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The meat industry's choicest cuts
Sharp increases in prices, rising demand and tighter supplies have boosted the bottom lines at companies that produce beef, chicken and pork. And it may be a while before there are big price breaks. Here's a look at five top names.
By Michael Brush
Mad cow disease -- that devastating affliction that can enter the food chain and take the lives of humans -- popped up again in the headlines over the weekend when the Agriculture Department reported fresh signs of the ailment in the United States.
But come Monday morning, investors in meat producers such as Tyson Foods (TSN, news, msgs) didnt even bat an eye. Instead, at least in the early part of the day, they drove the stock higher, along with the rest of the market.
And you can hardly blame them.
For one thing, the new mad cow scare was based on a preliminary test, so it may turn out to be no big deal. But bigger forces are getting the juices flowing among investors in our countrys meat producers. Prices for chicken, pork and beef are at multiyear highs, after rising anywhere from 30% to 70% in the last year. And they could go even higher.
For consumers, that means Fourth of July barbecues will be more expensive this year. For investors, it means some stocks look tasty.
Given the impressive momentum in these stocks, should you jump aboard and join investors who are bullish on hogs, bulls and chickens? The short answer is yes, because it looks as if prices will at least hold steady, if not continue to rise.
Just keep in mind two caveats: First, two of the major meat producers in the U.S. Pilgrim's Pride (PPC, news, msgs) and Hormel Foods (HRL, news, msgs) -- look expensive. Better to go with the cheaper producers, or Sanderson Farms (SAFM, news, msgs), Smithfield Foods (SFD, news, msgs) and Tyson.
Next, these arent buy-and-hold stocks. You need to watch the underlying fundamentals closely. Meat, after all, is a commodity. And as any investor knows, the prices of commodities, whether computer disk drives, basic metals or pork bellies, can swing wildly as new supply comes on line or demand falls off. For now, however, it doesnt look like meat prices are going to plummet. Heres why.
Demand for meat remains very strong
You can chalk that up to the Atkins diet craze, of course. Atkins dieters avoid carbohydrates, but they are allowed to eat just about as much meat as they want. It looks like they are doing just that. We dont have any hard data to support this, but we do know that demand for our product has increased as a result of these high-protein diets, says Michael Cockrell, the chief financial officer at Sanderson Farms, which produces chicken.
Indeed, a survey by Morgan Stanley this spring found that 43% of adults were eating more chicken compared with a year before. Demand for beef is up, too, for the first time since it got a bad rap 20 years ago as a coronary risk. Experts say the economic rebound has also helped spur the demand for meat, since consumers can now afford to put more of it on their tables.
Supplies arent yet going up
Constrained supply growth is key for investors in companies that produce a commodity such as meat, because it means prices will continue to stay strong, or even go higher. Normally, when the price for a commodity goes up, producers expand a lot and that makes prices fall sharply. That will happen sooner or later in this market. But it doesnt look like it will play just yet. Why not?
Lets take chicken first. Suppliers suffered a quick and bloody downturn in prices in 2002 when Russia embargoed U.S. chicken in retaliation for U.S. limits on Russian steel imports. About 8% of our supply came back on the market, and there was an exceptional amount of red ink in the industry, Cockrell says. Producers went bust and shut down. Others were snapped up in an industry consolidation.
Now, demand is back. Theres Atkins, and Russia began buying again last year. Another positive for U.S. producers: Many Asian suppliers were shut down when the avian flu hit their farms, taking about 4% of the supply of chickens off the market this year.
Now, even though prices have shot up, chicken producers are cautious about opening new plants, because they are still shell-shocked by what happened in 2002. That is fresh on their minds, and on the minds of their bankers, says Cockrell. Aside from an expansion in the works by Sanderson Farms, no new plants have been announced. It takes about two years to get one up and running, says Cockrell. So it doesnt look like supply is going up any time soon.
Thats definitely the big driver, strong demand for chicken and modest supply increases, says Lance Swanson, an analyst with OTC Insight, which recently put a "buy" recommendation on Sanderson Farms, despite the commodity pricing risk. OTC Insight is one of the top 10 performing investment newsletters over the long term, according to Hulberts Financial Digest.
We continue to believe that the overall U.S. chicken market is in the middle stages of a recovery, agrees Kenneth Zaslow of Morgan Stanley. One key number to watch is a weekly report by the USDA on increases in the breeder stock. It is up about 2% compared to a year ago. But that is not enough to make a difference.
What about the market for cattle and hogs? Here, supply looks even less likely to shoot up overnight for a simple reason. While chicken producers can grow a bird in just 58 days, it takes 12 month to 24 months to raise a steer, six months or so to raise a hog. The USDA thinks U.S. beef production will fall by 3% this year, in part because cattle growers are holding on to heifers to rebuild cattle herds. We remain in a multiyear supply cycle downturn, says Jonathan Feeney, an analyst who follows the sector for Wachovia. Breeding inventory for hogs, meanwhile, continues to decline, according to the USDA, which means pork supply should continue to be restrained.
Foreign demand should continue to increase
The U.S. is the worlds biggest meat supplier, and foreign demand will continue to increase for two reasons. First, the weak dollar helps make U.S. meat look cheap in foreign countries. Next, barring news of more mad cow or avian flu in the United States, important markets for U.S. meat -- such as Japan -- could reopen in the next six months. We expect many key countries to lift their bans, Wachovias Feeney said.
Heres a closer look at five big meat producers in the United States:
Sanderson Farms
Based in Laurel, Miss., Sanderson Farms is the seventh-largest chicken producer in the country, supplying supermarkets in the Southeast and Southwest such as Safeway (SWY, news, msgs), Kroger (KR, news, msgs) and Winn-Dixie Stores (WIN, news, msgs). Sanderson Farms is the cheapest among the major meat producing companies. Thats one reason OTC Insight recently added the company to its buy list. The company trades for about 10.3 times forward earnings, compared with 15.4 times for Pilgrims Pride. This discrepancy seems unjust to us, in light of Sanderson's superior profitability, says OTC Insights' Swanson.
Tyson Foods
Based in Springdale, Ark., Tyson Foods dominates the market for chicken and beef. Indeed, its the worlds largest processor of chicken, beef and pork. That means Tyson will be one of the biggest winners if Japan and other countries lift bans on U.S. meat imports later this year. Tyson is also building up its lines of branded, prepackaged frozen and refrigerated foods, which should help boost profit margins. The company is using its cash flow to bring down debt. That should lower interest costs by $35 million next year, says Feeney.
Smithfield Foods
Based in Smithfield, Va., Smithfield Foods is the largest hog producer in the United States. Its beef packing business is the nations fourth largest. Smithfield gets about 35% of its revenue from fresh pork and 25% from beef production. The rest comes chiefly from processed meats. Thanks in part to Atkins, its beef division recently turned profitable.
Pilgrim's Pride
Analysts have been bumping up the earnings estimates aggressively for this Pittsburg, Texas-based company because its underlying chicken business is so strong. But the stock has had a great run, tripling over the past 12 months to hit $30 recently. Thats why Diane Geissler at Merrill Lynch recently cut her rating on the stock to neutral from buy. "While we believe earnings are likely to be robust in the upcoming quarters, we believe this is currently priced into the stock," she says.
Hormel Foods
Besides fresh pork, this Austin, Minn.-based company brings well-known processed foods to the table, including Spam, Hormel and Stagg chili, Cure 81 hams, Dinty Moore stews and Jennie-O turkey. Thanks in part to Atkins, bacon, pork and beef sales were up anywhere from 20% to 40% in the most recent quarter. But this companys stock has had a nice run and now looks expensive. At $31.50, the stock has a forward price-to-earnings ratio of 18, well above the group average. At these levels, it even trades $1.50 above the 12-month price target of $30 set by Prudential analyst John McMillin.
Risks
Whats on the horizon that could make meat prices fall considerably and bring these stocks down to earth? Analysts say you need to monitor two main risks. First, a country like Russia might block imports again, because of some geopolitical trade row. Second, an outbreak of disease in the United States could be devastating. U.S. chicken producers got hit with a less virulent strain of the Avian flu than the form that hit Asia earlier several months back. But if the nastier kind broke out here, foreign embargoes on our chicken would mount.
Next, ever since mad cow turned up in a single Holstein in Washington state last December, the USDA has been gearing up for broader testing. No one thinks the disease is prevalent in the United States, but stepped-up testing could prove otherwise.
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