3 Nov 2021

Cherkizovo Group CEO Sergei Mikhailov: We’ve lost all hope of anything going down in price – we can only hope nothing goes up any further

Sergei Mikhailov

Sergei Mikhailov
Photo: Cherkizovo press-service

Cherkizovo Group, one of the Russian meat market leaders, has this year found itself between a rock and a hard place, like the sector as a whole, for that matter. On the one hand, there has been a considerable increase in costs, which not even the group’s vertical integration is able to rein in, and on the other a decrease in the purchasing power of consumers.

Sergei Mikhailov, Cherkizovo’s CEO, tells Interfax in an interview how the company is fighting the growth in costs, whether the grain export restrictions are having any effect, whether he forecasts any drop in prices for the Group’s own products and when work will begin on one of the Russian meat market’s biggest projects.

Question: Recently, the spread of the coronavirus has again overshadowed all other topics. During the first wave you talked about a decline in sales of the company's products for food service. Do you expect new problems in sales due to the worsening epidemiological situation?

Answer: If we talk about commercial issues, about sales, then in the last year and a half we have seen more volatility than we are used to. Our markets are generally volatile. But the current situation is special.

Firstly it’s food service. It is clear that if we have lockdowns, restrictions, their sales drop. Globally they have they dropped to zero, then stabilized at 50%, then 80%, then again 50%. In the last couple of months we see they have returned to the pre-Covid level, some of them even went 15-20% higher. But that’s the last two months. We’ll see what happens in the next month or two, given the latest surge in the disease.

Q: In one of its reports the company said growth in production costs has become systemic this year. What do you see as its main reasons and what action is the company taking to reduce costs?

A: Yes, we are now seeing unprecedented growth in production costs. I have been working for more than twenty years, I have seen different situations. But this is the first time I’ve seen anything like this. It's easier for me to say what is not going up in price. All that is left is gas and electricity tariffs, which are regulated by the state.

Packaging has gone up 30%-50%. Grain cost 10-12 rubles per kilo a year or two back, now it is 16-17 rubles. Soybean meal, soybeans have doubled in price, lysines and vitamins have gone up 20%-40%. Then the oils – palm oil has broken all records. I could go on. The growth is systemic, throughout the whole manufacturing chain. We are seeing this has become entrenched for at least the last three quarters. We have been unable to stabilize the situation yet.

We’ve lost all hope of anything going down in price – we can only hope nothing will go up any further. In the past any rise would be followed by a correction and a fall, but this is not happening this time.

But it’s the same the world over – our situation is just a link in one big chain.

Q: Are you feeling any effect from the restrictions on grain and vegetable and sunflower oil exports?

A: Yes, it’s a little easier for us than for other markets, thanks partly to the action the government has taken. The duties are smoothing the excess growth for world prices, enabling us to keep our own prices in check at least somehow. But that growth is so enormous that the overall picture is still not changing. It is not stopping overall inflation.

We are looking for ways to become more efficient but you have to agree this is hard to do when absolutely everything goes up in price.

Q: Pig farmers complained about lower prices last year, saying they had completely substituted imports in the domestic market and were developing exports. Prices have increased this year, and processing plants, the Agriculture Ministry says, have started talking about the need for a quota on duty-free pork imports. Is there any need for imports given that pig farming has taken off practically from scratch with the help of billions of investment?

A: We should not pin our hopes on imports because, as I said, the cost of production abroad is even higher, there are no floating duties on grain exports to protect the domestic market there. That is why it is vital to prevent a drop in production. By and large here in Russia we have all we need for this - our own grain, fertilizers, all the components and capacity needed for pig farming, and some of that capacity is not yet fully utilized.

This is the worst time to be a net importer. Saudi Arabia, the Middle East and China are having a meat shortage. I do not want to join them at all and compete for meat in foreign markets. That said, imports are generally open today. We are for example importing certain amounts of meat for our plant in Kaliningrad. Yes, counter-sanctions are in place, but we can import from other markets, from Latin America, for example. And the duty today is not zero, of course, but 25%, but it cannot be described as prohibitive.

It’s largely to do with the price. If these were even 15-20-30% higher than on other markets then there might be some incentive to import. If over here the prices is less than it is abroad, then no. and there’s another problem in the present situation – there is just physically not a lot of meat in the world market.

So I think it would not be right to focus on imports. What then would we have been working for in the last 15-20 years? If you look at our prices in recent years then they are among the lowest in the world. And you have to remember that in Russia, subsidies not just for meat production but for the agri-food sector as a whole are minimal as a percentage of GDP, just a few percent of output, while in Europe it is hundreds of billions of euros a year. So our production is very efficient, looking at it objectively.

Q: The Group at the St. Petersburg International Economic Forum in June announced it was setting up a meat cluster in the Tula region with investment of more than 50 billion rubles. How is that project going? Are there any plans to adjust it in view of the worsening epidemiological situation?

A: It’s a very big project, even for our company. A working group is in action. We are working at present on the plans that have been set, we intend to build not just the biggest slaughterhouse in Russia but probably in the whole of Europe. We held back for a long time from building capacity to slaughter pigs partly because we had always had two slaughter houses, one in the Lipetsk region and the other in the Penza region. We can slaughter up to 2 million animals at them each year. The Group now has the capacity to produce 3 million head a year, so the time has come to carry such a project out.

The new facility will slaughter between 3.5 million and 7 million head per year, depending on shifts.

We will then start producing semi-finished pork products, salami. Salami production will take place mostly in the Tula region. If all goes to plan we’ll be able to get down to the first stage of the project when the construction season starts, in May-June.

The next stage is poultry meat processing.

This is the main area four our company to develop in the next few years, that’s where the bulk of the investment will be.

Q: What’s the project’s timeframe?

A: I think there’ll be a four-year investment cycle, up to and including 2026. The project will be phased.

We are also working on other areas. We’ve boosted Tambov Turkey’s capacity by 50%, we’ve launched a plant to produce semi-finished beef products in Kaliningrad, we plan to expand production at Altai Broiler to 100,000 tonnes and we will be expanding processing capacity at Compass Foods in the Tula region – capacity there is fully utilized, and we are building there, capacity will be doubled.

The oil extraction plant project in the Lipetsk region is in the home strait. We plan to start processing soybeans there in March. This is one more step in our vertical integration. We plan to produce 200,000 tonnes of soybeans in the coming year, about 40%-50% of what we get through. That will make us 80% self-sufficient in soybean meal and oil which we import at present.

Q: Is there any particular guidance regarding the share issue on which a decision was reached last year? What are the prospects for an SPO?

A: We have developed three- and five-year business strategies. Today, there's no need for us to tap the capital market and raise money in order to implement them as of yet. At the same time, we do have the desire to remain a listed company. We will be monitoring the situation both at macro and sectoral level, and if the market is conducive to it, then we will take advantage of this opportunity.

We have experience here, including on the London exchange, but we won’t be rushing. There is no reason to. If we are going to increase our free float we’ll be doing so substantially, so it becomes fully fledged and the company has more liquidity and opportunities to be added to the Russia indices.

Half-measures have demonstrated that these do not work, especially not in the market we find ourselves in. The stock market is complicated, and liquidity is currently a problem. Although observations show that in the last six months to a year we have had the so-called retail investor starting to appear as a class. In the past year, up to 20 million new brokerage accounts have been opened in Russia. This is likely one of the reasons for us to look at capital market opportunities. We are the type of company for which the consumers, when they buy sausage, Petelinka or something else, they easily understand what they are investing in.

Q: Given your free float is not high, are you not thinking about a buyback and then offering shares on the exchange with a clean slate?

A: The free float is certainly not that big, around 3%. But neither is it a small amount in absolute terms. And I think that at least today, it satisfies small retail investors, but not institutional ones. We have a lot of loyal investors who refused to sell shares when we have held buybacks in the past and they are feeling fine today.

We see no need going forward to buy back shares and leave the exchange altogether. The company is transparent, public, and independent directors form the majority on the board of directors. This has been the case for years, if not decades. We don’t plan to change anything here as on the whole we plan to remain a publicly traded company and, as I have said, we are not ruling out increasing our free float.

Q: You said at the St. Petersburg forum that the SPO horizon had shifted. How do you assess the situation a few months later on?

A: I think little has changed for us in that time. There are things that don’t depend on us – the situation with banks, the sanctions.

What does depend on us is the size of the company. When implementing our strategy and demonstrating sustainable growth, we expect that business will already be of a different scale within two to three years. This will enable us to more quickly reach the critical mass that will allow us to have a free float in a sufficient amount for entering certain indices, as well as to get decent liquidity, which would motivate more institutional investors.

Q: The company has in recent years been increasing dividend payments. Are any changes to dividend policy being planned?

A: We aren't planning any. The dividend policy remains the same - 50% of net profit as a guideline. If profit grows, dividends increase too. We develop our dividend policy in such a way that it doesn't bear risks for the company not to fulfill its strategy, and so that it doesn't hinder its growth. High-quality, sustainable growth - this is the priority.

It has to be said that paying dividends on the Russian market has to a certain degree already become a generally accepted discipline, one of the necessary mechanisms to maintain investor loyalty. We did not pay dividends for many years, and some of our investors said let’s go and invest in other shares. There were a lot of them.

Q: China has a prominent place in the Group’s export program. How are relations going with them, given the tough anti-Covid requirements?

A: China does right and in this situation it is doing all it can to stop the virus spreading. And we for our part are doing all we can to comply with those requirements, from production to shipping, we are heeding the recommendations that Rosselkhoznadzor is relaying to us.

This is crucial because China is a very big chicken customer of ours.

Q: And do you see light at the end of the tunnel in the years of talks on access to China’s market for pork? After African swine fever was found in China it seemed it would soon be in need of Russian pork. But that did not happen and the talks are ongoing.

A: Moreover the impression is that China is looking to become self-sufficient in pork. If 18 months ago it was buying large consignments from Europe and the United States, and became a big importer, now the situation has changed.

But it is still unclear whether China’s pork market is saturated or whether this is a temporary phenomenon. The thing is that unlike Russia and other countries, they are not culling livestock when there is ASF but are processing it [ASF poses no danger to humans] and a lot of meat products are getting onto their market. Then there is a hole. And we are trying to understand whether their pork production has recovered or whether this is just another surge to be followed by a collapse.

It costs 2.5 times more to produce pork in China than it does in Russia and prices were at one time three times what they are here. Even so, the market is not opening up, although pork is an essential food there, like chicken is here – 65% of meat consumption. And they appear to have decided to suffer for three to five years but to safeguard against imports.

This is a conscious long-term decision, but not without cost, either for China or for the world market. Unlike Russia, China has already exhausted its potential to reproduce grain, corn and soybeans. And every new kilogram of pork produced in that country is piling more pressure not just on the Chinese grain and soybean market but also on the world market. China has become a market-maker for both soft and hard commodities.

Of course we would welcome a decision to open up the Chinese market for pork, although our company’s strategy remains geared towards the domestic market. This is above all value-added products, chilled products, produced under our brands.

This is also a promising channel for food service which will continue to grow, despite Covid-19, it has a lot of potential. I think that in the next year or two its share of revenue will approach 15%-20%.

I’d say exports are complementary in nature for our company and help to lower costs. Suppose chicken feet are shipped to China – these are a delicacy there, while we throw them away. If the pork market were to open up we could ship offal that is in demand there, like ears and snouts.

Q: The ESG agenda has been increasing in importance lately. Some experts are concerned that the decarbonisation requirement might turn into an impediment for Russian agriculture exports. What’s your position on this?

A: A balanced approach is needed here. We are working on this.

The new requirements could be a barrier, and not only for exports. Today there is already a class of investors that invests only in companies with a stringent ESG policy. And even if they like a company but it has no ESG they will not put money into it. Profile investors of that ilk have been growing in number over the last three to five years.

I think the trend will continue. We are also trying to comply with ESG regulations, so that this does not turn into a barrier but helps the company to become more attractive without limiting the pool of investors that we could have. All new projects are factoring the new requirements in, and we are trying to bring existing ones into line.

But again, a balanced, rational approach is needed in the drive for carbon neutrality, especially in agriculture, so that those requirements do not become an impediment not just for exports but also for the sector’s overall development, how it affects costs. Take chicken manure – it’s not production waste but organic fertilizer which is even sold in Europe and the United States. It’s one of the sector’s advantages, so we need the right approach so that ecological issues do not weigh on costs but help to lower them. We can’t run around in circles. We have to look at these issues more broadly.