Sanderson Farms Jumps from Fryer to Fire

Small Cap and Mid Cap Watch List member Sanderson Farms (SAFM) Released disappointing earnings (compared with analyst estimates of a ($0.07) loss on $277 million in sales):

Net sales for the first quarter of fiscal 2007 were $292.7 million compared with $236.2 million for the same period a year ago. For the quarter, the net loss was $2.8 million, or $0.14 per diluted share, compared with the net loss of $8.6 million, or $0.43 per diluted share, for the first quarter of fiscal 2006. Operating income for the first quarter of fiscal 2006 was reduced by incurred but unrecognized lost profits and expenses of approximately $3.0 million related to losses sustained as a result of Hurricane Katrina.

While fading bird flu fears helped stabilize poultry prices, demand for corn-based ethanol has caused feed prices to soar.

"While all of these factors, along with the favorable trends in chicken prices, are positive indicators for our business going forward in fiscal 2007, we expect our feed costs will continue to rise," [CEO Joe] Sanderson continued. "The demand for corn from ethanol producers is affecting market prices for corn and soybeans. However, we remain confident that the chicken and grain markets will strike a favorable balance over time."

Accounts receivable and accounts payable both rose far faster than sales. Sanderson Farms also released its 10Q yesterday, so we turned to that for more information. While the company did not address the receivables and payables directly, they did note that:

The additional pounds of poultry products sold can be attributed to the new complex in South Georgia, which began operations during the fourth quarter of fiscal 2005 and was ramping up production during the first quarter of fiscal 2006, and increased pounds of products sold at the Collins, Mississippi processing plant, which was down for one week during the first quarter of fiscal 2006 to allow for the conversion to serve the big bird market from the chill pack market.

The Company also sold fewer pounds during the first quarter of fiscal 2006 due to the destruction of inventories during Hurricane Katrina that would have been available for sale during the first quarter of fiscal 2006. In addition, the disruption of shipping caused by Hurricane Katrina and sluggish demand resulting from the appearance of H5N1 in certain countries in Asia and Europe during the first quarter of fiscal 2006 postponed the sale of certain export products until later in fiscal 2006.

It is possible that the delays caused an overall operational slowdown in Q1 2006 that caused both receivables (no sales to collect on) and payables (no new orders to pay suppliers for) to be artificially low.

However, turning to the 2006 10Q doesn't bear that out. Both were down, but only slightly. The reason for concern is that cash is relatively low, and if the company is having problems collecting on its sales it may be pushing out its own payments. As any credit card holder knows, that can be a costly decision.

Disclosure: The author may hold a position in the securities discussed. The author's current holdings are as follows: Long: Union Pacific (UNP) put options; Air Products (APD) put options; Bookham (BKHM; Ballard Power (BLDP); Syntax Brillian (BRLC); CMGI (CMGI); Genentech (DNA); Ion Media Networks (ION); Three Five Systems (TFS); IShares Japan (EWJ); StreetTracks Gold (GLD); Starbucks (SBUX); U.S. Oil Fund (USO); Plantronics (PLT) call options; Short: Landstar (LSTR) put options; Plantronics (PLT) put options

SAFM 1-yr. chart:

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