 2025, our baseline indicates that Mexico will have doubled its imports compared to 2010. Mexico s imports have been dominated by ham-specific products. Consequently, ham exports from the U.S. have grown from a five-year average of 23 percent of total U.S. pork exports in 2010, to 26 percent in both 2015 and 2016. With a clear position as number one importer of U.S. pork products (see Figure 6), Mexico is expected to be a critical part of U.S. exports through 2025. Growth in Mexican production of both pork and beef are projected to compete with imported exports. However, the lower processing cost of imported hams compared to the cost of processing the entire carcass favors U.S. exports. The low cost of live production (mainly as a result of lower corn and soybean meal prices) and close geographical proximity, are additional advantages for U.S. exports. In our baseline, we expect an annual increase of 200 thousand metric tonnes (440 million pounds) to be exported to Mexico in 2017, to around 1.3 tonnes by 2025. Over the baseline, South Korean pork import growth is projected to offset a slight decline in Japanese imports. Therefore, in order to reach the 400,000-tonne increase projected in the baseline, the U.S. pork industry will need to find new destinations for around 100,000 additional tonnes of pork exports from 2017 through 2025 to maintain a reasonable balance in the domestic market. Growth in exports to South-East Asia the Philippines for example and Central and South America appear most likely. Exports are necessary for future expansion but are not guaranteed. Due to the challenge of growing the domestic herds and expanding processing capacity in China and Mexico, the baseline projection for exports grows at a more rapid pace in the first three years. However, the effect of competing for international share over the long term is the difference between expansion and contraction of the U.S. pork industry. We have modelled two alternative scenarios to highlight how the baseline projections could change if U.S. exports do not grow as indicated. In a slow growth scenario, where baseline growth is still captured in the first three years before flattening out, total exports grow more modestly at a total of around 110,000 tonnes through 2025 (see Figure 7). In this scenario, U.S. exports lose market share to domestic Mexican and Chinese production as well as competition from Europe. Total slaughter declines by 1.6 percent (see Figure 7), carcass weights grow at a slightly slower rate as a result of decreased live prices, and the cutout to live price narrows from 2018 through 2020 as additional capacity becomes active (see Figure 8). 6/8 RaboResearch Steady Growth Ahead for the U.S. Pork Industry October 2017

Figure 7: Export Growth Scenarios, 2000-2025f 7,500 6,000 4,500 3,000 1,500 0 2000 2001 2002 thousand pounds 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Source: USDA, Rabobank Total Exports Baseline No Export Growth Scenario Total Exports Slow Growth In a no export growth scenario, exports remain relatively flat from 2017 on, and total slaughter declines by 2.4 percent, which dramatically narrows the live-to-cutout ration after 2018 to fill capacity space. Cutout values decline by 5 percent (see Figure 8) from the baseline, as distribution becomes more challenging. Total pork production also declines by just under 3.0 percent as live prices continue to incentivize carcass weight growth, but at 0.6 percent less than the baseline by 2025. Both the slow-growth and no-export-growth scenarios present considerable challenges for U.S. pork industry profitability. These scenarios are plausible but present different outcomes than those presented by the baseline projections. The alternative scenarios should signal the importance and implications of growing exports to the whole U.S pork supply chain. Figure 8: Cutout Values Impacted by Slower Growing Exports, 2000-2025f 130 110 90 70 50 2000 2001 2002 2003 USD/CWE 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Source: Rabobank 2017 Cutout Value Baseline Cutout Value No Export Growth Cutout Value Slow Export Growth 7/8 RaboResearch Steady Growth Ahead for the U.S. Pork Industry October 2017

Imprint RaboResearch Food & Agribusiness far.rabobank.com Sterling Liddell Senior Analyst - Global Data Analytics Sterling.Liddell@raboag.com +1 314-317-8038 Justin Sherrard Global Strategist Animal Protein Justin.Sherrard@rabobank.com Pablo Sherwell Head of RaboResearch Food & Agribusiness - North America Pablo.Sherwell@rabobank.com 2017 All rights reserved This document is meant exclusively for you and does not carry any right of publication or disclosure other than to Coöperatieve Rabobank U.A. ( Rabobank ), registered in Amsterdam. Neither this document nor any of its contents may be distributed, reproduced, or used for any other purpose without the prior written consent of Rabobank. The information in this document reflects prevailing market conditions and our judgement as of this date, all of which may be subject to change. This document is based on public information. The information and opinions contained in this document have been compiled or derived from sources believed to be reliable; however, Rabobank does not guarantee the correctness or completeness of this document, and does not accept any liability in this respect. The information and opinions contained in this document are indicative and for discussion purposes only. No rights may be derived from any potential offers, transactions, commercial ideas, et cetera contained in this document. This document does not constitute an offer, invitation, or recommendation. This document shall not form the basis of, or cannot be relied upon in connection with, any contract or commitment whatsoever. The information in this document is not intended, and may not be understood, as an advice (including, without limitation, an advice within the meaning of article 1:1 and article 4:23 of the Dutch Financial Supervision Act). This document is governed by Dutch law. The competent court in Amsterdam, the Netherlands has exclusive jurisdiction to settle any dispute which may arise out of, or in connection with, this document and/or any discussions or negotiations based on it. This report has been published in line with Rabobank s long-term commitment to international food and agribusiness. It is one of a series of publications undertaken by the global department of RaboResearch Food & Agribusiness. 8/8 RaboResearch Steady Growth Ahead for the U.S. Pork Industry October 2017