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Chick-News.com Poultry Industry News, Comments and more by Simon M. Shane

Justification for Costco Entry Into Rotisserie Production Questioned

10/02/2018

Recently CoBank released a report by Will Sawyer justifying the entry of Costco into broiler production through a captive subsidiary Lincoln Premium Poultry. Although the September CoBank report has received secondary amplification in the poultry press, the values presented in the CoBank report should be evaluated in the light of the U.S. industry. Articles based on the CoBank report failed to analyze either the risk factors or economic realities concerned and relied heavily on presumption and non-quantified considerations.

The Costco/Lincoln project which is currently under construction should be regarded as an experiment. This is the first time that a retailer has integrated backwards into any kind of livestock production. Recently Walmart commissioned a $170 million dairy project in Indiana to replace a major supplier, Dean Foods. The Walmart enterprise does in fact parallel the Kroger Company which operates dairies but neither retail chain has assumed the biological and climatic risks associated with livestock production.

The overriding consideration for the Costco/Lincoln enterprise is the determination by Costco to hold the price of a rotisserie bird at $4.99 per unit. Industry data suggests that 30 percent of broilers processed in the U.S. would fall within the range of 6-7 pounds bracketing the Costco requirement of 6.00 to 6.25 pounds. Only twenty percent of U.S. birds are marketed as whole although there would not appear to be any restraint to Costco negotiating supply agreements from either a major integrator who could provide the required quantities regionally or to dedicate one or more complexes to supply Costco stores.

It is estimated that 625 million rotisserie birds are sold annually comprising 7.3 percent of current broiler production. Costco claim to sell 90 million rotisserie broilers annually representing approximately 15 percent of all birds sold in cooked whole form. The projected initial capacity of the Lincoln Premium Poultry complex is one million birds per week expanding eventually to two million birds per week, representing a margin for expansion of approximately 16 percent.

The fairly narrow weight range required by Costco could be achieved given the diversity in live weight for age in straight-run flocks. Uniformity would be achievable with sex-separate placement, but this would involve a higher level of planning and logistics, although achievable with a dedicated complex.

Costco has a market capitalization of $87 billion and total assets of $32 billion on which it shows a return on assets of 7.4 percent. With a projected capital investment of $400 million in a feed mill, processing plant and hatchery, Costco would have to show a benefit  of $30 million annually from sourcing broilers internally to achieve an equivalent return on assets compared to their principal business of operating big-box wholesale club stores. With full capacity of 2 million birds per week, Costco would have to save 28 cents per bird. According to the CoBank report, Costco envisage saving from 10 to 35 cents per rotisserie bird sourced at the two million birds per week level. Obviously at one million birds per week, fixed costs would constrain the required saving achieved through internal acquisition to a level which would not provide a return on investment comparable to the company norm.

The 2016 outbreak of Salmonella Heidelberg attributed to Costco rotisserie birds supplied by a West Coast integrator may have been a consideration in the decision to invest in a dedicated broiler company. There is no assurance that Lincoln Premium Poultry could provide a cast-iron guarantee that Costco would not encounter foodborne infection from their operation.

Costco is literally putting all their eggs in one basket by producing broilers on one complex in Nebraska. This may have been a valid strategy prior to the 2015 avian influenza epornitic but the location of the Lincoln complex lies well within the Mississippi flyway and the operation could be vulnerable to infection irrespective of the level of biosecurity. Production in Nebraska presumes costs for distribution which hopefully have been taken into account in evaluating the viability of the enterprise.

Location of the complex in Nebraska assumes relatively low costs for major ingredients, but it is questioned whether this will represent any material advantage over acquisition of whole broilers from established producers in Kentucky, Tennessee or even the deep south, given that twice as much grain has to be transported over a short distance compared to the finished product which must be refrigerated.

In reviewing the Costco enterprise, CHICK-NEWS does not hold with the impression created by articles spun-off from the CoBank report that the Costco/Lincoln model will represent a future trend by major chains sourcing their poultry. The Nebraska complex will be a reality, but it is questioned whether Costco will carry the enterprise on its balance sheet beyond 2020 given the potential for higher return on investment from assets committed to retailing and also given the biological and climatic risks involved in live production.


 
Copyright 2018 Simon M. Shane