For months, African swine fever (ASF) has been decimating pig populations in China, the world's biggest pork market. Over a million hogs have been culled, it's spreading to neighboring countries, and it'll get worse. If you think this won't affect you -- since ASF doesn't make humans sick, and pork is just one industry -- you should reconsider.

In this week's episode of Industry Focus: Consumer Goods, host Nick Sciple and Motley Fool analyst Dan Kline explain how the ASF outbreak could affect everything from China's overall economy to American chicken prices, what's most likely to play out in the next few years, a few ag producers that are cashing in on increased meat demand, and more.

Also, Nick and Dan take a closer look at Charlie Munger's statement that even though Amazon.com (NASDAQ:AMZN) is crushing competitors left and right, "Amazon has more to fear from Costco (NASDAQ:COST) than Costco has to fear from Amazon."

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on May 7, 2019.

Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Tuesday, May 7th, and we're talking Consumer Goods. I'm your host Nick Sciple, and today I'm joined by Motley Fool contributor Dan Kline via Skype. How are you doing, Dan? 

Dan Kline: Hey, there, Nick! How are you? 

Sciple: I'm doing great! I think this is the first episode I've done with you, Dan, where we've been remote. It just doesn't feel right, not to have you right next to me here in the studio. 

Kline: [laughs] I'll be there in a couple of weeks. 

Sciple: Yeah, we'll have Dan up here soon, and we'll do podcasts again. Always love having Dan on! And today, we've got a fun topic. Imitation meat has been really in the news recently. Beyond Meat IPOed last week, had the largest first-day pop for an IPO this year, up 163%. Imitation meat has been really, really hot in the streets. But today, we're going to talk about the real thing, Dan. We're coming in for the real thing, and it's a really interesting story. 

Over the past year, it really started to ramp up in October, there has been a pandemic across the entire hog population in China that's showing ripple effects all across the world. Just to give you some background on what's going on, African swine fever has really ravaged the Chinese hog population. Over half the world's pigs are in China and China consumes over half the world's pork. First started presenting an issue in early August, when the Chinese government said they'd effectively controlled the outbreak at a small farm that had 400 hogs in Shenyang in China. However, starting in October, it really started to ramp up, and now this disease has spread across China into Mongolia, Vietnam and Cambodia. Over a million hogs have been culled from populations. We're expecting 100 times more than that before this is all over. 

Dan, I mean, this is a crazy story, right?

Kline: You're the first person to ever put "the death of a million pigs" and "fun" in the same context. [laughs] But, yeah, this has ramifications in that, it's not just about China not having pork. If people don't have pork to eat, they're going to eat something else. There's going to be a huge effect. Yes, the price of pork will get more expensive; the reality is, that could change demand and cause other problems. But this could wipe out half of the pork population of the world. That's not so easy to rebuild. These aren't chickens, which have a relatively quick life cycle. I'm not sure how long it takes a pig to go from birth to maturity. I'm going to guess you have a better chance of knowing that, having grown up where you did? But, it's got to be at least a year, right? 

Sciple: Yeah, it's a much longer cycle than it might be for other meats. Just to give you context, the U.S. Department of Agriculture is estimating that up to 134 million head of hog in China may have to be culled before this is all over. That's equivalent to the entire U.S. population of hogs, the entire country, and the U.S. is one of the largest meat producers in the world. Implications are that the global meat supply -- not just counting pork -- could fall as much as 5%. 

You mentioned ripple effects to other parts of the meat industry, but also, China's economy. Pork is a significant part of China's consumer price basket, kind of like the CPI here in the U.S. It's a $128 billion industry in that country. Because it's such a big part of the economy, any increase in pork prices actually can cause inflation to the yuan, China's currency. For context, if pork prices were to double -- which is probably not likely, unless this really ramps up -- their inflation, according to Citigroup's estimates, would ramp up to 5.4%. Above a 3% ceiling, the Chinese Central Bank has real limitations on their ability to take action to spur the economy there. 

And, you have to layer over the trade war negotiations that are going on this week. China has enforced tariffs along across a wide range of U.S. agricultural products, including meats. And then, of course, if Chinese domestic supply is hurt, and this is one of the largest parts of the country's diet, it's really going to limit Xi Jinping's ability to negotiate hard at the table, at least when it comes to this part of the industry. So it's really touching all kinds of things you would never expect. 

Kline: And let me put this into context for the average person. I know, Nick, you're sitting there, Austin's sitting there, and you're thinking, "How is this going to affect me going to buy bacon or a pork roast?" The reality is, the U.S. and China are competing for pork. The U.S. does not produce enough pork to meet its needs. So right now, there are suppliers that used to sell to the U.S. that are selling to China, because prices have gone higher. This has become a commodity that, really, there's a bit of a price war over. 

Sciple: Right. Again, you mentioned that other meats are substitutes. Beef and chicken are both substitutes for pork. So it won't only affect the pork market. We've seen wholesale pork prices surge 21% in China. The price for ham in the U.S. is up at the highest it's been since 2015. EU prices have surged 16%. But if you look at these other markets, the USDA expects China's imports of chicken to rise nearly 70% this year, which is absolutely massive. It trickles down to all the parts of the market. Dan, you had some interesting stats when we looked at some restaurant companies in the U.S. and how they're already starting to price some of these into their commodity costs going into 2019. 

Kline: Yeah, I mean, McDonald's says it could increase their costs by about 3%. And it's not pork. It's that the demand for beef and chicken is going to be higher. McDonald's really only uses pork in bacon, maybe their sausage in the morning. It's not a huge part of their menu. It's just how this all trickles down. 

But there's also some ways to manage this. I think we've talked about in the past, Buffalo Wild Wings last year did a promotion where they charged less for boneless wings, because at the time, they were able to buy boneless wings at a cheaper price than they were able to buy bone-in wings. That may have changed. The price of bone-in wings has actually collapsed a little bit. But basically, McDonald's might give consumers incentive to eat something else. That might be part of the logic -- you mentioned Beyond Meat before -- why more companies are introducing alternative products. If you can take away 5% of demand but still do the sales, then you can really curtail some of the damage this is going to do. 

Sciple: Right, Dan. We've seen these restaurant companies talk about their commodity prices going up. Obviously, these folks that are downstream, that are selling these commodities, are benefiting from the increased prices. Particularly, as you mentioned, these chicken producers have been the ones who have benefited the most because they can ramp up their production to meet this demand the quickest. Chickens are the quickest to grow and bring to market. We've seen... these chicken producers have really surged. Just since the start of the year, you've got Sanderson Farms, one of the largest chicken producers in the U.S., up 55% year to date. Pilgrim's Pride, up 85% year to date. Tyson also heavily exposed to chicken, but more of a diversified meat producer, up 44%. And then JBS, which is traded on a foreign exchange, but also owns Pilgrim's Pride, based in Brazil, largest global meat packer in the world, up 86%. So you're seeing all these producers benefiting from this supply coming off the market. We talk about it on the Energy show sometimes, when oil supply comes off the market, obviously, the producers of oil really benefit. This is yet another example of that. These meat producers, really, the market has really come to them in a really nice way. They're starting to invest, to build up their supply. And there's a chance that going forward, they could take meaningful market share in China. These U.S. and Brazilian producers do have a cost advantage. Now that supply's off the market, there's a chance they could gain a foothold there. Really interesting!

Kline: Yeah. It also becomes a matter of education. Now you're going to have people who were eating pork be forced into trying chicken or ground beef or fish or whatever else it is. Chicken is likely going to be the cheapest there. People might find that they're just as happy eating chicken as they were eating pork. There could be some long-term benefits of this. 

The other issue is, when you're manufacturing and you have to increase capacity, there's a huge expense to that. If volume doesn't keep up, then you end up with idle factories. All you need to raise more chickens is space. You can adjust your production from a year-to-year basis based on needs without there being huge cost. Because at the end of the day, you hatch a chicken, raise a chicken, and then eat the chicken. There's no more chicken, it's gone. 

Sciple: Right, yeah. This trickles down all over the market. This could be a multi-year, lingering issue. The breeding sow population in China down 21% year over year. But that doesn't mean rush out and buy these chicken producers right now. In the short term it's great for these folks if they can ramp up production quickly. However, the other side of the coin is true -- competitors can also ramp up their production quite quickly. Some other companies that could benefit, though you haven't seen a pop yet, you've got feed producers like Archer Daniels Midland and Bunge. As these chicken and hog producers in the U.S. ramp up their production, they're going to need to feed these animals. So there's some chance that we could see some trickle down. 

But really, the best bet that I would see is going to be these diversified meat producers like Tyson and JBS. And Tyson has been putting some investment into that. Just last month, they secured approval for two plants in Iowa to begin shipping pork to China. That's the first such approval since 2016, according to the FDA. Really interesting opportunity for these meat producers, an industry that's really under-followed. Something to pay attention to for investors.

Kline: It becomes a race. We know there's X amount of pigs that aren't coming to market. If you can start today... but again, it's not a simple process. You have to produce the pigs and raise them and grow them, and there's actually a significant investment in feed and care and all the other things, and then you have to hope that a year later, whatever the exact life cycle is, there's still going to be that demand. So I think there's going to be some caution, and you're probably more likely to have a shortage of pork and higher prices, for the next couple of years, probably.

Sciple: Yeah. It's going to be interesting to follow. Again, we mentioned, there's some overlays into China's broader economy and the tariff war that's going on between the U.S. and China. Something to follow. If any of our listeners are interested in a deeper dive into any of these meat companies, we'd be happy to do that. Tweet us, @MFIndustryFocus, let us know you're interested, and we'll see if we can do a deeper dive on some of these guys. 

All right, Dan, on the back half of the show, I want to unpack this quote we got from Charlie Munger over the weekend. He sat down for an interview with Jason Zweig of The Wall Street Journal. We got a nice little nugget out of there that I want to break apart. We'll read it to you then we'll break it down. Jason Zweig asked, "Do any companies have a sustainable moat against competition from the likes of Amazon? Who is Amazon-proof?" And Mr. Munger replied, "I think Amazon has more to fear from Costco than Costco has to fear from Amazon, because Costco has a better warehouse situation, much cheaper, plus a public that totally believes anything they sell will be high-quality and low-price. They're the sleeping giant. They're coming late to any sort of delivery system, but in the end, they'll be more efficient, and they're already more trusted. So I would say the figures show that Costco has nothing to fear from Amazon."

Dan, just off the top, what was your immediate reaction when I sent you over this quote as we got ready for this episode?

Kline: I've written about this many times, that Amazon and Costco pretty much coexist. If you go to Costco, physically, it's not to buy one thing. You might jump on Amazon because you need a pen or paper towels or whatever it is. When you go to Costco, it tends to be for a large purchase. But what Munger is saying is something I never really thought about. There are 570-something Costco locations in the U.S. and Puerto Rico. That covers a huge amount of the country. While most of their business is people going into the store -- the warehouses, they call them -- and bringing items out, they have the ability to very quickly ramp up a delivery operation. To put it in context, Amazon has like 45 or 50 warehouses; Costco has 10 times as many. So their coverage, their ability to adapt -- if people say, "I'm not leaving my home, I want a robot drone to deliver and I want Costco to sell me one item at a time," their ability to do that... it'll take Amazon a really long time to get there. Their holdings -- Whole Foods is not a great facility to modify. Whereas 150,000 square foot bear warehouse, you could easily take 20,000 square feet of every Costco and make a robot-based fulfillment center, which is actually technology we saw at Shoptalk this year. There's off-the-shelf stuff they could buy where they could cut into Amazon, though, historically, they've been a very non-aggressive company. They move very, very slowly. 

Sciple: Right. Another thing when we're talking about comparing Amazon and Costco that I really want to call out is, we have to compare like for like. AWS, really, there's no comp for that on the side of Costco. When you think about Amazon's business from a profitability point of view, it drives substantially all the bottom line for the company. If AWS was out there by itself, that company on its own would be many hundreds of billion in market cap. But when you compare them like for like on the retail side, the comparison really starts to lean Costco's way a little bit. Core Amazon is profitable, but by a thread. You compare that to Costco, almost 100% of the profitability of the business is driven by the membership fees that the company generates. They're very reliably profitable year over year. Compare those markets, both of them have very, very high renewal rates for their membership programs, but a little bit of a different style there. When you compare the different strategies there, Dan, what do you think are the pros and cons of each approach for the businesses?

Kline: Costco makes about 75% of its money from memberships. Their goal is to take every single cost out of the items they're selling you. It's a limited selection, the stores aren't pretty, you don't get a bag, there's not a lot of people working on the floor. It's pretty much every lack of frill you could possibly have. Amazon takes a "we will sell you anything, everything." And they've only just begun culling their merchandise for things that are hard to ship and hard to sell. But both of them work hard to engender loyalty. Costco doesn't care if you only go there once or twice a year. But when you go there, it has to be a good enough experience that when it comes time to renew your membership, you're willing to do that. It's not just value. It's also the fun of seeing something -- maybe you're not going to buy the 10-foot teddy bear for your girlfriend, but it's fun to talk about it. Maybe it's looking at the samples, maybe it's a cheap hot dog. Costco has built an experience that fuels you renewing your membership, whereas Amazon actually wants you to use the service multiple times a week, and that's where your bond is. It's really two different takes on how to build loyalty. 

Sciple: Sure, yeah. In my own personal habits on Amazon, folks talk about how Amazon's the first place people go when they're looking to buy a product online. It's, at least for me, a very surgical approach to when I buy on Amazon. When I'm in Costco, I'm just walking around googly eyed, "Oh, look at this over here, look at this over there." And I always end up with three or four more things in my basket than I ever planned. I think both strategies work, and both strategies have built trust with customers. When I go to Costco, I'll tell you, I don't price check, I just assume it's going to be the cheapest price. When I go to Amazon, I assume it's going to give me the fastest delivery time, going to be the most convenient way to get it to me. I think both these companies have done an outstanding job of, when a customer thinks of them, they know exactly what to expect and they more often than not get what they're looking for. 

Kline: There's been a lot of studies on price, and which is cheaper. It really depends how you look at it. If you're willing to buy 800 aspirin, your per-aspirin price is probably cheaper at Costco. If that's impractical for you -- it's impractical for most people -- Amazon might be a cheaper price, even though it's actually a slightly higher price. It really depends on your needs. I shop at both. For our main home here in West Palm Beach, Florida, I don't have room to store a pallet of paper towels just to save a couple of bucks. Whereas we have a vacation home, where I have a shed that I could literally put a two-year supply of something -- I'm pointing as if the shed is right over there -- a two-year supply of cleaning supplies and other things that don't go bad, just so I don't have to worry about, do I have toilet paper, when I visit once a month. 

Sciple: Right. I also am a member of both, I also use both. I have a big dog, so I get all my dog food at Costco, and that sort of thing. Maybe one of these days, these companies will be much more and antagonistic than they are today. Charlie Munger's prediction there, that they really will be at odds with one another, whether Costco will have the advantage or not, we'll see. Today, you pulled a stat for me from the Seattle Times and Morgan Stanley that suggests that 45% of Costco members are also Amazon Prime members. Both you and I would be in that category. It seems to be that neither of those groups are looking to spend more at one than the other. They serve different needs for the population. They're great at it. 

Kline: It's absolutely a different need. Amazon is my every day. I am walking around the house, I see that I'm out of the flavor of tea I like, or I'm down to the last one, I jump on and I order on Amazon. Costco is an event. Once a month, you go to Costco, you bring the kid, you bring your wife -- in your case, your girlfriend, and you don't have a kid -- and maybe you have lunch there, maybe you buy a bag of candy you otherwise wouldn't have because they had samples on the floor. Maybe they have books or a kayak. It's definitely part entertainment, part shopping. Where these two companies become antagonistic is if consumer behavior changes. Costco has stand-alone stores. It's not affected by mall traffic. And they have not shown a drop in traffic. In fact, they've shown increases in traffic, during this whole retail apocalypse. But if consumers decide, "I don't leave my house for shopping," or set a much higher bar for that, then the company has to change its experience. And that might mean figuring out how to get you those values and delivering. And they have the real estate for that, they have the infrastructure for that. But they're not going to make a change until it's absolutely demanded. Everyone would argue that they waited maybe two or three years too late to go into delivery. But their numbers don't reflect that. They've maintained an 89-90% renewal rate for year over year for a very long time. That includes raising prices a couple of years ago. So, as long as that metric stays the same, there's no incentive for Costco to make big, expensive changes. 

Sciple: Yeah, I don't think we're going to see these folks become directly competitive, at least going after each other's throats, anytime soon. But it is interesting. Costco clearly has a lag when it comes to being the first place that people come to when it comes to buying things online. Amazon is the first place to go for that. But you could argue that Costco, when it comes to their physical presence, they have a more robust presence closer to the customer that could be leveraged down the line to push an advantage for them. It's going to be really interesting to see, and a really interesting observation from Mr. Munger. 

As we go away, I wanted to throw up another question for you, Dan. The next question that Jason Zweig asked Charlie was, "Hey, what about Berkshire? If Amazon should be afraid of Costco, should Berkshire be afraid of Amazon?" He said, "Everybody else has a lot to fear from Amazon." He didn't name Berkshire, he just named Costco. Charlie said that everybody has something to fear from Amazon. So, Dan, as we go away, just for a little fun, what is your boldest prediction for the next industry that Amazon might come to disrupt? 

Kline: I think Amazon largely has to go into industries that are already broken. If you're executing well -- and we've seen this in retail, the retailers who have executed well, Best Buy, for example, have done fine. I mean, Best Buy was a struggling company that made major changes and competes well with Amazon. But I think what's broken is pharmacy. If you look at Amazon, they have your credit card information, they have all of the customer service help, they own PillPack, so they have the mechanism in place to get you drugs. And they haven't quite figured out how to connect that. But I assume at some point, my health insurance is going to be incentivizing me to go to Amazon because that will be the cheapest way to get drugs. Right now, you could argue that Costco might be the cheapest way to get drugs. And still, it's not a huge part of their business. 

Sciple: Yeah, getting that pharmacy space, as healthcare becomes a bigger share of the economy, clearly something Amazon is going after. For my bold prediction, I think Amazon is going to go after image-based search. I think they're going to go after the Pinterest/Instagram market of the world. As you've seen over the past year, Amazon has really pushed into the purposeful search aspect of the market, growing their advertising presence and taking some market share away from Google. Again, a lot of what Amazon has done throughout its history, whether it's through AWS or recent moves when it comes to freight brokerage services for third-party sellers, they've really solved some problems for third-party folks. The problem that Amazon hasn't yet solved is that discovery buying process that you really get from something out of a Pinterest or an Instagram. I think, given that they've already shown a move to go after that purposeful search part of the category, it would really be interesting to see Amazon go after that more discovery aspect, image search aspect of the market. We'll see how it goes. But Amazon is always disrupting everybody. We'll see. 

Kline: Some of that ties to technology. One of the things you and I have talked about before is, I bought pants using a tailor that I set up on my phone and had to spin around. And the pants were OK, but... Amazon at some point will be the leader of that. You say image-based search, but I think it's more driven image-based, where I'm going to show Amazon, "This is what I wear, and these are things I like," and Amazon is not only going to show me some things that are like it or fit that mold; they're actually going to show me how I look in those things. That's where the real disruption could come in. Think about it now -- how absurd is it to drive to the mall, go to Macy's, pick through some things, take them into a room and try them on, when realistically, robots can do that better and you don't have to go anywhere to try things on. Stuff should just show up that fits you.

Sciple: Yeah. Jeff Bezos, if you're listening, here's a few ideas for the next industries for Amazon to run into. Dan, thanks again for coming on the show! Looking forward to having you on again soon!

Kline: I'll see you soon!

Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass! For Dan Kline, I'm Nick Sciple. Thanks for listening and Fool on!