Monday, March 9, 2009

Marcial: Sanderson Farms, A Grade-A Poultry Play

Marcial: Sanderson Farms, A Grade-A Poultry Play

In this market, equity investors must sometimes feel like they're playing chicken with an oncoming freight train. (Guess who's winning.) However, there is one attractive chicken play that might help them sidestep disaster.

Sanderson Farms (SAFM), hardly a household name, is the fourth-largest U.S. poultry producer and processor—and a tempting pure play in chicken. Providing both fresh and frozen chicken products to food-service companies, restaurants, grocery stores, and supermarkets, Sanderson is poised to be the first outfit to gain from the imminent recovery of the chicken industry, some analysts assert.

In the pecking order of the poultry business, the leader is Tyson Foods (TSN), but it produces and processes not only chicken but also beef and pork products. It has 20% of the chicken market, vs. Sanderson's 6%. Tyson's 2008 revenues of $26.8 billion and market cap of $3.5 billion dwarf Sanderson's $1.7 billion and $675 million, respectively.

Lower Grain Prices Help

Pilgrim's Pride was the largest producer, with 24% of the market, until it filed for Chapter 11 bankruptcy in December. It has since closed three of its processing facilities. Privately held Perdue Farms is the third-largest producer, with an 8% share.

Some analysts contend that Sanderson's stock is the top choice in the industry. For starters, the stock has been agile and upbeat. It has gone from a 52-week low of 20 a share in mid-November to 33 on Mar. 6, trading at 9 times projected 2009 earnings of $3.66 a share. Tyson's stock has climbed from 4.40 on Nov. 20 to 7 on Mar. 6, trading at 18.8 times 2009 estimated earnings of 40 a share.

The chicken business has had little to crow about: Thus far in 2009, production is down 3% to 5%, with many producers still in the red and burdened by troubled balance sheets. Part of the problem was the rising prices of grain in 2008, which pushed up production costs. But the rise in commodity prices has abated, analysts note.

Although Sanderson beat consensus fourth-quarter earnings estimates, the company posted a loss of $2.13 a share for all of 2008. But based on the company's outlook, some analysts aren't feeling discouraged.

Balancing Supply and Demand

"Sanderson is well positioned to benefit from the recovery in the chicken industry," says Farha Aslam, managing director at investment bank Stephens (it has done business with Sanderson), who rates the stock overweight with a 12-month price target of 50. She raised her 2009 earnings forecast from $3.56 a share to $3.66. For 2010, she expects profits of $5.25 a share.

Aslam's outlook for the chicken market is "cautiously optimistic," as supply and demand appear to be coming more into balance, with prices showing signs of improvement. At the same time, she anticipates feed costs coming down this year. The analyst notes that Sanderson sees 2009 feed costs likely declining $166 million, or 6 a share.

"Investors can be confident in holding the stock through a volatile period in anticipation of an earnings recovery," assets Aslam.

"Best in Breed"

Sanderson produced 2 billion pounds of chicken, or 343.6 million chickens, in 2007 and owns 7 hatcheries, 6 feed mills, and 8 processing plants. The Mississippi company's products are sold under the Sanderson Farms brand name, sold mainly in the Southeast and the West.

"Sanderson remains best in breed in our view, as it is not only most capable to weather the storm but also will gain the greatest momentum in earnings power from the chicken margin recovery," says Kenneth Zaslow of BMO Capital Partners (BMO) (it has done banking for Sanderson), who rates the shares outperform with a 12-month price target of 50. He adds that notwithstanding persistently weak demand from food-service companies, earnings at Sanderson have hit bottom and have started to rise as prices—chicken breast meat prices, in particular—increased and feed costs declined.

Sanderson's most recent fiscal quarter results affirm "the bull case argument that the company is moving out of the trough," says analyst Christopher Bledsoe of Barclays Capital (BCS), who rates the stock overweight, with a higher 12-month price target of 58 a share. At its current price, Bledsoe says, the stock affords investors an opportunity to build positions ahead of expected earnings improvement throughout 2009, "with Sanderson's clean balance sheet providing a bridge to a potentially more favorable period." Any way you slice it, investors may find Sanderson an inexpensive way to add some protein to their malnourished portfolios.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

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