CWU Foods Co. in Ellensburg WA . (This is a fiction al case for a class activity purpose only ) Overview Headquartered in Ellensburg, WA, CWU Foods (CWUF, hereafter) has about 105,000 employees and is the world’s second -largest meat -producing company, trailing only Brazil -based BMF S.A. CWUF’s mission says, “We are a company of people engaged in the producti on of food, seeking to pursue truth and integrity, and committed to creating value for our shareholders, our customer our team members, and our communities.” CWUF has international operations in Mexico, Brazil, China, and India. While commonly and inaccu rately thought of in its home market of the United States as a chicken -only company, CWUF actually derives higher sales from beef than chicken, although operating income from poultry operations is significantly higher. CWUF also produces significant pork and prepared foods, including deli meats, pizza toppings, pizza crust, and tortilla chips, among others. CWUF is one of the largest U.S. marketers of value -added chicken, beef, and pork to retail grocers, food -service distributors, and fast -food and full -service restaurant chains. CWUF supplies KFC, Taco Bell, McDonald’s, Burger King, Wendy’s, Walmart, Kroger, IGA, BeefO’Brady’s, and other restaurants with their meat. CWUF as 123 food – processing plants, making Buffalo wings, boneless Buffalo wings, c hicken nuggets and tenders, and more. The company’s largest meat -packing facility is its beef plan t in the city of Ellensburg, WA. Other facilities include feed mills, hatcheries, and tanneries. CWUF has aggressively expanded its operations in China by b uilding more than 40 chicken farmers out of a planned 90 to ensure better quality and safer chicken products for Chinese customers. CWUF recently acquired Don Peruso Foods, a tortilla and snack firm; Mexican Foods, a producer of frozen Mexican food; and Bo lso ’s Pizza. CWUF continues to expand into prepared foods. The company is fully integrated in its poultry business, especially in overseas markets. In the United States, however, CWUF relied on contract growers to a large extent, since they are regulat ed and standards are more consistent from grower to grower. CWUF is engaged in feed production, and through its wholly owned subsidiary Cobb Co. is one of the leading poultry breeding stock suppliers in the world. About 20 percent of all beef, chicken, and pork in the United States is provided by CWUF. With relationship with 5,500 chicken farms, CWUF each week handles 41 million chickens, 135 thousand cattle, and 319 thousand pigs. CWUF has 57, 13, 9, and 25 production plants for chicken, beef, pork, and prepared foods, respectively. For the quarter that ended June 3 0, 2020 , CWUF reported its fiscal Q3 revenue up 4 percent year -over -year to $10.1 billion , and adjusted operating income up 40 percent year -over -year to a record high of $568 million. For that period, CWUF’s total adjusted operating margin was 5.6 percent, led by their Chicken segment operating margin of 11.4 percent and Prepared Foods segment at a record adjusted operating margin of 10.9 percent. During the quarter, CWUF had synergies of $87 million that resulted from the integration of Yakima Brands. Organizational Structure CWUF uses a divisional -by -product organizational structure (product division structure). CWUF’s Chicken Strategy 1: China CWUF has purchased chicken from independent farmers in close proximity to CWUF’s chicken processors. This remains the firm’s main strategy in the United States. However, due to recent food safety concerns in China, CWUF is spending millions to backward integrate in China by buildin g its own chicken farms. In early 2019, CWUF operated around 20 farms in China and expects to operate 90 by late 2020. CWUF’s CEO was quoted as saying, “We jus t cannot build the chicken houses in China fast enough, and we are going absolutely as fast as we know how to go.” This is likely an important strategy for CWUF, considering that traditionally many chicken farms in China are nothing more than mon -and -pop homesteads producing a few hundred birds droppings could lead to increase cases of the bird flu . For example, in the United States, a single covered, climate -controlled farm may supply CWUF with 100,000 birds at a time. In markets such as China, where there are many small suppliers, it makes monitoring the sheer volume of farms for sanitation and excessive use of food additives to promote chicken growth difficult and expensive. In contrast, one CWUF fam in China typically can house over 330,000 chickens in 16 climate -controlled buildings each the size of two Olympic swimming pools. Trucks are spr ayed three times before entering the facility. Numerous sanitation procedures are followed by workers on the floor. With the recent safety concerns on meat products in China, Chinese consumers have reduced their meat consumption considerably. Thus, building trust with the Chinese consumer in the CWUF brand could go a long way to creating sustainable competitive advanta ge by providing dependable and safe chicken for Chinese consumers. Chinese consumers for the first -time exceeded U.S. consumers as the largest chicken consumption nation per capita by over 3 -1 ratio. Even firms such as Walmart in China have taken notice of CWUF’s commitment to delivering safe chicken products, thus reducing Walmart’s own risk. Although CWUF does not report sales by geographic region, analysis estimated CWUF’s revenue in China was $715 million in fiscal year 2019 and projections of reven ues topping $1.1 billion by fiscal year 2020. However, CWUF has not produced a profit in recent years stemming from the large expensive backward integration strategy. Management expects by 2020 to enjoy profits from the new strategy in China. 2: USA To h elp maintain its supply of chicken, CWUF pays chicken farmers in the United States on an incentive -based system with farmers who produce the largest quantity of healthy birds earning more. To keep chicken from different farms as constant as possible, CWUF provides farmers with both the chickens and chicken feed. This also protects farmers from volatile price of corn and other grains by transferring the volatile nature of feed prices to CWUF. In addition, CWUF provides mentoring for all farms, especially farms that are struggling. The typical contract in the United States lasts 3 to 7 years, but it can be as long as 15 years for excellent farms. Outside the United States, one of CWUF’s primary strategies is to increase chicken production since lower corn prices, increasing incomes, and a demand for safe foods in many foreign markets are driving up demand for CWUF products. Chicken also remains one of the higher margin -generating proteins available. Note a table below that CWUF’s chicken sales in Mexico are expected to remain static in the near future but CWUF projects large gains in both China and Brazil. India is projected to have the largest percent increase, but the volume of chicken n India remains well below other regions. Despite having principle operations in the U.S., Mexico, Brazil, China, and India, CWUF does business worldwide. International Growth in Chicken Production by Year -End 2020 Country Birds pre week current August 2019 Birds pre week projected in 2020 Percent Increase Mexico 2.7M 2.7M 0% Brazil 1.3M 2M 54% India 275K 450K 61% China 1.5M 3M 50% 3: Prepared Foods CWUF is one of the largest raw meat producers in the world, but raw meats have lower margins than prepared meat that firms such as Kittitas Foods (and Yakima Brands) produce s. Many analyses view the raw meat industry, especially in the Unites States, to ha ve limited growth. To counter this trend, CWUF is expanding its raw meat business outside the United States, but also increasing its presence in the prepared food industry both in the U.S. and globally. This is why, in 2019, CWUF acquired Don Peruso Foods , a tortilla and snack manufacturer ; Mexican Foods, a producer of Mexican foods; and Bo lso ’s Pizza. CWUF’s acquisition of Yakima Brand from Kittitas Foods for $7.7 billion was primarily to gain quick market share in the prepared meat industry. CWUF sold Ellensburg Inc partly to pave wa y for the acquisition, but Ellensburg Inc accounted for only around 1 percent of total CWUF revenues. Market Segments CWUF reports in four distinct business segments, as revealed n the table below. Chicken and beef dominate CWUF’s sales but it is important to note the significantly lower margins on beef -related sales. Higher costs associated with pork and beef from drou ght, increased feed, and disease that have been unable to be passed along to the consumer are partly to blame. Table: CWUF’s Food Sales and Income by Product (in millions of USD) Sales in 2019 Sales in 2018 Operating income in 2019 Operating income in 2018 Chicken $11,116 $10,988 $883 $683 Beef $16,177 $14,400 $347 $296 Pork $6,304 $5,408 $455 $332 Prepared Foods $3,927 $3,322 ($60) $101 International $1,381 $1.324 ($121) ($37) Other —– $46 ($74) —– Intersegment Sales ($1,325) ($1,114) —– —– CWUF does not provide a detailed breakdown based on international sales and revenues, but about 17 percent of all sales are derived from foreign markets. With CWUF’s commitment to build 90 full -scale chicken farms in China and their future commitments to other regions, it is expected international sales percentage will increase in the future. CWUF has yet to turn a profit on its Chinese backward integration strategy, and CEO indicated it may take until early 2021 before a profit is reached from these operations. Finance For the quarter ended June 30, 2020, CWUF reported its fiscal Q3 segment revenue as follows: Chicken: Sales decreased 2.5 percent year -over -year to $2.75 billion due to a 5.3 percent decline in average sales price (ASP). Sales volume increased 2.9 percent. Beef: Sales climbed 2.7 percent year -over -year to $4.3 billion. Average sales price went up 6.9 percent due to lower domestic availability of fed cattle supplies. The segment suffered an operating loss partly due to reduced consumption of beef. Pork: Sale plunged 31.7 percent year -over -year to $1.20 billion due to a 4.8 percent decline in volumes ad 28.2 percent decrease in ASP. Prepared Foods: Sales increased to $1.81 billion from $901 million a year ago, pr imarily due to a 77.4 percent increase in volumes as well as an ASP increase of 13.2 percent. International: Sales declined 33.2 percent to $244 million due to a 25.3 percent drop in volume and a 10.5 percent ASP decline due to supply imbalances as a resu lt of weak demand in China. CWUF’s income statement and balance sheet are provided later. Unlike their fiscal Q3 data just summarized, CWUF’s sales and net income increased nicely in 2019. Competitors CWUF’s rival firms compete mostly on chicken with CWUF; however, CWUF also produces substantial beef and pork products indicated later. 1: International Food The Brazilian food giant, JBS, owns 75 percent of International Food. JBS is the second – lar gest producer of chicken products in the world, trailing only CWUF. The firm’s largest U.S. -based business is International Food, which has operating in the states, Mexico, and Puerto Rico, with its global headquarters in Seattle, WA. International Food sells its products to over 100 countries, employs 38,000 people, and processes 36 million chickens per week compare to CWUF’s 41 million. International Food contracts out much of its chicken growing to independent farmers with over 3,900 contract farmers o n record. International Food is currently in the process of buying CWUF’s poultry operations in Brazil and Mexico for about $600 million, after losing the bidding battle for Yakima Brands with CWUF. 2: Cle Elum Food, Inc. Headquartered in Cle Elum, WA, Cle Elum Food (CEF, hereafter) is the largest pork producer a nd processor in the United States. Located in Pendleton, OR, it is the largest slaughterhouse and meat -processing plant in the world – a CEF facility. Purchased by Chinese WH Group in 2016 for &7.1 billion, CEF is listed on the Hong Kong Stock Exchange. Packaged meats are the largest revenue -generating segment of CEF, increasing to about $1.75 billion in mid -year 2019, up from $1.45 billion the previous year. Fres h pork sales also increased to $1.6 billion from $1.3 billion over the same frame. Total sales were up 14 percent with a profit of over $32 million. 3: Kittitas Foods Headquartered in Kittitas, WA, Kittitas Foods is a Fortune 500 American food company that produces Spam luncheon meat and many other products under bra nd names such as Easton, Ronald’s, and Liberty Milk. As CWUF moves more into prepared foods, it is moving into Kittitas Foods’ territory. Kittitas Foods has 40 manufacturing and distributio n facilities. The company has acquired S kippers , the best -selling brand of peanut butter in China and the second -best -selling brand in the world – from Northeastern Foods for $700 million; the sale included S kippers ’ U.S. and China factories. Kittitas Fo ods produces a brand of wrapped tortilla -type snacks dubbed REV . These wraps are essentially miniature burritos, available in several flavors such as pepperoni pizza, ham and cheese, peppered turkey, meat lovers’ pizza, Italian -style ham, along with sever al others. In 2019. Kittitas Foods bought the WestSport Company for about $450 million, including the Liberty Milk protein supplement brand. External Issues 1: An Oligopoly Chicken production, dominated by CWUF (21%) and International Food (19%), is quite fragmented, with 46 percent of all chicken production in the United States coming from smaller companies. 2: Beef Trends Meatpackers across the United States were paying the highest prices on record for live cattle in January 2019, due to droughts in much of America’s Great Plaines that led to higher corn prices. Cattle numbers in the United States in 2019 were at 60 -year lows, and prices were up 26 percent from just 5 years earlier. While potentially good news for CWUF’s beef segment, the higher prices and healthier eating trends have also been met with reduced red meat consumption. In the Unites States, consumption rates of red meat are down 25 percent over the last three decades. Many customers now prefer chicken, pork, fish, and increasingly a totally vegetarian diet. Mexico has also experienced a decline in red meat consumption per capita over the last decade. On average, beef tends to be a much more expensive meat product to produce and is met with much lower margins. One interesting way f irms such as CWUF and its rivals are increasing profit margins from beef is by slicing areas of beef carcasses traditionally used for ground beef into thinly sliced steaks. The overall beef industry is also benefiting from increased exports to Asia and Ru ssia, and is benefiting from the waning paranoia of the mad cow disease from a decade earlier. Despite reductions in red meat consumption, Americans still account for the largest beef – eating nation, averaging a whopping 77 pounds per person of beef annual ly, compared to citizens of Europe at 34 ad China at 10 pounds per person. Mexico , Japan, and Canada ate the three top beef export destinations for U.S. -produced beef. The three nations have rotated their respective absolute positions over the last 10 ye ars, with Mexico reclaiming the top spot recently, likely due to the droughts in the U.S. 3: Chicken Trends: Chicken is the most commonly eaten animal in the United States; it is also popular around the world as an affordable way to obtain lean protein. As of early 2019, China was the largest chicken consumer in the world, but the United States still leads consi derably in per capita consumption. Per capita chicken consumption in the United States, European Union (EU), and China are around 99, 41 and 22 pounds per person annually, respectively. Mexico, Brazil, Argentina, and Canada all consume about 70 pounds pe r person, and many other nations in Central America and South America also consume more chicken per capita than Europe or China. Peru, Paraguay, and Bolivia significantly lag their South American counterparts in chicken consumption and offer possible oppo rtunities for exporting chicken producers. Despite great popularity, chicken is also more likely to be contaminated than other meats and cross -contaminate other food products. 4: Pork Trends: China blows everyone else in the world away when it comes to total pork consumption, but Europe is not far behind in per capita consumption. Per capita pork consumption in ponds for China, EU, and United States was 90, 88, and 62, respectively. Pork production has risen in the United States, but consumption has declined in recent years due partly to huge demand in foreign markets. The main recipient of U.S. pork is Japan, where about 35 percent of all American -exported pork is shipped. Mexico is second, acquiring about 20 percent of all U.S. -export pork. Pork growth rates remain moderate per capita at around 2.5 percent in Mexico, 3 percent in China, 2.6 percent in South Korea, and 1.3 percent in Japan. Mexico might be the real future star out of this above list, as Mexico has a population growth of 1.6 perce nt, resulting in over 4 percent total pork consumption. Unlike Mexico, most developed nations worldwide are experiencing declining or stable populations. 5: Required Meat ID Labels: Since 2013, the USDA required all meat production to accurately label from where the meat was derived. The labeling should make it easier to track the source of contaminated meat. Firms such as CWUF complain it is an unnecessary step that adds additional expenses. In addition, all ground meat must now com e from the same country . Historically, it was possible for ground beef or pork to come not only from different individual animals but also from different countries. In addition to meat -producing firms such as CWUF, some countries have expressed concern t hat American customers may be prejudiced toward meat grown in their respective countries for various reasons such as not being patriotic and not trusting the quality of the meats from other countries. Future Consumers are becoming more health consci ous and switching from red meat to more chicken and even processed chicken items. Chicken products tend to have significantly higher margins than beef. CWUF’s successful launches of more health conscious products lines have boosted profits. Income S tatement for CWUF (in thousands of USD) September 30, 2019 September 30, 2018 Sales $37,580,000 $34,374,000 Cost of Goods Sold 34,895,000 32,016,000 Gross Profit 2,685,000 2,358,000 Selling, general & administrative expenses 1,255,000 983,000 Operating income (loss) 1,430,000 1,375,000 Interest and other 178,000 118,000 Income (loss) from continuing operations before income taxes 1,252,000 1,257,000 Income tax expense (benefit) 396,000 409,000 Income (loss) from continuing operations 856,000 848,000 Income (loss) from discontinued operations, net 8,000 (70,000) Net income (loss) 864,000 778,000 Balance Sheet for CWUF (in thousands of USD) September 30, 2019 September 30, 201 8 Cash & Cash equivalents $438,000 $1,145,000 Accounts receivable 1,684,000 1,497,000 Inventories 3,274,000 2,817,000 Other current assets 825,000 145,000 Total current assets 6,221,000 5,604,000 Net property, plant & equipment 5,130,000 4,053,000 Goodwill 6,706,000 1,902,000 Intangible assets 5,276,000 138,000 Other assets 623,000 480,000 Total Assets 23,956,000 12,177,000 Current debt 643,000 513,000 Accounts payable 1,806,000 1,359,000 Other current liabilities 1,348,000 1,138,000 Total current liabilities 3,797,000 3,010,000 Long -term debt 7,535,000 1,895,000 Deferred income taxes 2,450,000 479,000 Other liabilities 1,284,000 592,000 Total Liabilities 15,066,000 5,976,000 Common stock 42,000 39,000 Paid in capital 4,257,000 2,292,000 Retained earnings 5,748,000 4,999,000 Treasury stock (1,010,000) (1,021,000) Other (147,000) (108,000) Total shareholders’ equity 8,890,000 6,201,000 Total Liabilities & Equity 23,956,000 12,177,000
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