A Primer on Protein—Are Shortages on the Way?

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Are meat shortages the next challenge consumers will face due to COVID-19? If so, why would a global pandemic impact the supply of protein? What’s going on?

To most, pondering how the meat supply chain works is probably not interesting or even terribly relevant to their daily lives. In this case, however, a basic understanding of how protein goes from the farm to the grocery store/restaurant is key to understanding why the shortage risk exists.

At a high level, there are three primary links in the meat supply chain:

• The farmers (who raise the animals).
• The processors (who buy the animals from the farmers and process them into cuts of meat).
• The customers (grocery stores and restaurants—the people who buy meat from the processors).

(There are a number of nuances/caveats to the list, but it’s the basic picture and all that’s necessary to roughly understand the current situation.)

Of the three links (farmers, processors, customers), there are thousands of farmers and thousands of customers. However—and this is crucial to understand—the processing sector is extremely concentrated in just a few facilities. Using pork as an example, just 12 plants process more than 50% of total US pork production and 26 account for over 80% of pork production.

What’s happening is a number of these plants have seen a significant rise in COVID-19 cases due to the close-quarters nature of the processing business as well as the fact that many of the plant workers live in close proximity to each other outside of work. The rise in cases prompted local/state governments to shut down many processing plants to prevent the virus from spreading in their communities, and with each major pork plant closure, 3%-4% of US production went offline.

President Trump recently signed an order designating meat plants as essential facilities to keep them open, but it’s uncertain how much that will help production on a national basis. Increased social distancing in the plants and a higher rate of absenteeism as workers fear getting the virus could cause a material slowdown in meat production even if all the plants are open. Initial estimates for the week ending May 2, 2020, are that pork and beef production were down approximately ~35% year/year. These are very material numbers as, despite the decline in restaurant demand, US meat consumption is likely not down that much year/year. This implies that we are eating into the existing approximately two-week supply of meat in US cold storage.

At this point, there is a wide range of possible outcomes. If there are no more major plant closures, those that have been shut are able to come back online safely, and the existing plants can figure out a way to keep processing moving, meat shortages may not be a big deal. However, if COVID-19 continues to cause employees to avoid work, social-distancing laws create processing slowdowns, or if processors are forced to keep up rolling plant closures to deep-clean the facilities, it’s almost inevitable that protein shortages result and/or protein prices rise until COVID-19 is resolved.

There are also a number of other considerations we are pondering. For example, will the fear of meat shortages cause people to, in essence, create a meat shortage (à la toilet paper in March)? What happens in emerging markets if protein that was meant for them remains in the US—would that increase the risk of social unrest? Will the restaurants that survive the COVID-19-related shutdowns face intense margin pressure from higher protein costs when they re-open? Will the protein industry consolidate further? Will residents be more leery about allowing packing plants in their backyards, thus constricting new processing supply growth? Etc.

From an investing perspective, usually in times of market stress such as these, the companies with the best balance sheets and most opportunistic management teams are able to take advantage of the volatility to increase their competitive position over the long term, and that’s how we are currently positioned at Diamond Hill.

This material is for informational purposes and is prepared by Diamond Hill Capital Management. The opinions expressed are as of the date of publication and are subject to change. These opinions are not intended to be a forecast of future events, the guarantee of future results or investment advice. Reliance upon this information is in the sole discretion of the reader. Investing involves risk, including the possible loss of principal.