IS FACTORY FARMING MAKING US SICK?

Insights paper IS FACTORY FARMING MAKING US SICK? Human resistance to antibiotics: an earnings risk for the global food and beverage sector April 2017

Key points > > Recent scientific studies have linked the increased pace of antibiotic resistance to the use of antibiotics in agriculture. > > Antibiotic resistance is currently estimated to claim approximately 100,000 lives in the US and Europe every year. The numbers are much higher in developing countries. By 2050, it is estimated that 10 million people globally may die every year because of antibiotic resistance. > > During the last 50 years, global meat production has> almost quadrupled to meet the increased demand for animal protein. > > Human resistance to antibiotics represents a risk to earnings in the agricultural sector if consumer awareness of the issue grows, leading to reduced demand for factoryfarmed meat. There is also a risk to earnings if regulatory intervention results in banning the use or limiting the use of antibiotics in animal farming. > > Livestock producers that don t farm intensively stand to gain from the movement toward antibiotic-free meat. There may be export opportunities for countries such as Australia, which could be well placed for low antibiotic use. > > In the medium to long term, we anticipate that the regulatory intervention and reduced consumer demand for factory farmed meat are likely to impact livestock producers, restaurants and suppliers to food retailers. Antibiotics have enabled the growth of large-scale factory farms, originally by limiting and preventing the spread of disease then by stimulating animal growth rates. However, an alarming reality is emerging: humans are building resistance to some of the antibiotics used in meat production, leaving vast numbers of people exposed to potentially fatal diseases that many assumed were treatable; for example, pneumonia. The most recent studies suggest that about 70% of bacteria globally have developed some level of resistance to antibiotics, leading the World Health Organisation and the World Economic Forum to declare antimicrobial resistance one of the biggest threats to health and human development in the world. About 700,000 people are estimated to have died from antibiotic-resistant infections globally in 2016. The vast majority of antibiotics are used by the agricultural sector. In the European Union, two-thirds of the region s antibiotics by weight are given to livestock. In the United States (US), that number is 80% by weight. For investors, human resistance to antibiotics presents a significant earnings risk to the agricultural, food and beverage sectors. 2 ANTIBIOTIC USE IN AGRICULTURE

The risk lies in consumer demand and potential regulatory intervention. As consumers become more educated about the health risks, they are increasingly likely to demand antibioticfree meat. This is already happening in the US and some parts of Europe. Regulators may also intervene by banning the use of antibiotics for disease prevention in food supply chains or at the very least limiting their use. Both of these dynamics would lead to much lower antibiotic use. Production costs would likely rise as a result, leading to margin compression or price rises. This paper discusses human resistance to antibiotics, the implications for factory farming and the agricultural sector more generally. We also discuss the health and wellness trend that is simultaneously impacting growth rates for factory farmed meat and mass-produced food. These are long-term trends that will shape the food and agricultural sectors during the next three to five years. Of course, there are likely to be significant impacts on the healthcare and pharmaceutical industries as well, particularly as the current suite of antibiotics lose their effectiveness, but this paper is focused on the agricultural and food sectors. As long-term investors, AMP Capital studies trends like these in detail. It is an integral part of our environmental, social and governance (ESG) research. Human resistance to antibiotics: it s in the science Humans become resistant to antibiotics when bacteria develops resistance to the drugs designed to treat them. Standard medicines then become ineffective. While resistance naturally occurs over time, the pace of resistance appears to be accelerating at a time when the development of new antibiotics has slowed. Recent scientific studies have linked the increased pace of antibiotic resistance to the use of antibiotics in agriculture. The problem is that humans are exposed to the antibiotics given to animals via: > > Direct contact with animals > > The consumption of undercooked or unpasteurised > animal products, or > > Effluent from factory farms which are absorbed into > the environment. Antibiotic resistance has a number of health impacts. It results in higher mortality rates as diseases that were thought to be treatable prove fatal, longer hospital stays and higher treatment costs. It also threatens the safety of commonplace surgical procedures such as caesarean sections and hip replacements. Right now, antibiotic resistance is estimated to claim about 50,000 lives in the US every year, and another 50,000 lives in Europe. The numbers are much higher in developing countries with high rates of malaria, HIV or Tuberculosis. By 2050, it is estimated that 10 million people globally may die every year because of antibiotic resistance. This exceeds the number of people who currently die from cancer every year. The economic impact also appears large. A 2016 report commissioned by the UK government, The Review on Antimicrobial Resistance, estimated the economic impact of antibiotic resistance would be a reduction of 2%-3.5% of global GDP by 2050 or US$100 trillion > (A$134 trillion). ANTIBIOTIC USE IN AGRICULTURE 3

Factory farming: a response to increased consumer demand for animal protein Income and population growth, especially in countries with large middle classes in Asia, South America and the Middle East, has spurred very strong growth in the demand for animal protein. Over the last 50 years, global meat production has almost quadrupled from 80 million tonnes in 1964 to 318 million tonnes in 2014 (see Figure 2). Intensive farming, otherwise known as factory farming, enabled this growth in supply. In a factory farming system, livestock are typically kept indoors and confined at high stocking density to produce the highest output at the lowest cost. Factory farms are also natural breeding grounds for diseases. The close confinement of animals is the perfect environment for diseases to spread and mutate. This is why antibiotics were originally needed. Without antibiotics, mortality rates would have been extremely high. The modern factory farming business model relies upon mass disease prevention (prophylactic use) and treatment. A more recent development has been the use of antibiotics to stimulate animal growth. Animals that receive antibiotic treatments reach their target weight faster than the animals that don t, increasing the profitability of the factory farming business model. Figure 1: Use of antibiotics in agriculture per country Norway Iceland New Zealand* Sweden Australia Slovenia Finland Lithuania Latvia Denmark Luxembourg Ireland Austria Estonia United Kingdom Slovakia Netherlands Chech Republic France Bulgaria Poland Belgium Germany USA* Portugal Hungary Italy Spain Cyprus 0 50 100 150 200 250 300 350 400 450 Antibiotic use in mg/kg Source: UK Review on Antimicrobial Resistance, 2016 4 ANTIBIOTIC USE IN AGRICULTURE

Potential impacts on agricultural sector For the agricultural sector, human resistance to antibiotics presents an earnings risk if any of the following occur: 1. Greater consumer awareness. Consumer demand for massproduced meat is likely to decline as consumer awareness of > the issue and health impacts grows. The risk is substitution > with smaller farmed, non-antibiotic treated meat or > plant-based protein. 2. Regulatory intervention. Some countries may ban the use of antibiotics for disease prevention or limit their use overall in animal farming, given the public health cost. 3. Greater penetration of the health and wellness trend. A trend towards healthy lifestyles is driving a shift to plant-based protein and/or demand for sustainably-sourced animal protein. CONSUMER DEMAND As consumers become aware of the health risks associated with the use of antibiotics in factory farming, they are likely to demand antibiotic-free meat. This is already occurring in the US. In 2015, sales of antibiotic-free beef, pork and chicken grew 44% faster than meat not labelled antibiotic-free. The total market for antibiotic-free beef, pork and chicken accounted for 6% of meat sold in the US but the market appears to be growing quickly. Figure 2: Global meat production Million tonnes 350 300 250 200 150 100 50 0 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 Year Source: Food and Agriculture Organization of the United Nations A signal that consumer awareness of the issue is growing can be seen in the US fast food industry. Typically adept at picking consumer trends, companies such as McDonalds, Subway, Panera Bread, Chipotle and Chick-Fil-a have recently announced that all of the chicken used in their outlets will be antibiotic-free in 2017. US food retailers and wholesale suppliers Tyson Foods and Whole Foods Market are making similar commitments. Market research firm IRI estimates that by 2022, antibiotic-free chicken will become industry standard in the food and beverage sector, with market share greater than 40%. In 2015, antibiotic-free chicken represented 12% of all chicken produced in the US. To date, most of the movement on antibiotic-free meat in the US has centred on chicken. Of the restaurant chains listed above, only Chipotle and Panera Bread have extended their antibiotic-free policy across all types of meat. This is probably because it is easier to remove antibiotics from chicken supply chains. The industry is vertically integrated in the US and their shorter life cycle means changes can be implemented faster than with other intensively farmed animals. REGULATORY INTERVENTION Regulatory intervention seems likely, given the potential public health cost and increasing consumer awareness of the issue. EUROPE The European Union banned the use of all antibiotics for growth promotion in 2006. Not all countries adopted the spirit of the ban, though, and producers were able to simply re-categorise the use of antibiotics from growth promotion to routine disease prevention. This has led to a change in approach. In March 2016, the European Parliament voted for legislation that would see antibiotics banned for routine disease prevention throughout the EU. The final stop for EU member countries is for this law to be approved by the European Commission and the Council of Ministers. The measures would include a ban on the prophylactic use of antibiotics via feed or water, establish a list of antibiotics that are for human use only, and ban the online sale of antibiotics. Some European countries have taken further measures and introduced greater restrictions on antibiotic use, comprehensive monitoring systems and targeted reduction goals. This has occurred in Denmark, Sweden, Finland, Iceland and Norway where prescriptive labelling for veterinary products have been introduced. In the UK, antibiotic sales for livestock are monitored by an industry body and in 2013 the government introduced a five-year strategy to combat resistance. Political perceptions around the prophylactic use of antibiotics are also changing in the UK. Ahead of the EU vote, some UK ministers confirmed that the government is opposed to the routine preventative use of antibiotics in healthy animals, which is a change in position. UNITED STATES The US has recognised the problem but is still considering how to respond. The Federal government has introduced new rules banning the use of some antibiotics for growth promotion but livestock producers are still able to use medically important antibiotics for routine disease prevention as long as they are administered by veterinarians. Reputationally more progressive, California passed a bill in 2015 that banned the use growth promoters as well as the regular use of antibiotics. This became effective in January 2017. Other states such as Maryland, New York and Oregon also have legislation in place limiting the use of antimicrobials. CHINA China is the largest consumer of meat products in the world, with a fast-growing livestock sector. Pigs were found to be resistant to a last resort antibiotic, Colisitin, in 2015. While the government has pledged to crack down on the use of antibiotics, no formal rules have been set. ANTIBIOTIC USE IN AGRICULTURE 5

AUSTRALIA A Federal Government body is responsible for approving or banning antibiotics before they can be used in Australia (the Australian Pesticides and Veterinary Medicines Authority (APVMA)), and the Australian Veterinary Association (AVA) has developed guidelines for prescribing and authorising the use of antibiotics on food-producing animals. Some antibiotics that are critically important to human health are effectively banned because the APVMA will not approve their use in veterinary medicine. There are strict rules around the use of antibiotics in livestock given Australia's export markets. Livestock administered with antibiotics need to be declared and withheld from consumption for certain periods of time to ensure any residue is beneath maximum residue limits. Having said that, it is difficult to get a sense of how frequently antibiotics are being administered to farm animals. There is no national monitoring system, nor are there records of the quantities and types of drugs provided. Figures collected by APVMA are limited to total weights sold and only reported on a voluntary basis by pharmaceutical companies. There have been recent surveys on the use of antibiotics in food production but these are not regular reports. This looks set to change in the next few years, with increased monitoring and supervision two key pillars of a new federal government strategy to tackle the issue of human resistance to antibiotics. In November 2016, the Federal Government released an implementation plan for its first National Antimicrobial Resistance Strategy 2015-2019. The strategy brings together the Department of Health, the Department of Agriculture and Water Resources, the Commonwealth Chief Medical Officer and the Commonwealth Veterinary Officer. A new surveillance system across the Australian agriculture industry is one of the priorities of this strategy. A summary of global regulatory responses to the use of antibiotics in livestock production is contained in Figure 3. Figure 3: Global comparison of national regulation ANTIBIOTIC USE FOR GROWTH ENHANCEMENT? ANTIBIOTIC USE FOR ROUTINE DISEASE PREVENTION? MONITORING OF ANTIBIOTIC USE? TARGETED REDUCTION OF ANTIBIOTIC USE? EUROPEAN UNION Banned in 2006 Generally allowed. The EU requires veterinary prescriptions but allows member states to grant exemptions Not at the EU level No UNITED STATES Banned as of 2017 but only for medically important antibiotics Allowed Yes. Established National Antimicrobial Resistance Monitoring System (NARMS) in 1996 to track changes in bacteria found in ill people, retail meats and food animals. No DENMARK Comprehensive ban on all growth promoters effected in 2000 Generally not practised. Unclear if separate regulations exist. Strict antibiotic labelling rules suggests effective ban. Yes. Established Danish Integrated Antimicrobial Resistance Monitoring and Research Program (DANMAP) in 1995 to monitor antibiotic resistance in humans and farm animals Target of 50mg of antibiotic per kilo of meat THE NETHERLANDS Banned in 2006 > (as part of EU law) Generally not practised. Unclear if separate regulations exist. Strict antibiotic labelling rules and veterinary prescriptions suggests effective ban. Yes. Established Monitoring of Antimicrobial Resistance and Antibiotic use (MARAN) in 1999 to monitor antibiotic resistance in food, animals and indicator organisms. Yes. In 2009, mandated a 50% reduction in total antibiotic use by 2012. AUSTRALIA Allowed with restrictions on > the antimicrobials that can > be administered Allowed with restrictions on the antimicrobials that can be administered Yes, a degree of monitoring by > the APVMA. No Source: AMP Capital HEALTH AND WELLNESS TREND Consumers are increasingly opting for plant-based protein as they link meat with animal welfare concerns, significant environmental impact and health risks such as obesity. While this is a trend that is already occurring, it may accelerate with greater consumer awareness of the health risks of antibiotic resistance. Some research predicts that demand for meat substitutes, including products made with tofu and tempeh, will grow by 8.4% annually over the next five years 2. Other research predicts that alternative proteins could constitute a third of the total protein market by 2050. Nearly half of all Americans are reported to consume non-dairy milk, with some linking this change in consumption to a concern about health and weight loss, and in the UK, the number of vegans has increased by 360% during the last ten years. Driving this shift in consumption are statements made by public health bodies. In 2015, the World Health Organisation warned that red and processed meat is carcinogenic and that animal protein increases obesity risk. 1>>>See http://www.aph.gov.au/parliamentary_business/committees/senate/finance_and_public_administration/completed_inquiries/2010-13/jetacar/report/index for a review of progress implementing JETACAR s 1999 recommendations. 2>>>https://www.alliedmarketresearch.com/press-release/global-meat-substitute-market.html 6 ANTIBIOTIC USE IN AGRICULTURE

Investment implications OPPORTUNITIES IN THE AGRICULTURAL SECTOR Broadly speaking, livestock producers that don t farm intensively stand to gain from the movement toward antibiotic-free meat. In Australia, the beef industry in particular can expect to benefit. BEEF INDUSTRY Australia is the third largest exporter of beef globally and the vast majority of cattle are grass-fed and raised largely without the use of antibiotics. This contrasts with the farming practices of other major beef exporting countries such as Brazil and the US where cattle are typically raised on feedlots and given antibiotics on a daily basis. The shift in consumer preferences is already benefiting the Australian beef industry. US restaurant chains with antibiotic-free policies have started sourcing their beef from Australia. Chipotle switched to grass-fed Australian beef in 2014 when it couldn t find enough beef in the US to meet its standards. Carl Jrs, another prominent US fast food chain, also sources Australian beef for its antibiotic free All-Natural Burger. Australian beef exports to Asia, where the emerging class is only now starting to eat beef, is naturally considered a bullish thematic. While consumer preferences haven t clearly shifted in Asia to demand antibiotic-free beef, we can expect this to change in the future and, more broadly, the threat of human resistance to antibiotics still provides Australian beef with a future tailwind. THREATS TO THE AGRICULTURAL SECTOR In the medium to long term, regulatory intervention and increasing consumer awareness is expected to impact livestock producers, restaurants and suppliers to food retailers. While Australia is identified as a country with relatively low usage of antibiotics, they are provided to some animals in some supply chains. ANIMAL PRODUCERS If producers are not able to use antibiotics to prevent disease, there are some key risks to financials. There would likely be some increased operational costs, capital expenditure, reduced food to conversion ratios, and potential reputational damage if antibiotic resistance continues to increase before practises change. In more detail: > > Operational costs may increase if disease prevention is no longer possible or treatment costs are more expensive. > > Capital expenditure may increase as producers are forced to use other methods to keep animals healthy; for example, vaccines, strong hygiene and husbandry. > > Lower feed to conversion ratios as intensity rates need to be reduced to limit the risk of spread of disease. > > Risk of litigation costs and reputational damage if antibioticresistant bacteria lead to fatalities. In Denmark, pig farmers were forced to change their intensive farming practises in 1998 when the government introduced a voluntary ban on the use of antibiotics for growth promotion, followed by a compulsory ban in 2000. Several large producers experienced problems with animal health as diseases spread and costs increased. If a similar ban on growth promotion is introduced in the US, two academics (Hayes and Jensen) estimated that it would cost producers an average of US$3 to US$4.50 per pig in the first year and about US$700 million over 10 years. They found that the corresponding price increase for consumers would be about 2% 3. Regional legislative changes or bans would also impact exporters outside that region. For example, when the EU legislation referred to above was introduced in 2006, it was estimated to cost beef exporters in the US US$100 million a year. RETAILERS & RESTAURANTS For food retailers and restaurants, the impact may be increased costs if meat prices rise, with an impact on margins, depending on whether higher costs are passed on to consumers. A compounding risk is a change in demand. Consumers may substitute animal protein for grains, vegetables or non-intensively farmed meat. This is likely to occur naturally, in any case, as the health and wellness trend gains pace. Could a positive be that they can charge consumers more for all natural products? 3>>>See http://www.farmdoc.illinois.edu/policy/choices/20033/2003-3-01.pdf for a review of the paper. ANTIBIOTIC USE IN AGRICULTURE 7

CONTACT DETAILS If you would like to know more about how AMP Capital can help you, please visit www.ampcapital.com CONTRIBUTORS Kristen Le Mesurier Senior Analyst, ESG Investment Research Phoebe Jin Graduate Analyst In Summary According to the World Health Organisation, human resistance to antibiotics presents one of the most significant public health risks in the world. It is an issue that is likely to significantly impact the agricultural sector, given that the science suggests that human resistance is linked to the use of antibiotics in meat production. The EU and the US are both moving to restrict the use of antibiotics in animal production, which will present some significant challenges to factory farmers whose intensive farming models depend upon the use of antibiotics as a preventative measure. Consumers are likely to add to the pressure, demanding antibiotic-free meat as awareness of the issue grows. For investors in the agricultural sector, this issue represents a significant earnings risk and should be monitored. There may also be export opportunities for countries such as Australia, which could be well placed for low antibiotic use. Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital. Copyright 2017 AMP Capital Investors Limited. All rights reserved.