Industry Outlook - Euler Hermes

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the food industry is constrained by market share imperatives ... 800 Red Brook Boulevard Owings Mills, MD 21117 Phone: +
Euler Hermes | November 2015

Industry Outlook: Key Points 1 C  ash receipts for agricultural commodities sales by farmers are projected to decline by -7.7% in 2015 due to low commodities prices while revenues and the value added by food manufacturing are forecasted to rise by +3% and +2% respectively. 2 U  S food manufacturers are expected, however, to report lower profitability, down -3% vs. 2014. But profitability should remain at a satisfying level, with a forecasted operating result of 9% for the 10 largest US-listed agrifood companies in 2015. 3 T  ough competitive pressures are impeding food manufacturers from benefitting from the lower input costs related to declining commodity prices; the situation should not substantially improve in 2016 as no upturn of demand is foreseen. 4 T  he US is the #1 agrifood exporter, with export gains expected to grow by USD 20 billion to USD 175 billion in 2015-16 thanks to a diversified portfolio of both products and customers and despite weak global economy conditions.

Food

Umar Sheikh Senior Risk Underwriter [email protected] In collaboration with Farah Allouche Sector Advisor for Agrifood and Retail [email protected]

Overview – low price of agrifood commodities weighs on US agrifood wealth in 2015, but the sector’s strong financial standing will help it pass through this temporary lull US agrifood activity increased steadily through 2014, with output of USD 748 billion (+3% y/y). Higher yields and favorable prices helped farmers generate higher cash receipts. Meanwhile, major food manufacturers maintained profitability due to dominant market positions and strong foreign demand — despite absorbing higher input costs. US agrifood also benefited from growing international demand as exports grew to 20% of production in 2014 (+2ppt vs. 2010). The current year has posed challenges for US food producers. Falling commodity prices (-12% y/y) have dragged down cash receipts while low inflation has put pressure on food manufacturer margins. In addition, the gloomy global economy has impacted major trading partners overseas. In this backdrop, farming activities should experience a -7.7% decline of cash receipts in 2015 while food manufacturers are expected to suffer at the earning level with a -3% drawback in operating profit. As a result, Euler Hermes forecasts the US agrifood sector value to draw back by -4% to USD 721 billion, mostly driven by lower farmer income, which explains the surge of the export ratio in 2015 to 23.5%

Domestic Situation – Agriculture is reliant on commodities prices while the food industry is constrained by market share imperatives Domestic agriculture production has proven dynamic in recent years. Cash receipts — the gross income from the sale of agricultural commodities — grew by a compounded annual rate of 7.8% to USD 420 billion from 2009 to 2014, including sharply-higher cash receipts for cattle and calves (higher prices), dairy products (growth in exports), broilers (higher production), corn (higher prices, lower yield), soybeans (higher prices, lower production), and almonds (increase in acreage, yields). This trend has reversed in 2015, primarily driven by lower prices for hogs, dairy products and corn. As a result, cash receipts are projected to decline by -7.7%, down to USD 372 billion for 2015. Looking ahead, no recovery of farmer income is forecasted as agricultural commodities are set to remain at a low price in the backdrop of slowing demand growth from emerging markets. The revenue of food and beverage manufacturing should maintain momentum in 201516. Producer prices of domestic food manufacturing surged by 20% in 2014 vs. 2010 while consumer prices were up 10% in the same period. These trends translated into an annual

growth rate of 4.7% in shipment value between 2009 and 2014, though the trends did not translate into a substantial rise of profitability. The value added by food and beverages manufacturing only grew at a modest +1.6% annual rate to USD 328 billion from 2009 to 2014, hampered notably by volatile input costs. As for 2015-16, food processor earnings are not expected to take advantage of the decline in commodity prices as competitive pressures will offset the benefit of lower input costs. Producer prices have indeed already ceded -2% since the beginning of 2015. Graph 1: Output of the Agrifood Sector in the US

Sources: USDA, US Census Bureau, Euler Hermes

In USD billions

Graph 2: Shipment Value vs. Value added by the Food and Beverages Manufacturing Industry

Sources: USDA, US Census Bureau, Euler Hermes

In USD billions

Euler Hermes North America Headquarters 800 Red Brook Boulevard Owings Mills, MD 21117 Phone: +1 877-883-3224 Fax: 410-753-0952 [email protected] www.eulerhermes.us

Graph 3: Producer Price vs. Consumer Price in the US Market

Sources: IHS, Euler Hermes

Index: 2010=100

International Presence – Agrifood exports to gain USD 20 billion in 2015-16, solidifying the US leading position and fueled by demographic momentum and the rising middle-class in emerging markets Graph 4: US Agrifood Exports

Sources: ITC, Euler Hermes

In USD billions

On top of enjoying dynamic domestic demand, US agrifood is also fueled by foreign markets: exports represent a fifth of agrifood output on average. This makes the US the number one exporter of agrifood products in the world, accounting for 10% of world agrifood exports at USD 155 billion in 2014, of which USD 52 billion was oilseeds and cereals. Since 2010, exports have grown at a compounded annual growth rate of +8%. China, Mexico and Japan are the primary destinations, but other smaller markets are proving very dynamic, such as Colombia where cereal exports have more than tripled.

Euler Hermes North America Headquarters 800 Red Brook Boulevard Owings Mills, MD 21117 Phone: +1 877-883-3224 Fax: 410-753-0952 [email protected] www.eulerhermes.us

The US is also a leader in meat exports, totaling USD 18 billion in 2014. Double-digit growth for several items — including meat, fruit, liquids, dairy and egg exports — have been the key drivers behind the sustained growth rate over the past five years. Greater demand for these higher-value items can be attributed to long-term foreign-consumer spending trends shifting to food items such as meat, dairy, fruits and vegetables as well as the declining expenditure shares on staples (i.e. rice and wheat). Exports are expected to grow to USD 166 billion in 2015 and nearly USD 175 billion by 2016. Higher volumes are expected to more than offset deflationary pressures on commodity prices while growing middle classes and the related continued shift in spending on higher-valued food items, such as meat or dairy, fuel the growth.

Financial Results of Major Players – race for volumes at the cost of earnings US food companies slipped through the 2008 crisis without too much damage, but managing the volatility of commodity prices has proven very challenging. In 2011 and 2012, food companies had to cope with higher commodity prices while being unable to fully pass the higher costs downstream to not lose market share in the backdrop of the fierce price war. A +24% increase in commodity prices from 2010 to 2011 saw a -40% decline in operating profits as major food producers were only able to raise revenue by +7%. As commodity prices stabilized in 2013, operating profits improved, though not recovering completely. The operating trend turned downward in 2014 for the 10 largest US-listed agrifood companies with an operating profit decline of -15%, down to 9.6%. This was due to the strengthening US Dollar and the resulting negative impact on earnings from foreign operations. Graph 5: Influence of commodity prices on income and earnings

Sources: Bloomberg, BLS, Euler Hermes

Index: 2007=100

While operating performance has been volatile, major food producers in the US have successfully grown revenues with an annual compound growth rate of +3% between 2007 and 2014. Food producers have also remained profitable—though at lower levels with -4% of profit per year on average. They also generated positive cash flows over the past several years. This can be attributed to growing international demand from developing markets as well as continued innovation in the US.

Euler Hermes North America Headquarters 800 Red Brook Boulevard Owings Mills, MD 21117 Phone: +1 877-883-3224 Fax: 410-753-0952 [email protected] www.eulerhermes.us

Graph 6: Profits and Cash Flow of 10 Largest US Agrifood Listed Companies

Sources: Bloomberg, Euler Hermes

% of revenues

(f)

Outlook, Opportunities and Threats – Gloomy environment must not hide bright prospects ahead In 2015, Euler Hermes does not expect profitability to recover, with operating results forecasted to decrease again by -3%. Competitive pressures will partially offset the benefit of lower commodity prices while the recent strengthening of the US Dollar — which has gained between 15% and 20% on JPY, CAD and EURO — will continue to drag down results of major US food processors in the current year.

About Euler Hermes Euler Hermes North America is the oldest and largest provider of trade credit insurance and accounts receivable management solutions. We offer both domestic and export credit insurance policies that insure against commercial and political risk in more than 200 countries worldwide. Euler Hermes maintains a database of proprietary information on more than 40 million companies worldwide and is rated A+ (Superior) by A.M. Best and AA- by Standard & Poor’s.

To contact us today and learn more about how Euler Hermes can help your business, visit us at www.eulerhermes.us or call 877-883-8224.

The operating result for major agrifood companies in the US is hence set to decrease again to 9.3% in 2015. Cash flow from operations for these companies is forecasted to be 8.6% of turnover, far below the long-term average of 10%. Euler Hermes anticipates performance to stabilize in 2016 as competitive pressure is not set to soften. However, the medium-term to long-term outlook for the industry remains positive due to continued expansion of the middle classes in foreign markets and the relative strength of the domestic market. Food producers have growth opportunities in the diversification of exported products and their destinations while exports to smaller trade partners — such as Belgium, the United Arab Emirates and Columbia — have grown in recent years, driven primarily by higher volumes in raw products. While a majority of current exports to major trade partners are raw products, prepared foods and beverages have also seen solid growth in recent years, with a CAGR of +6% for edible preparation and +13% for beverages since 2010. Continued growth in these markets and products will help offset concerns surrounding the slowing growth in China and lull economic conditions in Japan, Europe and Canada.

What this means for your business As demand for US agrifood continues to increase, growers and producers will need to maintain a secure method of conducting business across borders as major trading partners face economic headwinds. For food suppliers that prefer to continue to do business only in the US, the recent and projected volatile operating results could result in a riskier customer base. Obtaining a trade credit insurance policy from Euler Hermes provides a secure means to expanding sales globally while also providing a way to mitigate the risks of slow pay and domestic bankruptcies.

Euler Hermes North America Headquarters 800 Red Brook Boulevard Owings Mills, MD 21117 Phone: +1 877-883-3224 Fax: 410-753-0952 [email protected] www.eulerhermes.us