A few years ago, chicken was all the rage. Healthier than beef! Less fat! Less cholesterol! But something has changed, and the public companies that produce chicken have been suffering. There are many crosscurrents at work here, but the primary movers are falling demand for chicken and the cost of corn (used as feed), which is tied to the commodities market.
The advantage is that chicken producers can control the bird population, which affects the supply market. So during the economic crisis, when people ate out less, demand fell. Meanwhile, demand for corn increased in foreign markets and for domestic ethanol production.
In response, producers have been lowering the chicken population recently in order to restrict supply. And it isn’t just whole chickens that influence the market. Demand for various chicken parts need to be managed. All of this makes margins volatile.
The stocks are facing challenges. Sanderson Farms (NASDAQ:SAFM) recently missed its expected earnings number. In FY 2011 the company lost money due to an almost 30% increase in costs. This latest quarter resulted in a $30 million loss. Sales increased 6%, but costs increased 31%. Ouch. The company was free-cash-flow negative in FY 2010 and FY 2011, and operating cash flow was negative in FY 2011.
The balance sheet is O.K., but not great, with $273 million in debt. Because of the company’s volatile earnings history, it’s tough to peg a fair value for the stock. But what I can say is that I am not comfortable with it at 14x this year’s earnings, with negative cash flow. I would sell if you hold it. If the cash-flow situation remains bad this year, consider shorting.
Pilgrim’s Pride (NYSE:PPC) isn’t faring any better. The company saw flat sales on a quarterly comparison basis and an $85 million loss. Sales increased 9.5% on an annual basis, but like Sanderson, huge cost increases resulted in a $497 million loss. Double ouch. Adjusted EBITDA was -$150 million, so again we have a negative cash-flow situation.
In this case, though, the company has $1.4 billion in debt. This means four straight years of negative free cash flow. I think the company is in a very difficult position, and at $6 a share, I would sell and consider shorting.
Tyson Foods (NYSE:TSN) is the biggest player in this space. It’s also diversified across all kinds of prepared foods, including beef and pork. Unlike its chicken-focused peers, Tyson has solid free cash flow, ample cash at $716 million, with $2.1 billion in debt and more predictable earnings.
The company trades at 9x this year’s estimates, consistent with its growth rate, and at only 1.2x book value. If you want to be in this space, Tyson is the best choice, but I think you can find other 9% growers in other sectors that are better bets.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.