Owning Responsibility for the Future
November 11, 2020
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Rob Almeida discusses the impact of a disease outbreak on the price of protein and its potential impact on profit margins
Inflation risk is the driver of sovereign bond prices and in recent months, markets have come to the belief that central bankers are losing their inflation anchors and that they are unlikely to reach their price level targets over the next few years.
With nearly all measures of global inflation in decline, over $13 trillion worth of bonds now carry a negative yield.
But there is one discrete pocket of inflation that is notable because it could have knock-on effects for some companies. The skyrocketing price of pork is something that has grabbed the attention of our analysts in recent months.
Specifically, prices have jumped around 50% since last winter due to an outbreak of African swine fever in China.
While not harmful to humans, the disease does kill pigs in about a week. Since the first outbreak last August, over 100 additional occurrences have surfaced, including recent reports that the disease has spread to North Korea and Vietnam.
There is no cure, and pharmaceutical companies that we have spoken with suggest a potential vaccine to guard against the illness is likely three to four years away.
China is the world's largest pork producer, and so far, about one-third of China's hog population has succumbed. That represents over half of global pork production. And upon eradication of the disease, it is likely to take two to three years just to restart production.
The potential impact to the world's pork supply is material. We've never seen a potential protein shortage of this size before. So we can expect not just a rise in pork prices, but potentially in other proteins such as beef and chicken as consumers potentially substitute other meats.
Now, unfortunately, this is not the type of inflation that central bankers have been trying to engineer in the deflationary aftermath of the global financial crisis.
So who's at risk?
Many restaurant operators, potentially.
In recent years, they've been able to take pricesto cover mounting labor and commodity costs. This chart illustrates the widening gap between food costs away from home which outstripping the cost of food eaten at home.
The gap between the two has widened to abnormal levels and may explain why traffic has turned negative in all US restaurant categories over the last 12 months.
While dining out may not be cost prohibitive for today's fully-employed customer base, the price-conscious consumer could perhaps see better value in eating at home. Consequently, future restaurant price hikes may no longer be on the menu.
Over the long term, we believe there are only four things that are material to asset prices: units, price, margin and earnings. If units have turned negative, pricing power has peaked, what may happen to restaurant margins and earnings as African swine fever worsens? Margins and earnings are likely to be pressured.
However, rather than simply avoiding restaurants, investors may want to consider categories or other store concepts with less exposure to the price of protein, such as coffee sellers, that may have a better chance of maintaining their margin profile.
These are the things we discuss, debate, and challenge one another over and over in our sector meetings – who has pricing power and who does not? I think paying greater attention to whata compay does and how it does it, is a better way to invest than chart-chasing macro data points and focusing on central bank speeches.
The views expressed are those of the speaker and is subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor.
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