The latest ‘MSCI 2022 ESG Trends to Watch’ report shows us that the topic of food security is of the utmost importance and calls for attention from companies to reduce antibiotics usage in the future, especially in agriculture.
Following the pandemic, there has been an increased global focus on animal welfare and tracing antibiotics usage in Asia – being home to the largest livestock-producing country and the leading consumers of antibiotics in the world, China. According to a study by Thomas et al. (2015), the livestock production system in China has intensified with the help of antimicrobials.
Antimicrobials consumption is projected to nearly double in the future. In recent decades, the meat-producing industry has been affected by factors such as a tightening of environmental protection policy and outbreaks of viral zoonotic epidemics – such as African Swine Fever and H1N1 – and tripled by increased awareness among the public about the issue about food safety.
Contagious animal diseases are one of the typical material risks that these companies in the intensive animal farming industry are exposed to. One of the causes of these diseases is the overuse of antibiotic drugs in intensive animal agriculture industry. Corporations in this industry use antimicrobials as a feed additive to marginally improve animal growth rate.
As a result of natural selection, drug-resistant bacteria survive and multiply inside farm animals’ body, weakening animals’ immune system and therefore making them susceptible to virus pathogens. Christy et al. (2018) also informs that antibiotic-resistant bacteria inside farm animals might transmit to human beings through food chains or disseminate in the environment through animal wastes. The disease spread tendency and antibiotic resistance problems go hand in hand, bringing food safety crisis to the spotlight.
How can this be addressed?
Improving animal welfare and addressing the issue of antibiotics overuse should start with setting up a feasible ESG reporting framework to enable stakeholders track companies’ achievements in managing animal welfare. The SASB and GRI reporting frameworks recommend that corporations in the animal farming industry consider animal health and welfare as a material topic to disclose in their practices for responsible and prudent use of antibiotics and how they protect animal health and welfare. Companies can improve their animal welfare in reference to the ‘five freedoms’, which are globally recognized as the gold standard in animal welfare. They include freedom from hunger and thirst, freedom from discomfort, freedom from pain, injury and disease, freedom to express normal behavior, and freedom from fear and distress. The five freedoms form the basis of animal welfare legislation in many countries.
The next step is to connect this social factor with corporate risk management and financial performance. Companies that do not control antibiotic usage in their supply chain will face risks from multiple perspectives. The first is the regulatory risk from authorities and potential waste management costs. In 2019, the Ministry of Agriculture and Rural Affairs in China started to promote the regulation of antibiotics in the aquaculture industry. There is a trend that pollutant discharge of antibiotics will be gradually included in the regulatory scope of water pollution discharge of key industries.
Apart from regulatory risks, these companies also face rising business risks. This risk stems from the uncertainty of livestock prices and sales. Livestock prices directly influence the profitability of these companies. For example, frequent outbreaks of African Swine Flu cause the replacement of highly productive pig breeds with low productive pig breeds.
A public statement from an investor activities record, published by Zhengbang Inc. in August 2022, shows that its PSY (a major indicator of sows’ production yields) decreases during African Swine Flu episodes. As a result, firms find it difficult to predict the quantities of future sow herds required to maintain production.
Risks can also come from animal epidemics directly related to companies’ inability to raise funds. Most companies in this intensive industry in China have an ‘outsourcing from individual farmer to company’ production model. This model requires less capital investments and makes it easier for companies to expand their production in no time. However, expanding the business without gauging the business cycle stage properly subjects the business to the risk of limited cashflow for its daily operations. To fill this gap, most companies choose debt financing to support the initial cash outlay of its investment project.
A lot of corporations are already subject to the high debt-to-equity ratio problem. However, a high debt ratio in capital structure is not a serious problem as long as there is a stable operating cash flow. But the cyclical characteristics of this industry puts a question mark on solvency. Rising debt ratios in capital expenditure makes it more difficult for these companies to obtain short-term funding.
Zoonotic diseases also increase the risk of biology assets impairment for companies. Due to diseases like African Swine Flu and demand fluctuations, those companies are also subject to credit rating downgrading. According to Wen’s company 2021 financial report, its international depository receipts are downgraded because of African Swine Flu. China Chengxin Credit Rating Group also provides a negative rating outlook regarding Muyuan’s convertible debt in the medium term. The likelihood of future debt downgrading might increase the cost of financing for these companies.
The intensive animal agriculture industry in China is typically a cyclical one. Target customers for large-scale companies in this industry are quick-serve restaurants and hotels. During the pandemic, those restaurants and hotels suffered massive revenue losses due to lockdowns. In several annual reports of corporations in this industry, there were sharp declines in gross profits margins which culminated in short-term liquidity problems. Most companies are also suffering from having a decrease in diluted earnings per share from 2020 to 2021, which indicates companies’ decreasing ability to create short-term value to shareholders.
Given that China has demonstrated it determination towards a “zero-Covid policy” for decades to come, a key priority for companies is to rebuild consumers’ confidence towards food safety issues in order to switching their target market from quick-serve restaurant to individual consumers.
One way for companies to successfully get over tough times is to transform their business models – addressing food security problem in supply chains, and paying attention to animal rights and antibiotics usage. The ‘outsourcing from individual farmer to company’ production model makes it difficult for companies to secure animal welfare and avoid the overuse of antibiotics. Due to African Swine Flu, backyard households that lack technical knowledge of animal disease prevention are exiting the market. It is expected that the market will become more concentrated in the future. Since the majority of companies in this industry are developing domestic disease resistance breeds and hedging risks from feed price increases by signing forward contracts, an alternative way for these companies to improve their profitability and increase competency is to control material risk from animal disease by improving animal welfare. This differentiates their products and helps them to gain more pricing power.
In the future, the ‘self-production and sales model’ might be a good way for companies to directly control risks arising from animal epidemics. Innovation and application of new technology will be a trend in maintaining good living environments for livestock. For example, Muyuan Inc. recently incorporated a fresh air filtration system and separate ventilation system to improve herd health management. Consequently, firms may also seek to improve their ability to trace antibiotic usage with the help of intelligent technology.
The author calls for an active engagement among shareholders and stakeholders with ESG principles, to address the issue of antibiotics overuse by companies in the intensive animal industry in China. An active engagement with animal welfare and antibiotics overuse issues among these companies will help accelerate the transformation of their business production models and improve companies’ ability to resist short-term shocks from animal epidemics. This might prove to be a viable solution to financial dilemma for companies in intensive animal agriculture in China.
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