Why China is worried about pigs

If the US economy is hooked on oil, then for China the addiction is pork. China consumes some 550 million pigs a year – about 70% of local meat consumption and a large part of the average household budget.

If the US economy is hooked on oil, then for China the addiction is pork. The Chinese consume some 550 million pigs a year about 70% of local meat consumption and a sizeable proportion of the average household budget. The government even maintains a central reserve of pigs, live and frozen, to support consumption in the case of emergency. But after an 87% run up in the price of pigs over the last year, China's inflation rate has jumped to 6.5%, the highest rate in 11 years. With the government facing the prospect of an upset economy before its big Olympic showpiece, it is doing everything in its power to facilitate an already booming pig sector.

The trouble is that an outbreak of blue ear disease a reproductive and respiratory illness that is fatal to pigs is devastating China's pig population and putting a serious squeeze on the price of pork. The disease has killed more than 70,000 animals and infected 280,000 already this year. This is a problem that borders on a national emergency in China. The spectre of inflation fuelling broader discontent as it did when protesters marched on Tiananmen Square in 1989 taps into the government's "deepest existential fears about mass disorder", notes Richard McGregor in the FT. Beijing has already tightened controls on corn exports, vowing to increase the supply of poultry, and decreed that pigs be given privileged access on all transport services. The government was even moved to reach into its central reserve, releasing 30,000 tons of live pigs into 22 cities nationwide.

But considering that the country consumes up to 150,000 tons of pork a day, this delivery is barely "a drop in the bucket", says Peng Danuxe, an analyst at Everbright Securities. The price of pork is not going to fall off any time soon, says James Rice of Tyson Foods. The actual size of the pork reserve might remain a state secret, but it's doubtful that it is big enough to have any real impact during the crisis. Added to that is the fact that there is already a serious shortage of pig farmers. With pig prices slumping two years ago, farmers have flocked to the cities to take up jobs as manufacturers and labourers. The escalating cost of corn on the back of the ethanol boom has also scared off farmers who can no longer afford to feed their pigs.

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Of course, this could all be part of a natural part of the "hog cycle", says John Garnaut in the Sydney Morning Herald low production by farmers leads to a run in prices, producers are attracted back into the market, and the price starts to fall. In fact, the government has already managed to attract farmers back to the homestead with a string of financial incentives.

But it will take about 18 months for any new piglets to mature, so we can't expect new initiatives to affect the price of pork until the second quarter of next year, Bi Jingquan, vice-chairman of China's National Development and Reform Commission, told Forbes. Farmers, spooked by the spread of blue ear disease, have also been slaughtering younger pigs, and there is scepticism about official reports on how far the pandemic has spread. Some of China's bigger pig owners, interviewed by the Sydney Morning Herald, said the virus death toll is more likely to be in the region of 100 to 500 times the number officially disclosed. That would put it at between four to 20 million pigs. In such a pressure-cooker environment, pig producers supplying China have some pretty tasty prospects for the year ahead.

The "king pig among pork producers" is Smithfields Foods (NYSE:SFD), says Markos Kaminis on Seeking Alpha, producing 26 million pigs a year. Analysts got very excited last week when Smithfields announced that it had secured an order for 60 million pounds of pork from the Chinese government. In the grander scheme of things, this is equivalent to just 1.9% of the company's pork sales last year but it means that Smithfield has more than a foot in the door of the Chinese market, says Kaminis. With blue ear disease expected to wipe out 20% of China's pig population about the size of America's entire pork production industry the Chinese government may increasingly have to turn to Smithfield for further orders. On top of this, the group the world's biggest hog and turkey processor trades at a significant discount to its peers on a forward p/e of 12.6.

One Chinese pig processor that looks particularly attractive is Zhongpin (OTCBB:ZHNP), according to James Altucher on TheStreet.com. The company recently announced a 73% jump in annual profits, which gave it the impetus to raise $50m through a share issue to construct new pork processing plants and snap up other small Chinese pig processors. The company is valued on a very cheap-looking forward p/e of 6.6.

Eoin came to Money Week in 2006 having graduated with a MLitt in economics from Trinity College, Dublin. He taught economic history for two years at Trinity, while researching a thesis on how herd behaviour destroys financial markets.

Eoin acts as managing editor of MoneyWeek's newsletters.