Thanks to a confluence of events, prices for corn, soybeans and
wheat have been surging recently. And that has set agricultural
equipment stocks afire. Shares of irrigation equipment maker
Lindsay Manufacturing (
have surged more than +10% since last Thursday, while
has made a similar move since last Monday. The same can be said for
many other sector names, a number of which now sport
price-to-earnings (P/E) ratios that are starting to get frothy.
It may be too late to make a quick hit on this farm belt trade, but
another sector has suddenly become very attractive simply because
these commodities are seeing a surge in prices. I'm talking about
the major producers of chicken, beef and pork. Their costs just
went up, and their shares just went down. Yet viewed in the context
of traditional long-term
power, these stocks are suddenly quite cheap.
To fatten up livestock, farmers buy up massive amounts of corn and
soybeans, which often account for a big chunk of operating
expenses. But these "protein" producers have little control over
revenue, even as their expenses rise and fall. The supply of
animals on the market controls pricing, which is dictated by supply
and demand on global markets. So with expenses rising and those
costs unable to pass through, profit forecasts are falling.
For example, back in July analysts thought poultry producer
Sanderson Farms (Nasdaq: SAFM)
would earn $6 a share next year. Now they think profits will be at
least 20% below that view.
But Sanderson's profit forecasts are dropping for another reason as
well: the nation's production of chicken and other poultry is set
to rise +3% next year, according to the U.S.D.A. And rising
supplies usually means falling prices in this industry. Yet that's
not the case for beef and pork, as those producers have shown a
great deal of discipline by culling herds. Fewer hogs and cattle
coming to market next year mean that prices should rise, according
to the USDA's World Agricultural Supply and Demand Estimates
(WASDE) surveys. By this time next year, global beef production
should be -4% lower. (Pork production is slumping now, but is
expected to rebound by the second half of 2011.)
So if expenses are rising for all protein producers but the revenue
pictures are diverging, investors need to be selective. Smithfield
Foods, which focuses solely on the pork market, is looking
increasingly attractive, as the company should benefit from surging
pork prices. Goldman Sachs expects hog prices to rise +25% to +30%
next year, which should be more than enough to offset rising feed
costs. If feed costs pull back to historical levels, then earnings
could really take off. After a recent pullback, shares of
Smithfield Foods trade for less than 10 times projected 2011
A long-term shot at poultry
Even as poultry producers are struggling from near-term expense
hikes, their shares are setting up for a long-term buy. That's
because these stocks tend to rise and fall in conjunction with
earnings forecasts. Those forecasts have been cut lately, and
shares of Sanderson,
Pilgrim's Pride (
now trade closer to their 52-week low than their 52-week high. Yet
estimates should soon hit a bottom -- and so should share prices.
Looking into 2011, other factors are conspiring to take profit
forecasts back up. For example, poultry exports to China and Russia
are finally starting to rebound after recent embargoes were lifted.
And poultry producers have a much greater ability than pork and
beef producers to alter industry supply dynamics, as it takes much
longer to fatten a hog or cow. As a result, poultry production is
likely to peak in the first half of 2011 and start dropping from
there as farmers realize lower prices and move to bring supply back
in line with demand.
Shares of the major poultry producers are trading for around eight
times next year's downwardly revised 2011 profit forecasts. An
expansion of the multiple to around 10, coupled with an
eventualuptick in forecasts, should set the stage for meaningful
upside -- once this current round of rising feed costs have been
cycled through to the investment community.
Action to Take -->
Smithfield's pork focus makes its shares attractive right now.
Investors need to show more finesse with the poultry stocks,
however. Wait until quarterly results are out and lagging analysts
finally reduce their estimates. Once that happens, forward
estimates are likely to find a floor -- as are share prices. As
estimates start to rebound in ensuing months, shares are likely to
rebound at an even more robust clip as the
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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