Poultry House Risk

[caption id=“” align=“alignleft” width=“224” caption=“Plymouth Rock… or something”]Plymouth Rock... or something [/caption]

There’s an interesting article in the WSJ this week about poultry farmers who grow for Pilgrim’s Pride (PPC). PPC is in bankruptcy and have canceled grower contracts with 400+ poultry growers. In poultry farming the farmers own the chicken houses and provide the labor but the poultry company (Pilgrim’s Pride, Tyson, Perdue, etc) own the birds and provide the feed. The producers get paid for every pound they put on the flock and they get extra bonuses for efficiency. If there is only one poultry company in the area, or if there are multiple companies but they are not taking new growers, then a grower is truly beholden to the poultry processing company. If the processing company cancels a grower’s contract then that grower can end up with hundreds of thousand’s of dollars of capital and/or debt that is going fallow.

One of the jarring annicdotes in the WSJ story is this one:

Last May, a tornado whipped through Center Ridge, population 1,332, demolishing two of the Dixons' chicken houses. Their $370,000 insurance payment wasn't enough to rebuild; they grappled with whether to quit. Mr. Dixon says he received a visit from a Pilgrim's representative who said, "Build them back as quick as you can and get 'em rolling again." The Pilgrim's spokesman says, "At the time of the May tornado, the company was in need of square footage for housing...But no one could have foreseen the dramatic changes that occurred in the U.S. chicken industry last summer." The Dixons tapped their savings to rebuild. On Aug. 1, a fresh batch of Pilgrim's chicks took up residence. Ten days later, Pilgrim's called to say those chicks would be the last.

There are two big business risks mentioned above. Both of these risks are difficult to deal with, but critical. The first is the risk the growers face if the poultry processing company goes bankrupt. The second is the reputational/legal risk faced by the processing company if they encourage growers to expand and then cancel their contract as happened to the Dixon’s.

The risk producers face if the poultry processor goes bankrupt is exactly the type of risk that a credit default swap (CDS) can hedge. Interestingly enough I have not heard a single mention of a poultry farmer or rural bank buying a CDS against a poultry processing company. WTF? Seems like JP Morgan would put their jeans and boots on and head out to the fly-over states and make some money. Too late now. You can’t shut the barn door once it’s on fire.

The other risk, legal/reputational, is much harder to manage. The risk is qualitative not quantitative, like credit risk. The WSJ article mentions a group of farmers who are suing PPC because the farmers think PPC made verbal promises that were not lived up to. I’m not a lawyer, I just sleep with one every night, but if the farmers can make a strong case that PPC was saying ‘go’ with one hand then ‘stop’ with the other they might just have a case at which point I guess they line up behind all the other creditors in bankruptcy court. This is a hard risk to avoid and this type of mixed message issue is increasingly more common as a firm gets larger. My guess would be that the probability of a firm employee saying/doing something stupid goes up exponentially as the firm gets larger. At least PPC employees were not blogging about it… we hope.

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