Risk Factors In A Global Market

Fred Mitchell

Intercontinental Packers (1997) Ltd., 3003 - 11 Street W., P.O. Box 850, Saskatoon, SK, Canada, S7K 3V4

Introduction

I would like to set the context for my remarks by providing you with a short background on our company and its history. Intercontinental Packers was founded by my grandfather, the late Fred Mendel, in Saskatoon, Saskatchewan in 1940. Throughout its 57 years of operation, Intercontinental Packers has been one of Saskatchewan's leading private sector employers, specializing in the killing, cutting and value-added processing of hogs.

Today, Intercontinental Packers (1997) Ltd. is also a major force in the Canadian meatpacking industry. With the recent offer to purchase Schneider's by the Maple Leaf Foods conglomerate, we could become the second largest national value-added pork processing company in Canada, with 1996 gross sales of approximately $350 million.

In fact, our modern and productive Saskatoon plant is now the single largest pork processing plant in the country, by number of full-time employees. We are the only Saskatchewan company I am aware of that is processing, packaging, and distributing national brand product lines from its Saskatchewan headquarters to about 8,000 retail and wholesale customers across North America.

Value-added processing means jobs and economic activity for our province. Intercontinental Packers (1997) Ltd. now has 1,040 full-time employees, who collect $37 million a year in salary and benefits. We are the fifth-largest private sector employer in the province and growing. In addition, our company's modern and efficient hog slaughter and processing plant is a major customer for a number of Saskatchewan businesses.

Last year, we purchased more than $172 million worth of goods and services to help run our plant. Of that, $110 million was for the purchase of Saskatchewan hogs. We purchase all of our hogs from Saskatchewan-based producers, and include most of Saskatchewan's 2,200 hog producers among our suppliers. In addition, we purchase about $62 million a year in other goods and services from Saskatchewan businesses. Everything from stainless steel, to refrigeration units and supplies, to equipment components, to transportation, to boxes.

In a recent study, the national management consulting firm KPMG said that when the multiplier effect is taken into account, the operation of the Saskatoon plant of Intercontinental Packers (1997) Ltd. contributes $688 million a year to the Saskatchewan economy.

With that context, let me turn to my specific topic for today.

Challenges in the Global Marketplace

I believe the risks ­ I prefer to call them challenges ­ facing the Canadian pork processing industry today, are much the same as those facing any industry in the global marketplace:

Let me discuss each of these challenges one by one.

The Product

First, do we have a product that buyers want?

Canada exports pork or pork products to nearly 70 countries around the world. We are the third largest exporter of pork and pork products on the globe ­ behind only the United States and the European Union. In 1996, total Canadian exports topped $1.1 billion, a 45% jump in just 3 years. While world demand will always be subject to economic cycles, I see the trend lines remaining positive well into the new century.

Nearly two-thirds of the pork and processed pork products that Canada exports, go to the United States, a growing customer since the passage of CUSTA and NAFTA, and the strongest economy in the world. Our second largest export market is Japan, the country with the world's highest per capita consumption of pork. Japan buys about one-quarter of all Canadian exports, and this has been increasing rapidly in recent years. Then comes a long list of developing countries, where a rapidly growing middle class ­ current currency turbulence aside ­ will contribute to a steady growth in demand for processed food products. In fact, I believe that one of the most exciting markets for Canadian pork and processed pork products into the next century, doesn't even appear among our top export locations today, and that is the People's Republic of China. China's far-reaching economic reforms are turning a nation of more than a billion consumers away from their agricultural roots and toward rapid industrialization. "Who will feed China?" is not only a catchy book title; it is a marketplace reality for all those involved in the food processing industry at the threshold of the 21st century.

I also want to stress that Canada's improved sales prospects are not just a case of a 'rising tide lifting all boats'. Canada enjoys an excellent reputation around the globe for the quality of its products, and this is helping Canadian processors claim an increasingly larger share of the world market. Our reputation is based on our ability to provide pork which is lean, high yielding, disease-free, and which can meet any buyer's demanding specifications.

Canada's solid reputation equals increased global sales opportunities. That's why major Canadian processors like Intercontinental Packers (1997) Ltd. remain strong supporters of the national associations which serve both the hog production and pork processing industries: The Canadian Meat Council, Canada Pork International, The Canadian Meat Research Institute, and The Centre for Advanced Technologies for the Canadian Meat Industry. These and other joint efforts of industry, governments, and researchers are critical to maintaining Canada's competitive edge in world markets through constant improvements in breeding and herd management, feeding techniques, and processing technology.

If we continue to work together, I am confident that Canada has a product the rest of the world will continue to want in increasing quantities.

A Competitive Price

The second challenge I listed was price: Is your product priced at a level that your buyers find competitive?

There is no doubt that Canada enjoys a strong competitive advantage related to the cost of hog production. Our large land base, our availability of high quality feed grains and other inputs, make large-scale hog production a very profitable business in this country.

When the hogs get to Canadian meatpacking plants, they are slaughtered and processed in some of the most productive plants in the world. In fact, in spite of some recent comments to the contrary, OECD comparisons show that Canada's unit labour costs in the food industry are below those of the United States. Intercontinental Packers (1997) Ltd. sees its employees as people first and meat packers second. We have worked hard to form a strong partnership with our employees, and they have worked hard to make our success possible. That's why Intercon's unionized workforce has been such a strong and supportive partner in the corporation's recent efforts to modernize and expand. In early 1997, our employees agreed to open their existing contract many months before its expiry to implement a number of changes, which will benefit both the employees and management. The new 27-month contract provides Intercon with a guarantee of strong employee partnership as the company moves to expand its markets and increase its production.

However, I believe that the biggest competitive advantage available to the Canadian pork processing industry is Canada's favourable exchange rate. Since virtually all export sales are made in US dollars, our relationship to the American dollar is a critical factor in our marketplace competitiveness. A 71 cent Canadian dollar means new market opportunities in the United States and around the world. Of course, as we have seen in recent months, this kind of global marketing can hold significant risk.

In early November, it took 126 Japanese Yen (JPY) to buy one American Dollar (USD). That represents an 11% increase since the currency turbulence that hit the Pacific Rim last summer. In short, the cost of Canadian pork and pork products in Japan increased sharply during the fall of 1997. The same kind of currency turbulence was even more dramatic for customers in Korea or Hong Kong or Malaysia. Currency shifts will be a constant risk for Canadian companies wanting to do business in the global marketplace.

Reliable Supply

The third challenge I mentioned is ­ Do you have access to a reliable supply of your product at a competitive price?

I maintain that this is the biggest challenge or risk facing the entire Canadian pork processing industry today. With worldwide demand for pork and pork products increasing sharply each year, Canadian production has not increased to keep pace.

This is especially a problem on the prairies, where our natural advantages should have resulted in sharp production increases, but instead our herd numbers have left the pork processing industry operating at well below capacity. For example, our company is in the midst of a $14 million expansion, which will give our Saskatoon mega-plant the capacity to kill, cut, and process up to two million hogs a year. But that is about double the current production levels for the entire province of Saskatchewan! We have the markets. We have the processing capacity. We don't have the hogs. That's why Intercon, and most other major pork processors, remain strong proponents of incentive programs to encourage increased hog production.

In Saskatchewan, we have even entered into a unique partnership with hog producers to try to encourage increased production. Saskatchewan hog producers today own a 16% share of Intercontinental Packers (1997) Ltd. Their central marketing agency, SPI Marketing Group, purchased the shares in September 1997. This means that Saskatchewan hog producers will share in the profits from the value-added processing of their hogs. In addition, we have signed a five-year sales contract with SPI Marketing Group. The five-year contract guarantees that our Saskatoon plant will buy 82% of all the hogs that Saskatchewan can grow, at a price guaranteed to be competitive by formula. Our partnership with producers provides them with guaranteed markets at a guaranteed competitive price, and gives them a share of the profits from the value-added processing of their hogs. We believe that it is an unique solution to the problem of how to encourage more hog production, value-added jobs, and economic activity in our province.

I say again -- we have the sales; we don't have the hogs. Most Canadian processors are in a similar situation. I maintain that every hog we fail to kill and process here in Canada represents lost economic opportunity for our nation. Unfortunately, Canada today represents a land of untapped potential when it comes to hog production. We don't need new packing plants in Canada, we need more hogs.

Today we enjoy a solid reputation for high quality pork, but we have to develop a similar reputation as a reliable supplier, if we hope to gain an ever-increasing share of the world market. That is why governments, industry, and researchers should be joining forces to find the right mix of incentives that will encourage a rapid increase in Canadian hog production.

Access to Capital

The fourth risk or challenge is ­ Do you have access to the level of capital required to help you maintain your competitive position in the marketplace? Our company has been a family owned and operated company since its creation 57 years ago by my late grandfather, Fred Mendel. The capital for expansion, modernization, and new marketing efforts came from cash flow or family-backed debt financing.

In today's global marketplace, that formula can no longer get the job done. That's why, early in 1997 we formed Intercontinental Packers (1997) Ltd. and welcomed a number of new, private sector investors into the ownership of our company. The Fred Mitchell family, my wife Luan and myself, are still the majority owners, but our new partners include: RoyNat, Tai Fang Foods of Taiwan, a number of Western Canadian private investors, and SPI Marketing Group. These new partners made more than $33 million in capital available to our company to help consolidate our operations in Saskatoon, to help refinance existing debt, and most important of all, to help finance our $14 million expansion and modernization. My expectation is that within a year or two we will want to pursue other options to provide our company with increased access to the capital that will be required to constantly upgrade, modernize, and expand. That could very well mean the launching of an Initial Public Offering for our family-owned company on a major Canadian stock exchange.

The story of the Canadian pork processing industry in the last year or two has been one of rapid consolidation. The Maple Leaf Foods conglomerate has gobbled up many longstanding industry names ­ Swifts Premium, Burns, and now, perhaps, Schneiders. As ownership in our industry becomes more and more concentrated, we are finding more customers who have an interest in supporting high quality, reliable, independent suppliers like ourselves, in order to maintain some level of competition in the marketplace.

Therefore, I suggest that well-managed, strongly focussed processors like Intercon do have a bright future, with the prospect of raising the capital required to remain competitive.

Distribution and Delivery

The fifth risk or challenge is ­ Do you have reliable distribution and delivery systems to get your product to market?

Some suggest that this is the Achilles heel of a strong Canadian pork processing industry. I disagree. At our mega-plant in Saskatoon we have built a world class distribution and delivery system which allows us to process, package, and distribute 600 product lines under the Olympic Fine Meats brand name, and 25 product lines under the Mitchell's Gourmet Foods label.

We enjoy a strong and fiercely loyal customer base throughout Canada and important United States markets, with nearly 8,000 retail and wholesale customers. We have also signed a new ten-year export agreement with Tai Fang Foods of Taiwan, which guarantees us access to the Asian market. Tai Fang Foods, which is also a new investor in our company, is the world's largest exporter of pork and products to Japan.

In North America, our retail customers include such well-known names as: Safeway, IGA, Westfair Foods, Loblaws, Federated Co-ops, Costco, A & P, The Grocery People, and Oshawa Foods.

In addition, our plant processes, packages and distributes more than 120 private label products for various food chains across Canada and in the United States. Private label products represent a growing share of the North American market for value-added processors, and we are major suppliers.

Our success is proof in action that you can build a world class distribution system right in the heartland of North America.

The Market's Special Needs

The final risk or challenge is ­ Do you understand the special needs and cultural preferences of your global customers?

Intercon has approached this challenge by forming a strategic partnership with one of our new investors ­ Tai Fang Foods of Taiwan. Tai Fang understands the specialized needs of the Asian marketplace. For example, they have provided employees in our Saskatoon plant with training on some of the specialty cuts required for the Asian market. This kind of local knowledge and expertise helps to reduce the risks of doing business in these unique markets.

Conclusion

In conclusion, I believe that Canadian pork processors, working in concert with governments, researchers, and producers, have the ability to meet any of the challenges facing their industry at the threshold of the 21st century. I hope that our experiences and business decisions have provided some food for thought for those who face similar risks or challenges on a daily basis.