'The Next Hillshire Farms' Could Have 50% Upside

Whenever there is a bidding war on Wall Street, one company emerges as the victor, with the loser forced to regroup. Typically, the loser will then look for a consolation prize: another company in the same industry.

This could be what happens next as Pilgrim's Pride (Nasdaq: PPC ) and Tyson Foods (NYSE: TSN ) battle over Hillshire Brands (NYSE: HSH ) .

Only one company can win the bidding war for Hillshire Brands. Whichever company loses will likely then go looking for its next acquisition target -- but there are very few publicly traded meat producers.

I expect the next target for Pilgrim's Pride or Tyson ( one of my favorite stocks ) could well be Sanderson Farms (Nasdaq: SAFM ) , a $2.2 billion company that makes and sells chicken products in the U.S.

What makes Sanderson Farms an attractive target is that in the wake of rapid consolidation in the meat producer industry, there aren't many companies left to buy. For instance, pork producer Smithfield Farms was acquired last year by a Chinese firm for $7.1 billion to feed the growing demand for pork in China, the world's largest consumer of pork.

One of Sanderson's main competitors is Perdue Farms. Perdue is privately held, and Jim Perdue is likely not willing to sell his family legacy. That makes Sanderson Farms one of the few large integrated chicken companies left to buy.

Sanderson Farms has benefited from a perfect storm of tailwinds. For one, grain costs to feed its chickens have come down greatly. Corn prices are down 34% from a year ago. For Sanderson Farms, this translated into total savings of nearly 20% on this year's feed costs, which boosted profits.

Second, the price of beef has been on the rise, pushing cash-strapped consumers to buy chicken, which is cheaper. This should help boost demand during this summer's grilling season.

These tailwinds have been showing up in Sanderson's impressive earnings. Last month, the company reported earnings per share of $2.21 in its most recent quarter, beating consensus estimates by $0.50 and more doubling the $1.06 a share it earned in the same quarter last year. Revenue came in at $661 million, almost $40 million higher than expected.

With $84 million in cash on hand and just $30 million in debt, Sanderson's financials are sound. Its dividend yield of 0.9% is equal to a 9% payout of earnings, meaning the company has plenty of room to increase its distribution. Additionally, with a beta of just 0.05, SAFM is a very stable stock relative to the broader market.

Even if it isn't acquired, Sanderson still looks inexpensive, even after a 40% gain over the past year:

SAFM data by YCharts

SAFM is trading at multiples of 13.3 times next year's earnings and 0.8 times sales, and has an enterprise value-to-EBITDA (earnings before interest, taxes depreciation and amortization) ratio of 5.8. Compared with Hillshire Brands, Sanderson appears to be a much better deal: Hillshire is trading at 29 times next year's earnings, 1.8 times sales and an EV/EBITDA ratio of just over 13.

Risks to Consider: SAFM have already gone on a nice run as merger speculation has heated up, and investors that have already purchased shares could take profits if a deal does not happen in the next few months.

Action to Take --> Assuming SAFM should be trading more in line with Hillshire at a forward P/E of 20 leads to price targets of $115 based on the lowest analyst earnings estimate of $5.75 a share, for upside of 20% -- and $146 based on the consensus estimate of $7.32 a share, representing 50%-plus upside.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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