by Daniel Putnam | July 12, 2012 9:35 am
The surging price of corn might have fueled a blistering rise of more than 30% in the Teucrium Corn Fund (NYSE:CORN) in the past month, but it has hammered the stocks of food companies that rely on the grain as one of their key inputs.
Diversified meat producers Tyson Foods (NYSE:TSN) and Smithfield Foods (NYSE:SFD) have lost 10.9% and 7.6%, respectively, since June 19, while chicken processors Pilgrim’s Pride (NYSE:PPC) and Sanderson Foods (NASDAQ:SAFM) have shed 28.4% and 17.7%, respectively. The concern is that all four will see their feed costs soar, crimping their already-thin margins and eroding their profitability.
These smaller food stocks have suffered much more than large-cap companies for which corn is an input, such as Coca Cola (NYSE:KO), McDonald’s (NYSE:MCD) and General Mills (NYSE:GIS) — all of which have held up well through the spike in corn prices thus far.
The meat producers aren’t typically a favorite for short-term traders, as they tend to have modest volume and betas below 1. The sector is beginning to receive more attention in the wake of corn’s run-up, however, fueling extremely high volatility and causing trading volumes to pick up considerably. This might signal an opportunity for those willing to take on the elevated risk in this group.
Several factors support the case for buying into the meat producers here.
For Tyson, Sanderson, Pilgrim’s and Smithfield to remain at these depressed levels, two events would have to happen. First, the corn price would need to keep rising. The market is anticipating a continuation of the drought, so any better-than-expected news on this front would drive these stocks higher. Second, the market is assuming that the food companies won’t be able to pass along rising costs to consumers. This might indeed prove to be the case, but here too there is room for an upside surprise if this concern proves unfounded.
This risk/reward profile warrants attention given the low valuations in the sector. And even if analysts reduce their earnings estimates for these companies, the elevated corn price is a 2012 story and not one likely to affect the 2013 estimates upon which these P/Es are based:
Two other factors indicate that these stocks are shaping up for a nice trade from the long side:
Finally, a look at the past three years shows that on balance, these stocks have comfortably outperformed the broader market in the fourth quarter — indicating that seasonality will soon be working in the meat producers’ favor.
|4Q 2009||4Q 2010||4Q 2011|
The primary case against investing in these names is what we already know — at this point, they are being held hostage by the outlook for weather in the Midwest. If the drought continues and the outlook for this year’s harvest keeps deteriorating, it will be difficult for these stocks to make any short-term headway regardless of their P/Es. As a result, investors who buy any of these names are taking on substantial commodity-related risk.
It’s also likely that the sector will face additional negative news flow in the form of analyst rating cuts and reduced earnings estimates in the weeks ahead.
It’s a tough time to catch a falling knife given the combination of weak stock market performance and the challenging outlook for the corn harvest, but consider these four food stocks for a trading buy. And for those looking for a way to bet against corn after its sharp run-up, valuations make these stocks a lower-risk way to make the trade than shorting the corn ETF.
However, commodity prices can run much further than investors anticipate, so be sure to use tight stops if you attempt to bottom-fish in this group.
As of this writing, Daniel Putnam owned shares of PPC.
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