|
Published: October 13, 2010
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 (NYSE: LNN) have surged more than +10% since
last Thursday, while Deere (NYSE: DE) 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
earnings 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 profits.
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, Tyson (NYSE: TSN) and Pilgrim's
Pride (NYSE: PPC) 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 eventual uptick 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
P/E multiple expands.
-- David Sterman
Staff Writer
StreetAuthority
P.S. Investing in dividend-paying stocks is one of the
most profitable ways to beat the market. For more on stable
stocks that will grow your money with ever-increasing dividends,
see Carla Pasternak's latest course,
The 5 Rules Every Income Investor Has to Know. |
