by James Brumley | December 7, 2012 9:14 am
It’s possibly the first time it’s ever been written, but the truth is the truth no matter how weird it is — the meat industry has been beating the daylights out of the market over the past four months.
Yes … meat.
Tyson Foods (NYSE:TSN) and Smithfield Foods (NYSE:SFD) have rallied a respective 33% and 28% since Aug. 8, vs. the S&P 500’s whopping 0.56% rally for that timeframe. Even though Hillshire Brands (NYSE:HSH) and Hormel Foods (NYSE:HRL) have lagged the other two big names in the meat business, their respective 11% and 12% rallies have still been far more fruitful than an index fund would have been.
The big gains prompt a myriad of questions, like, for one, why, and whether more of the same is in the cards.
More than anything, though, investors might be wondering which of these names (if any) to get into now, in the shadow of a sizable run-up.
There’s not so much a bullish prompt for the meat industry as there is a lack of a bearish condition that was supposed to — but never did — materialize.
This summer’s drought was no small matter but was particularly painful for corn growers. Since corn is one of the key grains used to feed livestock, it was widely assumed that cattle, hog and chicken farmers would either have to raise their prices or cut production (or both) to absorb those higher costs. As it turns out, U.S. farms were able to harvest more corn than first feared, which in turn meant the pessimism surrounding meat producers was far more than merited; the recent rally reflects the dissipation of that fear.
In more direct terms, Smithfield survived the “Aporkalypse of 2012,” never really struggling to maintain the bacon output many figured was going to wither.
Farming — and livestock farming in particular — is a funny business. Investors and the media tend to view it as static and predictable, which is why soaring corn prices earlier in the year convinced many that meat producers were going to get squeezed into submission later on in 2012. But there’s more to it than that.
Sometimes there are lower-cost alternative feeds that may or may not be as impacted by a drought. Sometimes higher prices can be passed on to consumers, if the economy is strong enough.
Point being, it’s dangerous to come to any static conclusion about the industry. A good crop — or even just more rain — in 2013 could make this year’s corn crunch nothing more than a fading and irrelevant memory in the near future.
But, to the extent we can look at the future, yes, there’s more upside in the cards for the meat industry. We have to assume rainfall will return to normal next year, and we have to assume all four of these names will reach their slightly elevated target growth levels in 2013.
If there’s only room for one in a portfolio, however, which one should investors bite on?
Smithfield Foods was the last of the four major meat companies to report last quarter’s earnings, posting them Thursday, and they were good. Beyond a one-time accounting charge, the company earned 66 cents per share versus a year-ago number of 76 cents. On the other hand, earnings easily topped estimates of 44 cents. But is Smithfield the best of breed?
If earnings were the only measure of greatness, then Tyson Foods would be the top dog.
We’ve seen three earnings beats in the past four quarters from Tyson, and 12 beats in the last 16 quarters. Though the bottom line has ebbed and flowed a bit during that time — from 2010’s $2.19 per share to 2012’s $1.91 — TSN seems to deal with cost and price volatility almost strangely well.
Meanwhile, Hillshire Brands appears to have finally wrapped its hands around its challenges as of last quarter, earning 51 cents per share vs. estimates of 33 cents (and topping the prior year’s 10 cents). However, Hillshire has been inconsistent on the earnings front, missing estimates more often than beating them. It’s a sign the company might not have much of a cost-control plan in place.
Hormel Foods might have missed last quarter, but like Tyson, it has been eerily consistent with its earnings growth.
Thing is, even if they’re solid, earnings aren’t the only measure of greatness.
Smithfield Foods might be in the midst of celebrating Thursday’s good news, but once the dust settles, traders likely will remember that the company’s bottom line is erratic, and if nothing else, SFD shares are overbought right now. The same goes for Tyson, and though it superficially looks like it has value, the price/book value ratio of 1.18 is something of a red flag.
As such, Hillshire Brands and Hormel Foods are left standing as the last two contenders.
Neither is technically overbought, so newcomers don’t have to worry about waiting for the right entry point. So, since it comes down to basic value, Hormel’s the way to go.
Even without the reliable growth in its top and bottom line, it’s pretty clear the company not only has a cost-mitigation plan, but a cost-mitigation plan that actually works; CEO Jeffrey Ettinger specifically mentioned it a couple of times in the last earnings conference call, and the long-term results confirm its effectiveness. Simultaneously, most of HRL’s business lines saw sales growth last quarter, while other meat producers struggled on the revenue front.
In other words, whatever Hormel is doing, it’s working. Though it costs a bit of a premium to step in at 14.7 times next year’s forecasted earnings, this is one of those cases where you have to pay for quality.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
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