Chicken Producers For The Win

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 |  Includes: PPC, SAFM, TSN
by: Louise Coleman

Summary

Demand has shifted as consumers move from beef and pork to healthier, lower-cost chicken.

Continuous growth is expected by chicken producers Sanderson Farms and Pilgrim's Pride, compared to industry peer Tyson Foods.

Corn and soybean meal prices are potentially detrimental to this growth, but key indicators show little reason for concern.

As investors become more confident that the economy is in fact growing, money is moving from utilities into consumer staples. Attention is turning to the food-meat products industry group, where a demand shift is occurring.

Low supply of beef and pork, a subsequent price spike in these meats, and a more health-conscious consumer have initiated buyers' appreciation for cheaper chicken. This is good news for chicken producers Sanderson Farms, Inc. (NASDAQ:SAFM) and Pilgrim's Pride (NASDAQ:PPC).

The last few fiscal quarters has seen Pilgrim's Pride exhibit strong profit growth. Its 10-Q filed May 1 reported an 81.06% increase in net income compared with the same quarter in 2013, rising from $54.2 million to $98.1 million. Since its filing on May 1, 2014, the stock has risen 14.8% as of May 21 and is expected to climb higher as the chicken industry continues to improve.

This is a telling sign of what could happen when its competitor Sanderson Farms, Inc. files its second quarterly report on May 29. Comparing the first quarters of 2013 and 2014, Sanderson Farms increased its net income by 515.8%, from -$6.94 million to $28.87 million. Its earnings per share for the past and previous fiscal year further demonstrate a pattern of increasing earnings, with earnings of $5.67 per share compared with $2.34 previously. This year the company expects a further increase to $7.23.

As it stands, both stocks currently appear to be undervalued. Their current TTM P/E ratios sit below the industry average, with Sanderson Farms at 11.73 and Pilgrim's Pride at 10.97, vs. the industry P/E ratio of 25.7.

Compared to their strong industry peer Tyson Foods (NYSE:TSN), Pilgrim's Pride and Sanderson Farms are well positioned. Pilgrim's Pride has a strong distribution chain driven by partners such as Burger King (BKW) and Yum Brands (NYSE:YUM). It is also one of the biggest producers of antibiotic-free, or ABF, chicken. While the market for ABF chicken is still emerging, this position is an important string to the bow of Pilgrim's Pride, as on the obverse side Tyson's share price has dropped more than 10% due to bird and hog virus outbreaks affecting its second-quarter results.

Sanderson and Pilgrim's Pride are also a better value than their peers. In comparison, Tyson's trailing P/E ratio of 15 is expensive. Additionally, both Sanderson and Pilgrim's Pride have stronger net profit margins when compared to Tyson's 2.8%, with Sanderson at 6.2% and Pilgrim's at 7.07%.

A risk that is potentially harmful to the share price of both Pilgrim's Pride and Sanderson Farms is industry fluctuations in prices for feed. Corn and soybean meal have been in low supply due to a harsh winter, pushing up the costs. This did not dramatically affect Sanderson Farms' first-quarter profits, and should affect its second quarter even less. Looking longer term, both corn and soybean sales and exports upturned quickly last week, and the World Agricultural Supply and Demand Estimates (WASDE) recently released by the USDA states there will be an abundant supply for the 2013/14 (ending in May) and 2014/15 years.

As a whole, the food-meat products industry is currently ranked an outstanding six on IBD's list of 197 industry groups, up from rank 53 eight weeks ago. With consumer drive heading toward healthier eating as well as the unwavering pursuit of cheaper groceries, the emerging superstars of this industry group are the primary producers of the staple that ticks both boxes: chicken. While Sanderson Farms was recently downgraded by Goldman Sachs from "buy" to "neutral" due to a valuation call, clearly there's potential behind both stocks. These companies have displayed continuous growth and are expected to move higher within their industry. The numbers, supported by this chicken transition, strongly suggest a buy and a long-term hold of these two stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.