Beef recall left Edmonton’s XL Foods no choice but to sell: experts

By Marty Klinkenberg, Edmonton Journal October 18, 2012

EDMONTON – The threat to Canada’s beef industry from E. coli was underscored this week when one of its biggest players was toppled in the wake of the largest meat recall in the nation’s history.

With its losses mounting, XL Foods of Edmonton announced plans Wednesday to sell its slaughterhouse in Brooks and other assets to a multinational giant for $45 million less than it paid just three years ago.

As part of the $100-million agreement, JBS USA has taken immediate control of the facility that was shut down by federal regulators on Sept. 27 due to contamination with E. coli. In addition, the company has an option to buy beef packing plants in Calgary, Nebraska and Idaho, as well as a feedlot in Brooks and adjacent farmland.

Experts say it is no surprise that XL’s owners, Edmonton-based Nilsson Bros., decided to sell in the face of a financial tsunami. In the last month, XL Foods had likely lost more than $100 million in recalled products alone, not to mention the cost of recalling them from across North America and Puerto Rico. It also faces possible litigation from 15 people who have contracted E. coli poisoning, and was likely to lose market share due to waning consumer confidence.

“Generally, recalls are small, isolated events, but some of them get bigger as they go and become very large events,” said Ted Schroeder, a research professor and livestock marketing analyst at Kansas State University. “When it happens, it often ends up in a major restructuring like this.

“A company the size of XL Foods can’t have a plant shut down and keep paying its debts. They are often forced to sell before they lose everything.”

Acquired in 2009, XL Foods’ packing house in Brooks was processing 40 per cent of Canada’s beef before its licence was suspended three weeks ago by the Canadian Food Inspection Agency. Investigators are still assessing safety improvements that were ordered at the plant after E. traces of E. coli were detected in some of the 1,800 products recalled over the course of a month beginning on Sept. 16.

Although it is unclear how much Nilsson Bros. owes banks and other companies, Brian and Lee Nilsson had to dig deep to buy the now-shuttered packing house in Brooks.

To finance the purchase, a consortium of lenders headed by HSBC Bank Canada gave XL Foods a $225-million line of credit at an interest rate of 25 per cent. In addition, the Nilsson brothers used their 75,000-head feedlot operation and other lands near Brooks as collateral on an $18-million mortgage from Metropolitan Life Insurance Co. and a $20-million loan from the Bank of Nova Scotia, the latter at a rate of prime plus 10 percentage points.

“If this situation hadn’t occurred, XL Foods probably would have been fine,” Schroeder said. “But the company was expanding rapidly and because of that they were in a risky financial position. This became a real back breaker.”

Even before the biggest recall in Canadian history, the beef industry was paying a heavy cost due to E. coli. Recent studies done by researchers Kevin Grier and Claudia Schmidt at the George Morris Centre, an agricultural think-tank in Guelph, Ont., estimated that negative publicity generated by E. coli-related recalls costs cattle producers $100 million in lost sales a year.

That cost is above and beyond the cost of the recalls themselves, which become gradually more expensive based on scope and size. Recalling and then disposing products in a larger recall costs companies a minimum of $2 million, but complications in the XL Foods case would drive the cost dramatically higher.

In addition, demand and cattle future prices have been driven down by publicity generated by the recalls. At present, Grier estimates buyers are paying farmers in Alberta about less $50 per head than normal because feedlots are overcrowded and the closure of XL Foods’ plant has made it more difficult to find a processor.

“It has been very damaging when it comes to demand,” Grier said. “Every retailer I have spoken to tells me beef purchases are down 40 to 50 per cent. And during the height of the crisis, future process dropped dramatically.

“E. coli recalls scare traders, and that causes lower prices for the short term.”

The Morris Centre’s research shows that the beef packing industry spends more on E. coli prevention than on any other intervention — approximately $14.1 million each year. Those estimates do not include the cost of having to retool or clean a plant after multiple findings of E. coli bacteria, such as the case involving XL Foods.

Because of that the company incurred additional labour costs related to quality control and quality assurance, as well as lost production. Damage to its reputation threatened its long-term market share.

When it comes to selling, Grier said, “I would say that XL Foods certainly would not have found itself in a strong negotiating position. The pool of qualified buyers was one. The circumstances were pretty difficult.”

Union officials on Thursday met with representatives of JBS USA in an attempt to learn its immediate plans. All but a relative handful of the plant’s 2,200 workers have been temporarily laid off.

The cost of continuing to operate had become too difficult for the Nilsson Bros., who continued to pay employees for several weeks even after the plant’s licence to operate was suspended. In addition, the company has temporarily lost its privilege to export to the United States until an audit is conducted by the CFIA in conjunction with officials from the U.S. Food Safety Inspection Service.

The U.S. Department of Agriculture has estimated that about 2.5 million pounds of beef products that had been exported were recalled. But that is just a fraction of the amount that has been pulled from store shelves across Canada.

Sheri Monk, a reporter for Alberta Farmer with extensive knowledge of the cattle industry, said Thursday that 16 million pounds is the bare minimum of beef products that XL Foods would have recalled. The company ended up having to recall everything it produced over five days — and was slaughtering 4,000 animals each day, with each carcass weighing an average of 800 pounds.

In addition, she estimates that 12 to 15 million pounds of detained meat was still in the plant at the time it was shut down, much of which will likely be lost. Retailers may have also returned another 10 to 15 million pounds of other products to XL Foods that were manufactured around those same dates, Monk said.

Using an average price of $3 per pound — an amount that Grier said is plausible — the cost to XL Foods could range from a low of $48 million to a high of $135 million.

“That’s simply the value of the product lost,” Schroeder said. “But the value of the product is only a fraction of their cost. Other costs often times are at least as large, if not more.

“You would quickly find yourself in a bad financial situation.”

A bigger problem to the company — and for the industry as a whole — is a loss of confidence from consumers.

“Consumers respond adversely to recalls,” Schroeder said. “They don’t necessarily associate it with the company as much as the product, which in this case means they are reducing their consumption of beef.

“This is broader than XL Foods and it is broader than Canada-wide. It is causing consumers in the U.S. to pause and think twice and step away from the product a bit, too.

“From a trust perspective, when there has been a regulatory issue, it takes time. In that case, sometimes having a new company come in and take ownership can restore that trust faster than anything else.”

With files from Calgary Herald

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