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Sanderson Farms, Inc. (SAFM), incorporated in Mississippi in 1955, is a fully integrated poultry processing company engaged in the production, processing, marketing and distribution of fresh and frozen chicken products.

The company sells ice pack, chill pack, bulk pack and frozen chicken, in whole, cut-up and boneless form, primarily under the Sanderson Farms® brand name to retailers, distributors, and casual dining operators principally in the Southeastern, Southwestern, Northeastern and Western United States, and to United States-based customers who resell frozen chicken to export markets.

During its fiscal year ended October 31, 2010, the company processed 405.0 million chickens, or approximately 2.57 billion dressed pounds.

Basis

Financial information presented herein is based on the company's most recent SEC Form 10-K filing for year ending October 31, 2010, as filed with the Securities and Exchange Commission on December 14, 2010.

Short-Term Investment Valuation

The stock closed recently at $40.34, with first resistance at $44.50, a 10% increase from the recent close, and second resistance at $44.86, an 11% increase from the recent close. Should the stock price breakout above second resistance, the next resistance level is $49.47, a 23% increase from the recent close. The stock should find support at $38.177, a 5% decline from the recent close.

Earnings Growth Valuation

Earnings growth valuations are based on the spread between year-over-year earnings growth and the current P/E. In the case of Sanderson Farms, Inc., the company had a year-over-year earnings growth of 53%, ending FY10 with earnings of $8.45 per share. With a trailing-twelve-month P/E currently at 5, the spread between earnings growth and the PE is 11.4, meaning that for an investor focusing on earnings growth, the stock should be trading at $136.47, a $96.13 increase from a recent close.

Fundamental Investment Valuation

Liquidity: The company ended FY10 with a current ratio of 3.23, a quick ratio of 1.55, a cash ratio of 0.69, and a cash conversion cycle of 42 days. In addition, with goodwill and intangibles comprising 0.0% of total assets, the company ended the year with a book value of $29.22 and a tangible book value of $29.22.

Profitability: FY10 found the company with a gross margin of 18%, an operating margin of 13.5%, a net operation margin after taxes of 9.7%, a return on invested capital of 28%, and an effective tax rate of 35%.

Debt: The company ended FY10 with total debt of $65.2 million, a year over year decrease of 43%. Additionally, the company paid an average annual interest rate 4.14%, a year over year decrease of 4.3%, had a debt to cash ratio of 0.89, and a debt to equity ratio of 0.10.

Cash Flow: The company's FY10 operating cash flow was $10.58 per share, a year over year increase of 19%. The company also ended FY10 with free cash flow of $3.39 per share, a year over year decrease of 52%.

Dividends: During FY10 the company paid a $0.63 per share dividend, a 9% year over year decline.

Fundamental Valuation: Based on our review of the company's latest annual financial information, we think a reasonable value estimate for the company is in the $67-$72 range.

Value Thoughts

Considering a recent close of $40.34, an estimated M&A payback of 3.5 years (assuming EBITDA remains the same), and year-over-year earnings growth of 53%, we think on a fundamental investment basis, the stock is currently underpriced, and a candidate for additional research for the Wax Ink Portfolio.

Disclosure: We have no position in Sanderson Farms, Inc., and no plans to initiate a position in the next 5 business days. Additionally, we have received no compensation to write about a specific stock, sector, or theme.

Source: Sanderson Farms: Underpriced And Worth A Closer Look