Analyst Note| Rebecca Scheuneman, CFA |
Given the labor-intensive nature of meat processing combined with widespread worker shortages, we expected no-moat Pilgrim’s Pride to experience cost pressure in its third quarter, and we were correct. Adjusted gross and operating margins each contracted 50 basis points year over year to 9.7% and 6.6%, respectively. Labor shortages forced the company to sell a larger proportion of low-margin, less value-added product, the primary driver of the margin degradation. Despite Pilgrim’s automation efforts (which should eliminate 15% of its global workforce in the next few years), we expect labor shortages to persist into 2022, due to the drop in the U.S. and U.K. workforces, driven by the pandemic in the United States and Brexit in the United Kingdom, which has caused workers to leave for continental Europe. Even so, we think operating margins will improve from 2020’s pandemic-driven nadir of 3.7%, to 5.8% in 2021 and 6.9% in 2022, as chicken prices remain elevated, with the average cutout hovering between $1.10 and $1.20 per pound, compared with the five-year average of $0.60-$.70, offsetting Pilgrim’s higher costs. We expect chicken prices will remain high, as cold storage inventories are well below average and production is restrained by deteriorating hatchability, as an industrywide switch to a new breed (in an effort to improve breast quality) has caused hatch rates to fall to 77% currently, much lower than expected, compared with the 81% long-term average.