Unexpectedly Intriguing!
November 20, 2012

It is very hard to make money in the turkey business.

In fact, low profit margins are the main reason that Smithfield Foods (NYSE: SFD) sold off its 49% stake in Butterball, the top producer of turkeys in the United States, for $175 million back in September 2010.

But U.S. turkey producers would appear have been on a tear since 2003, collecting more and more revenue in almost each year and now having more than doubled after having had mostly flat incomes in the 14 preceding years.

Annual Turkey Farm Income (All Producers), 1990-2011

That increase in revenue becomes even more exaggerated when we consider the falling volume of turkeys produced over that time:

Number of Turkeys Produced, 1989-2011

Calculating the average income collected by turkey producers for each turkey they produce, we find that the average revenue collected per turkey has been rising at double-digit growth rates since 2003.

Average Farm Income per Turkey Produced, 1990-2011

And yet, "Big Turkey" is struggling to profit.

The only way this situation can exist is if the cost of producing turkeys in the United States to be rising at similar rates. Or more specifically, if U.S. turkey producers are directly passing on their higher costs of production to U.S. consumers on an almost dollar-for-dollar basis, which we can safely assume is the case given what we observe and the razor-thin profit margins for U.S. turkey producers.

So our question is what changed after 2003 that resulted in driving up the cost of producing turkeys in the United States in nearly every year since?

To find out, we began by looking at the main factors that can affect the cost of producing turkeys for market.

According to the University of Missouri's agriculture department, the cost of turkey feed can represent 70% of the cost of turkey production. With such a large share, we focused solely on this particular factor for our analysis.

Turkey feed typically consists of two main ingredients: soybeans and corn. Here, we observe that soybean prices suddenly spiked in 2003, then fell back to their pre-spike level in 2004 before beginning to increase in 2006. Meanwhile, the price of corn mostly held level until 2005, when it began to skyrocket in response to the U.S. federal government's increased ethanol fuel mandates - dipping only with the Great Recession in 2010.

The combination of the 2003 soybean price spike (which would be fed to turkeys in 2004) and the sharply increasing price of corn after 2005 would appear to account for nearly all of the increase in the cost of turkey production after 2003. Of the two, corn prices would appear to be the more significant driver, in that a larger and larger share of U.S. corn production has been required to be consumed to produce ethanol for use in motor vehicle fuel by the U.S. government over the years since 2005.

Percentage of U.S. Corn Crop Consumed by Ethanol Production and Corn Price per Bushel, 1980-2012

We should also note the role of the federal government's ethanol mandate in displacing other crop production, reducing supplies of those other crops while simultaneously increasing their costs at market.

And thus we discover the reality behind the illusion of prosperity for U.S. turkey producers. They've never generated more revenue, but they've never struggled so much to profit so little either.

That's the big reason why the industry isn't growing. The University of Missouri reflects on the role the industry's production cost increases have had on the state of the turkey business:

While such increases have boosted production costs of white meat and giblets, retail price pressure isn’t letting producers pass much to the consumer. Turkey eaters have reacted to price increases of almost eight percent over 2009 by eating more holiday ham and Thanksgiving pizza.

According to the US Department of Agriculture, turkey output dropped from 5,663 billion pounds in 2009 to 5,587 billion pounds last year, about a one percent reduction. Stocks of frozen whole birds also fell. Between September and October of last year, six percent fewer turkeys found themselves in freezers.

Grocers have tried to keep turkey prices low, even selling the birds below cost to attract holiday customers who load shopping cars with other goodies. With little opportunity to increase prices, producers have to eat higher costs to remain competitive.

In response, the turkey food industry now processes more meat into TV dinners, turkey ham and breasts, but this is only keeping pace with the decrease in holiday whole bird consumption. Annual consumption per capita has remained flat-lined for 30 years – about 16 pounds in some form, including Spam Turkey.

It is very hard to make money in the turkey business.

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