Earnings Trade - Smithfield Foods-SFD

Earnings season is becoming a distant memory. Actually, using Alcoa (AA) as a measuring stick, we’re closer to the start of next quarter’s season (which begins Jan. 11) than the beginning of last season (Oct. 7).

For the next few weeks, we’ll be occupied with the holiday shopping season and the impact on the retail sector, along with the usual end-of-year “look-back” articles. Plus, we’ll hear plenty of inane predictions about 2010. Before you know it, Jan. 11 will be right around the corner.

Despite this being the earnings off-season, so to speak, eight S&P 500 companies report next week, along with a few other familiar names.

Driveway mechanics will be in the spotlight, with earnings from AutoZone (AZO) and Pep Boys (PBY) on the docket. Retail of various stripes will also be featured, with reports from Costco (COST), Men’s Wearhouse (MW), Dollar General (DG) and Casey’s General Stores (CASY). Food will also get some play, with Kroger (KR), Smithfield Foods (SFD) and Brown-Forman (BFB) (OK, they’re into alcoholic beverages, but that’s kind of related).

I want to focus on one company that I find intriguing from a historical perspective. It’s Smithfield Foods (SFD), a packaged meat products company that operates in the same space as Hormel Foods (HRL) and Tyson Foods (TSN).

It hasn’t been a particularly kind season for this segment of the consumer goods sector. Both Hormel and Tyson beat earnings estimates this quarter, but the stocks were beaten lower because either sales or revenue disappointed the Street. That may prove to be a silver lining for SFD, though, as expectations for the group may have been lowered.

Actually, expectations for Smithfield are already low. The company reports before the bell on Dec. 10, and analysts expect a loss of 37 cents compared to a 21-cent loss a year ago.

And it’s not surprising analysts aren’t expecting much. SFD has lost money for the past five quarters and missed the consensus estimate in four of those quarters.

But here’s the kicker: The stock has done great after those reports.

During the past four quarters, the shares have zoomed an average of 14% higher in the first week and an astounding 29% higher two weeks after each report. That’s nuts.

Given that the company missed estimates in three of those quarters, the only explanation is that the expectation bar for SFD was scraping bottom.

SFD’s chart provides some additional hope. The stock has been pulling back from an annual high for the past three weeks. But that decline appears to have been stopped by the 20-day moving average. The stock now has about 10% of upside before hitting the November high, something that is well within reach given Smithfield’s recent post-earnings history.

The final piece of the Smithfield puzzle is sentiment, which is aligned against the shares. Just two of 13 covering analysts rate the stock a “buy,” while four consider SFD a “sell.”

The put/call ratio is meandering in the upper half of its yearly range, while the short-interest ratio sits at a very robust reading of 7.9.

Thus, SFD could benefit from analyst upgrades and a short squeeze.

The beauty of this play is that all Smithfield basically has to do is avoid a total meltdown in its earnings report and outlook. With expectations so low and history on our side, the post-earnings path of least resistance appears to be headed sharply higher. So think about purchasing call options on SFD ahead of earnings.

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