Dynamics of China s Pork Industry

Dynamics of China s Pork Industry Trending Towards Consolidation and Industrialisation Contents Introduction 1 Demand dynamics 1 Pork supply chain: Restructuring and consolidation 6 Key constraints for China s pork production 8 Supply availability Vision 22 9 Conclusions 1 China s pork industry is undergoing dramatic changes along the supply chain in response to consumers demand for food safety and quality. The structural changes in the farming and processing sectors, characterised by consolidation and industrialisation, will continue at a faster rate in the coming years. The government is responding to these market dynamics but potential remains for further improvements. Despite the current shortage of pork supply, China is expected to remain self-sufficient in the long term. Introduction China s pork industry has achieved remarkable growth in the past decades. China has become the world s largest pork producer and consumer. It is also attracting great attention for having brought about structural changes in the pork supply chain. Pork is the most important meat to Chinese consumers and will continue to hold a dominant position within China s total meat market, although its share is gradually declining. Pork consumption is still low in rural areas, indicating huge potential for further expansion. In urban areas, pork consumption is nearing the saturation point from a volume perspective. As a consequence, the pace of pork production growth in China has decelerated from the double-digit growth seen in the 199s. However, value growth has become significant, and the focus is shifting to food safety, convenience and quality issues. In response to changing consumer preferences, the pork industry is moving towards commercialisation and integration and is focusing on the restructuring of the pork supply chain. Larger scale production is gaining market share at the expense of smaller producers. The trend of increasing scale is reshaping the relationship between slaughterers and producers from a spot market towards a more coordinated supply chain. Rather than focusing solely on promoting the industrialisation of livestock production, the Chinese government is prioritising technological development, food safety, breed improvement and productivity enhancement. This will provide opportunities for foreign investors to break into China s market. The dramatic change in China s farming model combined with the limited availability of land and water raise the question of whether China will have the necessary resources to meet the growing demand for pork production. However, Rabobank expects that China will remain largely selfsufficient in pork supply, but will increasingly rely on the rest of the world for feed-grain supply in the coming years. This report aims to provide an up-to-date analysis of China s pork supply chain, as well as the key factors which have been driving its evolution in recent years. It also forecasts the future development in terms of pork production and international trade. Demand dynamics China is the world s largest pork market. Total pork consumption in China increased 1.6 times between 1996 and 21, with growth speeding up in the late 199s but slowing down upon entering the 2s. A number of factors contributed to this growth. While rising income levels are the primary reason for growth in meat demand, lifestyle changes, urbanisation and supermarket growth are also altering the dietary and purchasing habits of Chinese consumers. Consumers are increasingly shifting away from food as a need to convenient, healthy and value-added food products. Additionally, widening income disparity and migration from rural to urban areas are forming different market segments. High volatility of pork prices in recent years Compared with China s food price index and the consumer price index (CPI), the pork price index has shown more volatility in the past decade (see Figure 1). This was particularly the case in 27, when an outbreak of porcine reproductive &

2 Rabobank Industry Note 283-211 Figure 1: Chinese consumer price Indices for food, meat, and all consumer products, Jan 23-Apr 211 index* 16 15 14 13 12 11 1 9 8 7 6 Jan-3 Apr-3 Jul-3 Oct-3 Jan-4 Apr-4 Jul-4 Oct-4 Jan-5 Apr-5 Jul-5 Oct-5 Jan-6 Apr-6 Jul-6 Oct-6 Jan-7 Apr-7 Jul-7 Oct-7 Jan-8 Apr-8 Jul-8 Oct-8 Jan-9 Apr-9 Jul-9 Oct-9 Jan-1 Apr-1 Jul-1 Oct-1 Jan-11 Apr-11 CPI CPI food CPI meat * Prices indexed YOY on a monthly basis. Reference year was 2 for the period 23-25, 25 for the period 26-21 and 21 in 211. Source: National Bureau of Statistics of China, Rabobank, 211 respiratory syndrome (PRRS), also called blue ear disease, affected 2 percent of China s hog herd. Pork prices reached a historic high in the middle of 28 and became the driving force behind food inflation that year. The record was broken in June 211, and once again pork prices are driving increases in the CPI. In 211, China s CPI rose to 6.4 percent on a year-on-year basis, a three-year high. Food accounts for one-third of China s CPI basket, and pork is estimated to account for up to 1 percent of the country s food index. As pork prices rose 57 percent on a year-on-year basis, pork alone resulted in 1.7 percent surge in CPI. The rising pork prices were due to a combination of factors, including recurring diseases and rising input costs. Due to recurring diseases, pork production in China has become a high-risk business, stopping many farmers from building up stock in 21 and the first half of 211. A number of Chinese farmers are leaving pork production altogether, as rising input costs are squeezing margins and increasing the uncertainty of doing business. Piglet prices are more volatile than hog prices, meaning farmers who have no breeding stock and must purchase piglets from the market have a lot of uncertainty to deal with (see Figure 2). Such farmers are mainly backyard and small-scale specialised farmers who make up the majority of all producers. In comparison, the consistent differences between the prices of wholesale pork versus hogs indicate that primary processors are better off than farmers because they can pass on additional costs to consumers. The widening differences between the prices of retail pork versus hogs indicate that value-added processors are in an even better position than primary processors as they can command a premium even when the hog prices go up. Therefore, in the context of the whole supply chain, slaughterers and processors may benefit from the dynamic market while farmers are in the weakest position. Pork the staple meat despite a declining share Despite the soaring prices, pork remains the staple meat for Chinese consumers, with per capita pork consumption increasing from 25.8 kilogrammes in 1996 to 37.4 kilogrammes in 21. However, the share of pork consumption within total meat consumption has been decreasing and is expected to continue to decline in the coming years due to the faster growth of consumption of other meats. This is not only because of rising consumer health consciousness and the increased affordability and availability of other meats, but also because growth in consumption of other meats comes from a smaller base. Due to the larger base of pork consumption, the incremental pork volume in the coming five years will still be much higher than for other meats. Chinese consumers are diversifying their meat consumption patterns and increasing the share of poultry, beef, sheepmeat and seafood in their diets. As a result, pork s share within total meat consumption decreased from 8 percent in 1985 to 65 percent in 21 (see Figure 3). Beef, sheepmeat and poultry contain less fat and are perceived as offering different values than pork. The change in meat consumption reflects increasing demand for greater value-add, health attributes and variety. Going forward, overall meat consumption will favour poultry at the expense of pork. Pork s share of consumption is expected to decline further to 63 percent by 215. Food safety: Top concern for consumers Although pork prices have drawn a lot of attention, food-safety issues have become the number-one concern for Chinese consumers, according to a survey conducted by China Agriculture University in 21. Residues of medicines and/or chemicals, illegal additives and diseased meat are the major causes of food-safety issues in China. The pork market has been frequently challenged by foodsafety scandals. The recently publicised case of pork contamination involved the additive clenbuterol, also known as lean meat powder, a chemical which helps hogs to produce more lean meat, and may cause dizziness and nausea when ingested by humans. Shuanghui Group s Shineway, the leading pork company in China, has been negatively impacted by the clenbuterol scandal in the first half of 211. As a result, the company reported a loss of RMB 2 billion due to the negative impact on brand reputation and consequent sales decline.

Dynamics of China s Pork Industry 3 Having threatened demand for Chinese foods both internationally and nationally, food-safety issues have pushed Chinese suppliers to try to alleviate consumers health concerns. In 21, a handful of big Chinese supermarkets promised to stop selling genetically engineered food and food with dangerous levels of pesticides. Additionally, exporters have been more inclined to obtain third-party certification in order to assure foreign consumers of their commitment to providing food that meets strict food-processing guidelines or safety requirements. In response to domestic and international outrage at China s food-safety issues, the Chinese government passed the Food Safety Law of the People s Republic of China (FSL) in 29. Among promoting other safety standards, the FSL strengthens control over food additives. The new law limits the use of chemicals in food products to food additives, and sets out safety standards regarding the type, usage and amount of food additives allowed in food production. Additionally, the FSL orders companies to obtain production permits before producing food additives. Although the FSL is an improvement for China, it has been difficult to enforce due to the vastness of China s agricultural sector. Much of China s pork is still produced in small-scale backyard farms that are difficult to regulate. The entire supply chain is fragmented, and unsafe pork meat can flow into markets through the gaps. Furthermore, a complex administrative system, in which different ministries and agencies supervise the supply chain together, tends to obscure where final responsibility lies. In general, the frequency of food-safety concerns in China may boil down to the reality that punishments may be too mild compared to potential profit. The government s underlying desire to cover up safety issues, combined with the lack of an authoritative agency, has in the past made it easy for violators to escape punishment. In addition, it is no wonder that pressure on margins and the rising input costs may tempt players to save costs at the expense of safety. With rising food-safety concerns, middle and high-income level consumers would pay a premium for branded and high-quality pork products and shift their purchases from traditional markets to modern organised retail. This trend provides suppliers new opportunities with huge market demand for safe, high-quality products. Demand outlook: Greater potential for value growth over volume growth China s per capita meat consumption is still low compared to Western countries (see Figure 4). Figure 2: China s pork market prices, Jan 21-Jun 211 RMB/kg 45 4 35 3 25 2 15 1 5 Jan-1 Jun-1 Nov-1 Apr-2 Sep-2 Feb-3 Jul-3 Dec-3 May-4 Oct-4 Mar-5 Aug-5 Jan-6 Jun-6 Nov-6 Apr-7 Sep-7 Feb-8 Jul-8 Dec-8 May-9 Oct-9 Mar-1 Aug-1 Jan-11 Jun-11 Piglet Hog price Mark-up retail pork vs hog Mark-up wholesale pork vs hog Source: CAAA, Rabobank, 211 However, considering that Chinese consumers diets have been dominated by grains and vegetables for thousands of years, the current meat consumption level is already at a record high. Chinese consumers are not expected to begin to consume as much animal protein as their counterparts in Western countries do, which indicates that the potential for further growth of per capita consumption is limited. The growth of meat consumption in China is anticipated to come at a slower pace in the coming five years and to level off after that. Per capita meat availability is forecast to grow by a compound annual growth rate (CAGR) of between 2 percent and 3 percent, and to reach 67 kilogrammes by 215. Pork consumption in urban areas is reaching saturation, while further volume growth potential will mainly come from rural areas. Figure 3: Chinese meat consumption patterns, 1985-215f percent 1 9 8 7 6 5 4 3 2 1 1985 28 Pork Poultry Beef and sheepmeat f=forecast Source: MOA, Rabobank, 211 215f

4 Rabobank Industry Note 283-211 Figure 4: Per capita animal protein consumption, selected countries, 21 kg 12 1 8 6 4 2 India Indonesia Thailand Beef and sheepmeat Vietnam Philippines Pork Mexico Russia China Poultry Brazil Argentina Source: USDA, Food and Agriculture Organization of the United Nations, 211 Japan Canada EU Australia US With slowing volume growth, value growth will continue to feature in the future market dynamics. Consumers, particularly urban citizens, will demonstrate more changes regarding qualitative aspects, such as food safety and convenience, and a shift in demand towards different protein sources. Rising living standards will be accompanied by rising awareness of food safety. This will have significant implications for meat producers, processors and retailers, who need to focus on delivery of safe and quality products. Branding will be an important aspect for pork meat purchases, despite the decreasing confidence of consumers due to recent food-safety scandals. As wealth disparity has widened since the mid- 199s owing to the faster growth of the urban economy, the obvious need to quicken rural development to support China s consumption base as well as to appease a vast rural population of over 6 million people who were largely left behind by China s miraculous boom is clearly highlighted in the 12th 5-Year Plan. Regulatory framework Policy plays an important role in the Chinese pork market. This is because pork has strategic importance to Chinese consumers and therefore receives more attention from the government than other meats. Under the umbrella of China s 12th 5-Year Plan, which sets the priority for agriculture modernisation, the government has adjusted measures to respond to the market changes. To tackle the soaring pork prices, the government s latest policy would resume an RMB 2.5 billion investment programme to support large-scale hog farms. Generally, the Chinese government does not have a direct investment in the pork production and slaughtering businesses, but may provide fiscal support and other favourable policies to investors who establish large-scale farms. The government has made huge investments to improve areas such as research and development (R&D), infrastructure and transportation with the aim of benefiting a broader range of farmers. Going forward, the Chinese government will continue to increase investment in R&D, public facilities and breeding improvement. New framework for slaughtering/processing According to China s Guideline for National Hog Slaughtering Industry Development (21-215), stricter industry standards are to be enforced in the slaughtering and processing sectors. Licences will be reviewed and only issued to qualified slaughtering plants. With the enforcement of new standards, it is expected that 3 percent of small to medium-sized companies would be closed down by 213 and 5 percent by 215. This will leave a huge gap to fill in slaughtering capacity, and therefore offer attractive opportunities for the expansion of large companies. Subsidy policies Subsidies will be provided directly to farmers or slaughterers by the Chinese government. There are many kinds of subsidies, including tax exemptions for farming projects, VAT tax exemptions for feed production, income tax rebates for slaughtering, subsidies for treatment of slaughtering waste water and subsidies for fertile sow insurance. The latest subsidy policy will grant RMB 1 per fertile sow in order to increase pork supply and release price pressure. To push for upgrading of the slaughtering sector, a cash subsidy of RMB 5 per head will be granted to newly established and advanced slaughtering capacity. Local governments usually have additional support such as cash input according to the investment amount, tax breaks, land access. Subsidy policies effectively drive the expansion of hog production and slaughtering, particularly when there is a supply shortage in the market. The subsidy policy is expected to remain in place for the coming five years, given that pork production needs support during this transitional period of restructuring. However, the content of subsidies will be adjusted according to changes in the market supply and demand. In the long term, with the industrialisation of pork production, government direct subsidy will gradually be phased out. Subsidies received by key players in 21 were an important factor in the profitability of many of them (see Figure 5).

Dynamics of China s Pork Industry 5 Figure 5: Revenues and subsidies, selected key players in China s pork industry, 21 Player Subsidies, 21 (million RMB) Net profit, 21 (million RMB) Subsidy to net profit (percent) Types of subsidies China Yurun Food Group 66.63 2,266. 27 1. M&A fund from government 2. Fund supporting agri-food industrialisation 3. Subsidy on bank-loan interest 4. Subsidy on hog breeding 5. Subsidy on new slaughtering capacity Hunan New Wellful 79.98 14.77 541 1. Live hog and frozen pork reserve subsidy 2. Fund supporting export brand 3. Science and technology subsidy 4. Sow subsidy and frozen pork reserve subsidy Shineway Group 33.1 1,89.28 3 1. Special fund for hog industrialisation project 2. Subsidy on hog breeding 3. Fund supporting R&D into new technologies for livestock bone and blood processing 4. Tax rebate on domestically procured equipment Beijing Shunxin Agriculture 5.14 265.35 2 1. Financial support from local government Sichuan Gaojin Food 43.33 22.29 194 1. Live hog reserve subsidy 2. Subsidy on bank-loan interest 3. Government bounty Henan Chuying Agro-pastoral 1.19 122.97 8 1. Live hog reserve subsidy 2. Listed enterprise bounty 3. Local backbone enterprise bounty Source: Company data, 211 Pork price monitoring system and pork reserve system In 28, the Chinese government introduced a pork price monitoring system to ensure a stable pork supply to the market and to protect farmers benefits. A hog-to-corn price ratio of six is considered a break-even point for pig farming to make a profit. This ratio is used as an important index for the government to assess the possible market movement in the near term. When the ratio is higher than nine or lower than five, the government may release pork reserves or make central purchases of frozen pork to adjust the market price. It is worth noting that the government will not intervene in the pork market directly by setting a cap or floor price. China s government now has a closer watch on the market price movement than in previous years because pork prices have shown more volatility. China s Ministry of Commerce and Ministry of Finance jointly initiated a pork-reserve system in 27. The system consists of two parts, live-hog reserve and a frozen-pork reserve. This policy differentiates China from the rest of the world in the aspect of treating pork as a strategically important food. Large-scale implementation of the live-hog reserve system began in early 27, although it already existed on a smaller scale in previous years. The live-hog reserve may consist of a few million hogs which are rotated every four months within 2 to 3 commercial farms. The frozen-pork reserve was initiated in 27 when pork prices began to rise. The purchasing and storage of a frozen-pork reserve is through public bidding, open to any qualified meat plant with cold storage capacity of at least 3, tonnes. It is estimated that there are about 2, tonnes of frozen pork in reserve, which will be rotated every four months to ensure freshness and quality. The selling of the frozen-pork reserve is mainly through two channels, public auction and retail outlets. Frozen pork sold at public auction is purchased by processing companies or institutional users. Due to price hikes in mid-211, as of July, some of the frozen-pork supply was released directly via retail outlets. Some provinces in China, including Liaoning and Shannxi, have reportedly released reserves in increments to the retail market, aiming to cool local price hikes. In Liaoning, the reserved frozen pork has been sold through traditional stores and wet markets in communities where low-income consumers reside. The price of released frozen pork is lower than the market price of fresh pork by USD.3 per kilogramme. Due to the attractive price, the frozen pork was sold out immediately, although many consumers are cautious about its frozenness. In Dalian city (of Liaoning province) with a population of six million, only between three tonnes and five tonnes of frozen pork is being released per day, less than.3 percent of the total market demand. Due to the limited volume of frozen-pork reserve, such measures will have limited direct impact on the market supply, but will have more influence on market sentiment.

6 Rabobank Industry Note 283-211 48 47 46 Pork supply chain: Restructuring and consolidation With a pork output of 49 million tonnes and 453 million head in 21, China produces close to half of the world s pork supply. Despite a still fragmented structure, China s pork supply chain is undergoing a critical transformation. The market share of backyard farming, which was the dominant force one decade ago, has declined considerably while larger scale farms are emerging rapidly to fill the gap left by backyard farmers. The supply shortage in 211 is driving faster expansion of larger scale farms at the expense of backyard farming which has been discouraged in the past few years by great market volatility. The current pork supply shortage On entering 211, China was in the throes of a pork supply shortage. The monthly hog and sow inventory has declined since mid-21 (see Figure 6). The sow inventory has seen a deeper decline than the hog inventory, reflecting a negative sentiment in the pork business over the past year. The pork shortage is expected to continue throughout 211, as recurring diseases and rising input costs continue to impact production. Due to the soaring hog prices, hog rearing became more profitable. This became particularly obvious after May 211, making farmers eager to build up herds again (see Figure 7). Accordingly, both hog and sow inventories were slowly rising in Q2 of 211. The slaughtering segment has more stable profitability than the hog-rearing segment (see Figure 8). In addition, slaughtering profitability has seasonal movement, in accordance with consumption ups and downs. Figure 6: China's hog and sow monthly inventory, Jan 29-Jun 211 million head million head 5 49 48 Consolidation and commercialisation trends in farming, slaughtering and processing While China s pork value chain is still characterised by spot market exchanges among suppliers, producers, processors and retailers, integrated operations have increasing involvement and consolidation is taking place within each link of the supply chain. Consolidation of hog farming Hog production in China is currently conducted by three categories of producers: backyard farms, specialised households and commercial farms. While there is no strict definition of the three types of farms, backyard farms usually raise fewer than 5 hogs, specialised farms raise 5 to 3, hogs, and commercial farms raise more than 3, hogs. The structure of hog farms in China has changed significantly in recent years (see Figure 9). Chinese farmers traditionally raised one to three hogs with most of the hogs delivered to the open market for sale. The disease outbreaks hit backyard farmers harder than larger sized farms due to poor sanitation and poor farm management. Currently, about 37 percent of live hogs come from backyard farms, compared to about 74 percent in 21. Moreover, backyard farmers are more vulnerable to the uncertainty of input cost and market volatility. In addition, with urbanisation and migration of rural labour to cities, opportunity cost of rural labour increased. These factors make backyard farming less competitive when compared to larger sized farms. Going forward, it is expected that backyard farming will continue to decline along with the decreasing competitiveness. Commercial and particularly specialised farms are gaining importance in China, especially in developed areas and in the corn-belt region. The increasing scale of farms facilitates the relationship between slaughterers and pork producers to reshape the existing spot market into a coordinated supply chain. Specialised and commercial farms usually produce hogs for contracted slaughterers and processors, while some leading slaughterers and processors are establishing their own farms for supply. 45 44 43 42 41 Jan-9 Mar-9 May-9 Jul-9 Hog inventory Source: MOA, 211 Sep-9 Nov-9 Jan-1 Mar-1 May-1 Jul-1 Sep-1 Nov-1 Jan-11 Mar-11 May-11 47 46 45 44 43 Sow inventory Consolidation of slaughtering/processing Prior to the structural changes currently taking place in farming, consolidation was already taking place in the pork slaughtering and processing sectors for years. For example, over the past five years, Yurun s aggressive expansion plans resulted in their total slaughtering capacity reaching 35.6 million head in 21. This figure represents nearly 4 percent growth in slaughtering capacity on a year-on-year basis. Such an expansion pace

Dynamics of China s Pork Industry 7 is extraordinary, but not surprising given that China s pork market is in a transition period and is full of opportunities. As a result of consolidation, the total number of designated slaughterhouses has decreased from 3, in 26 to the current 12, due to the government s efforts to close down medium and small-sized players with lower efficiency and high food-safety risks. This number is expected to decrease to 2, by 22. In view of the fact that there are still many small designated slaughterhouses and a large number of illegal individual butchers active in the market, there continues to be considerable scope for further consolidation. The decline of backyard households and the emergence of specialised farms will definitely provide more opportunities to larger players over smaller ones, because small or individual butchers mainly source from backyard households. Going forward, consolidation will only accelerate with the enforcement of new slaughtering regulation. Mechanised slaughtering, which currently accounts for only 2 percent of the market, is expected to increase market share to 7 percent by 22 at the expense of half-mechanised and hand slaughtering s market shares (see Figure 1). Vertical integration With the consolidation taking place on the farming and slaughtering sides, vertical integration is taking place along the supply chain. A number of pork slaughterers and processors are extending upstream to establish breeding or farming assets, in order to secure consistent supply. Most of the expansion plans of key pork players are targeted at building up mega breeding farms and expanding slaughtering and processing facilities (see Figure 11). Companies such as Yurun Group, Shineway, Chuying Agropastoral and Zhongpin own breeding farms and supply piglets to contracted farmers for growout based on offtake contracts. Although not numerous, some companies such as Guangdong Wen s Foodstuffs, CP Group and Muyuan Foodstuff are developing large-sized commercial farms to build up their own hog sourcing channel. COFCO is a new comer to this group but has the largest investment plan, and is therefore expected to be the largest hog supplier in China in the coming three to five years. Contrary to upstream integration, downstream integration is another major trend taking place in China s pork industry. The top pork-producing companies such as Shineway Group, Yurun Group, People s Food, COFCO and Zhongpin are establishing their own retail outlets or distributing their products over the internet, in order to guarantee better access to end users Figure 7: China s hog-rearing profitability, Mar 28-Jun 211 RMB/head 1, 8 6 4 2-2 7-Mar-8 9-May-8 11-Jul-8 5-Sep-8 7-Nov-8 9-Jan-9 6-Mar-9 8-May-9 1-Jul-9 11-Sep-9 6-Nov-9 Source: Beijing Shennong Agribusiness Consulting Co., Ltd, 211 25. 22.5 2. 17.5 15. 12.5 1. 7.5 5. 2.5 8-Jan-1 5-Mar-1 7-May-1 9-Jul-1 3-Sep-1 5-Nov-1 7-Jan-11 11-Mar-11 Figure 8: Halved carcass premium over live hog prices in China, Jul 28-Jun 211 RMB/kg Jul-8 Sep-8 Nov-8 Jan-9 Mar-9 May-9 Jul-9 Sep-9 Nov-9 Jan-1 Mar-1 Source: Beijing Shennong Agribusiness Consulting Co., Ltd, 211 May-1 Jul-1 Sep-1 Nov-1 Jan-11 Mar-11 May-11 6-May-11 RMB/kg Live hog price Price of halved carcass Premium Figure 9: China hog herd by farm size, 21-213f million head 6 5 4 3 2 1 Backyard farm (1-49 head per farm) Commercial farm (>3, head per farm) f=forecast 5% 21% 7474% 21 Source: MOA, Rabobank, 211 7% 36% 57% 25 12% 51% 37% 29 Specialised farm (5-3, heads per farm) 15% 55% 3% 213f 5. 4.5 4. 3.5 3. 2.5 2. 1.5 1..5

8 Rabobank Industry Note 283-211 Figure 1: Hog slaughter in China by method, 21 vs. 22f million tonnes 8 7 6 5 4 3 2 1 Manual Semi-mechanised Mechanised f=forecast 74 Source: Rabobank, 211 2% 45% 35% 21 7% 25% 5% 22f and gain bargaining power against the emerging organised retailers. Going forward, when making investment decisions, partial or full vertical integration is the business model that China s pork players would give priority to over other business models which focus only on slaughtering or processing. This is because in China s pork market, where food safety is the top concern, vertical integration could convey more confidence to consumers and therefore ensure a possible strong market position. Zooming in, partial vertical integration (with hogs grown out) is more suitable for China s current situation than full integration, as the latter requires a large piece of land, which is a big issue for a country with limited farmland. In addition, a much higher investment is required to build up full vertical integration, adding more uncertainty to this already risky business. Furthermore, from the government s perspective, agricultural modernisation is encouraged by the parallel goal of ensuring farmers benefits, rural employment and social stability. Therefore, as the business model requiring less employment but a larger piece of land, full vertical integration is expected to receive only modest support from the government. For overseas investors, China s pork supply chain falls within the range of sectors which are encouraged for foreign investment. However, there are more challenges for foreign investors than domestic players in terms of receiving policy support. As local government has the flexibility of executing policies, there is a possibility that foreign investors could be treated differently from their local counterparts in terms of accessing local land, receiving subsidies and enjoying tax breaks. The fact that all of the top pork companies are locally owned proves that foreign companies have found it a challenge in the past years to establish an important presence in China (see Figure 12). Relationships with the local government are key for foreign investors to obtain the necessary support. However, investments which can bring in advanced technology and ensure food safety will be highly supported whether it is local or foreign capital. Key constraints for China s pork production There are some key constraints for China s pork production including disease, rising production cost, illegal handling (including illegal ingredients) and poor productivity. Figure 11: Expansion plans of key players in China s pork industry, 211 Company Location Investment type Estimated investment (USD million) Guangdong Wen s Foodstuffs Henan Hog raising 8. Charoen Pokphand (CP) Group Hubei, Shandong, Guangdong Hog and sow raising 85. China Yurun Food Group Heilongjiang, Shandong, Shanxi, Guangxi, Anhui, Sichuan Slaughtering 465. New Hope Group Sichuan Hog production.5 Shineway Group Jiangxi Hog production 18. Muyuan Foodstuff Henan province Hog production 32. Henan Chuying Agro-pastoral Henan province Breeding farm 625. Henan KangYuan Chemical Henan province Raising, slaughtering, feed processing, fresh and frozen pork processing 5. Zhongpin Hebei province Pork production 49. COFCO Tianjin, Jiangsu, Wuhan Pig farming bases 3,12. Source: Company data, Rabobank, 211

Dynamics of China s Pork Industry 9 Disease remains the top challenge for China s animal husbandry sector. The recurrence of disease outbreaks implies that domestic sanitation conditions still have huge potential for improvement. In addition to a poor farming environment, the whole national veterinary system faces a number of pitfalls which need to be improved. In the near to midterm, disease will continue to be the major obstacle for China s pork production. Figure 12: Key Chinese pork companies by revenue, 21 USD million 8, 7, 6, 5, 4, 3, Livestock costs will continue to increase due to the rising input costs of feed and commodities, despite some improvement in feed conversion efficiency. In addition to feed costs, operating costs, such as labour and energy, and pollution treatment costs are trending upward, and will cause the base level of hog production costs to rise further in the coming years. 2, 1, Shineway Yurun People s food Source: Company data, Rabobank, 211 Ng Fung Hong New Hope Zhongpin Beijing Shunxin Henan Zhi-Yuan Food Tangrenshen Group Gaojin Group Illegal handling, including adding illegal ingredients, is the major source of food-safety issues. The recent scandal of lean meat powder indicates a wide range of such activities, which even involve branded and large companies. Government supervision systems need to be responsible for correcting this issue. However, with the vast production area and numerous players, it will be difficult to halt all such activities in the foreseeable future. Although China is the world s largest producer and has thousands of years of farming history, the country s pork productivity is surprisingly lower than in many other countries (see Figure 13). Compared with European countries and the United States (US), hog production in China consumes more grain, has a much higher mortality rate and a lower meat yield. High mortality is linked to disease impact. However, the overall low productivity is due to the fact that China lacks experience and professionalism in specialised and commercial farming. Backyard farming has dominated for thousands of years, being part of self-subsistence agriculture. China is on the learning curve for large-sized farming. The introduction of foreign breeds, advanced farm management and feeding technology will hopefully improve the productivity in the coming years. Given the strategic importance to Chinese consumers, the pork sector will continue to receive support from the government. However, the policies will be adjusted frequently in response to market dynamics. It is likely that direct subsidy will be sustainable in the coming five years and will be phased out gradually after that. Pork trade landscape While China s overall pork demand will be met by local supply, imports absolute volume is likely to expand in particular years. Trade will gain more importance than before, given the supply and demand gap and the price gap. In the short term, China will frequently adjust the trading volume to accommodate the domestic supply situation. Pork imports are expected to increase significantly in 211 to cover the domestic supply shortage, but will return to normal in 212 when domestic pork supply catches up with domestic demand. Pork imports will be a temporary solution to fulfil the shortage rather than a long-term strategy. There is a lot of debate over whether China should import corn or pork to solve the shortage of feed stock. As China has no comparative advantage in intensive corn production, it would strategically make more sense for China to import corn in the Supply availability Vision 22 Despite the constraints, China will continue to mandate additional capacity in pork farming and slaughtering to keep up with bullish demand. Pork supply is expected to rise from the current 49 million tonnes to 6 million tonnes by 22, with a CAGR of 2 percent over the period. The majority of the additional supply will come from specialised and commercial farms. Large integrators will gain share. Figure 13: Hog-rearing performance in China and Europe, 21 KPI China Europe FCR 3.2 2.5 Hogs per sow per annum 13 23 Birth to sale 18 days 15 days Sale weight per head 9 kg 115 kg Source: Rabobank, 21

1 Rabobank Industry Note 283-211 long term. However, in the meantime, China should import more pork to cover domestic shortages. Moreover, Chinese consumers have a strong preference for fresh meat, making imported frozen pork unpopular at the retail market. Furthermore, pork is considered a strategically important food to Chinese consumers, thus self-sufficiency is a government priority. Although China is the largest global pork producer, it currently has a relatively limited ability to export to the rest of the world. China used to be a net pork exporter, mainly exporting high value-add pork meat or live hogs. However, since 28, China has become a net importer, and imported frozen pork has been purchased as a state reserve and released to the retail market when there are supply issues in the domestic market. Pork by-products (edible offal) have been imported in increasing volumes over the past decade (see Figure 14). Countries that are major exporters to China of frozen pork and by-products include the US, Denmark and Canada. Pork imports from the US reached 63, tonnes in the first half of 211, accounting for 49 percent of total imports. Going forward, China will remain self-sufficient in pork supply. However, there is long-term import potential for specific products, such as pork by-products, high-end products and livestock breeders. Conclusion While rising income levels are the primary reason for growth in meat demand, lifestyle changes, urbanisation and supermarket growth are altering the dietary and purchasing habits of Chinese consumers, as they shift from food as a need to convenient, healthy and value-added food products. This suggests that there will be greater value growth than volume growth in the coming years. Due to the strategic importance of pork in China, policies have been constantly reviewed and adjusted to reflect the market changes and dynamics. Subsidy policies have been launched once again to support pork production, particularly for large-sized farms. Although the regulatory framework is being improved, the inconsistency of policies due to constant adjustment creates uncertainty for market players. In terms of supply, consolidation and integration are featuring in the supply chain and will continue at a faster speed in the coming years. Commercial and particularly specialised farms are gaining importance in China, at the expense of backyard farmers market share. This is reshaping the relationship between slaughterers and producers so that it is becoming a more coordinated supply chain. Greater consolidation is taking place in slaughtering and processing. It is expected that the total number of slaughterhouses will decrease from the current 12, to 2, by 22, and the market share of mechanised slaughtering will increase from the current 2 percent to 7 percent by 22. China has essentially been self-sufficient in pork for the past three decades. Going forward, the self-sufficiency will likely continue in the medium to long term, although a larger trade volume will be allowed in the short term, to temporarily cover the supply gap. The sheer size of China s insatiable consumer appetite for pork will likely reshape the global landscape of the pork industry as it already has for oilseeds. While not likely to rely on the world to supply pork meat for the domestic market, China is likely to import feed grains after importing a huge amount of protein meal to meet rising demand for manufactured feed from increased farming industrialisation. Therefore, the next decade of China s emerging economy is likely to be the most interesting to date for the global pork market, as the magnitude of the country s growth is about to expand and deepen. Figure 14: China s pork meat and by-product imports, 1996-21 thousand tonnes 1, 9 8 7 6 5 4 3 2 1 1996 1997 1998 1999 2 21 22 23 24 25 26 27 28 29 21 Fresh, chilled, frozen pork (HS 23) Pork by-products (HS 263 and 2649) Source: UN Comtrade, BOABC, 211

Dynamics of China s Pork Industry 11

12 Rabobank Industry Note 283-211 Disclaimer: This document is issued by Coöperatieve Centrale Raiffeisen-Boerenleenbank B.A. incorporated in the Netherlands, trading as Rabobank International ( RI ). The information and opinions contained in this document have been compiled or arrived at from sources believed to be reliable, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. This document is for information purposes only and is not, and should not be construed as, an offer or a commitment by RI or any of its affiliates to enter into a transaction, nor is it professional advice. This information is general in nature only and does not take into account an individual s personal circumstances. All opinions expressed in this document are subject to change without notice. Neither RI, nor other legal entities in the group to which it belongs, accept any liability whatsoever for any loss howsoever arising from any use of this document or its contents or otherwise arising in connection therewith. This document may not be reproduced, distributed or published, in whole or in part, for any purpose, except with the prior written consent of RI. All copyrights, including those within the meaning of the Dutch Copyright Act, are reserved. Dutch law shall apply. By accepting this document you agree to be bound by the foregoing restrictions. Rabobank International Utrecht Branch, Croeselaan 18, 3521 CB, Utrecht, the Netherlands +31 3 216 Food & Agribusiness Research and Advisory Author: Chenjun Pan Telephone: +86 1 6655 5252 E-mail: chenjun.pan@rabobank.com www.rabobank.com/far