The U.S. Department of Agriculture (USDA) began tracking the
size of the nation's herd of cattle back in 1973. Since then, it
has never noted such a severe plunge in the number of cows -- until
now. Ranchers are expected to raise only about 99.4 million head of
cattle this year, the lowest level on record. Blame it on corn and
record drought. Prices for this basic feedstock have risen so
sharply and the ongoing drought across the South has been so
severe, that many ranchers are bringing their cows to auction,
causing supply to dwindle.
As ranchers cull their herds, an interesting dynamic is setting up
that should have investors taking notice. In coming weeks and
months, consumers will get a dose of sticker shock as they shop for
beef products. Restaurants will feel a similar strain. Pork and
chicken -- and the companies that produce them, will most likely
move back into vogue as demand shifts.
Wholesale ($1.92 per pound) and retail ($4.44 a pound) beef prices
are at levels not seen since 2004 and look headed even higher in
coming months as fewer cows are slaughtered and supply shrinks.
Prices are also surging because beef exports are up nearly 30% this
year, thanks to the weak dollar. But what should really interest
investors is that the price spike is likely to boost the relative
appeal of pork and chicken. Simply put, it may soon become too
expensive to serve up steaks and burgers to the family, so pork and
chicken dinners could be the alternative.
This is great news for pork and chicken breeders. The rising price
of beef means they can sell more of their products, or even raise
prices and still remain well below beef prices. For an industry
that has had a hard time sustaining profits, 2012 could shape up to
be a banner year, so this should a good time for investors to take
action. Analysts that track pork and chicken producers are only
beginning to raise their
forecasts, but get ready for a steadier stream of upward revisions
as the supply, demand and pricing dynamics for 2012 come into
Forget the chicken titan
You would think that
Tyson Foods (NYSE:
, the world's largest supplier of chicken, would make for an ideal
pick. Trouble is, Tyson has steadily expanded into beef in recent
years and isn't the chicken "pure-play" that many might suspect.
Beef now accounts for 34% of Tyson's sales.
Three other livestock processors, however, should more likely
benefit from the rising appeal of pork and chicken. Here they
Smithfield Foods (NYSE:
, the world's largest pork producer, struggled in recent years to
find a sustainably profitable formula. From fiscal (April) 2003
through fiscal 2008, it generated a cumulativefree cash flow loss
of $590 million. The company was repeatedly whipsawed by volatile
expenses for corn and other feeds, while suffering from a global
glut of pigs that pushed prices down. These days, management
appears to have a much better grip on the business by locking in
feed costs at hedged prices while moving up the food chain and
acquiring branded food products that carry higher prices and
Now, results are good and getting better. The company earned $3 a
share in fiscal 2011.It is also looking to boost
earnings per share (
to $3.60 in the current
that began in May and to $4.10 in fiscal 2013, according to D.A.
Davidson. Although Davidson has the most bullish profit forecasts
on the Street, the firm's analysis appears to address the effect
that rising beef prices will have on this pork producer more
precisely.Shares trade for just five times Davidson's 2013 profit
view, and the firm expects
to appreciate 30% up to $28.
The current low multiple stems from the fact that Smithfield
carries ample debt and is on the hook for $250 million in annual
interest expenses. However, ascash flow rises, debt should be paid
down, so investors should reward shares with an expanded multiple.
Best of breed
Sanderson Farms (Nasdaq:
) is clearly the class of the chicken industry. The company has
always maintained a strong
, managing costs well and appearing well-positioned to capture
gains as surging beef prices eventually provide a lift to the
chicken market in terms of demand and pricing. Analysts say the
company can earn close to $3 a share in fiscal (October) 2012, but
this could prove to be quite a conservative forecast if industry
demand and pricing dynamics improve fairly quickly, as I suspect.
Still, shares aren't cheap, trading for more than 10 times the
likely highest end of what the company may earn next year.
A poultryturnaround ?
If you're looking for deep value in the space, you'll have to dig
into a company with a checkered recent past. Pilgrim's Pride (NYSE:
), a major chicken processor, generated a $1 billion operating loss
in fiscal (September) 2008, which pushed the company into
bankruptcy that year, forcing it to accept a bailout from Brazilian
meat-packing titan JBS. JBS, which now owns two-thirds of Pilgrim's
Pride, not only provided money, but also expertise that has helped
Pilgrim's Pride become more efficient. An executive with JBS was
recently named Pilgrim's Pride'schief financial officer (CFO) .
Pilgrim's Pride's new CFO has his work cut out for him.
Just-released second-quarter results show a company still losing
money because chicken farmers are producing too many birds. But if
you dig into the company's results, you'll find the seeds of an
eventual change in industry dynamics. The company notes major egg
producers have started to throttle back output, which should reduce
the supply of chickens heading into this winter. (Changes in cattle
production can take up to two years to affect the market, thanks to
much longer gestation and fattening cycles.)
In addition to an eventual expected upturn in chicken prices,
management is also banking on a projected $400 million in
operational savings in the current fiscal year. Pilgrim's Pride has
started to make major inroads in the poultry export market, too,
boosting foreign sales by a 65% pace thus far in 2011.
Action to Take-->
You'll start to notice the coming spike in beef prices in the next
few months. As that happens, analysts are likely to turn
increasingly bullish on the prospects of the rival protein
producers discussed above. Sanderson Farms appears to be the
lowest-risk play, albeit with only moderate upside. Smithfield
Foods is the best way to pay the pork angle, while Pilgrim's Pride
has significant upside if poultry farmers can show the output
restraint they now appear to be promising.
-- David Sterman
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.