Sanderson Farms And Cal-Maine - Sensitivity To Corn And Soybean Meal Pricing

Summary

• This past week, an initial report was out illustrating a spike in both corn and soybean meal commodity prices; over the weekend prices peaked.
• Naturally, companies exposed to these feed costs, notably Sanderson Farms and Cal-Maine, were negatively impacted.
• Fortunately, the July 12th 2017/2018 annual report suggested that corn pricing may not rise as much based upon increased planted and harvesting areas.
• For each company's respective business cycle, Cal-Maine stands to benefit the most in the event feed costs remain lower for longer.

Source: Google Images

Review

Investors were provided two reports regarding corn and soybean meal pricing over the past week. On July 5th, Seeking Alpha announced that Bloomberg reported that soybean commodity prices had been up for seven straight days while corn prices were up for six straight days.

The focus of this article was on meat producers as Sanderson Farms (SAFM), Tyson Foods (TSN) and Pilgrim's Pride (PPC) were all down for the day. Despite meat producers being down, both Sanderson Farms and Cal-Maine Foods (CALM) did not witness significant weakening the following days as last week wrapped up.

The weekend of July 8th, corn prices finally generated a year-over-year (YoY) increase, the first of 2017. For East Iowa, low and high bid levels increased by 12 and 7 percent, respectively, from last year during the same week. In Chicago, bid levels were up 9 and 11.6 percent. On a week-over-week (WoW) basis, low and high bid levels were up from 6 to 8 percent.

For soybean meal, a similar WoW increase occurred with low and high bid levels increasing from 7 to 8 percent for both Iowa and Chicago. However, YoY prices for both regions remained down substantially from the previous year's week from -17.6 to -24.4 percent.

After the weekly data was digested for the remainder of 2016, corn prices were poised to potentially exceed last year's levels for July through December. For soybean meal, it was less clear whether the weekly increase would lead to an uptrend capable of exceeding last year's prices on a consistent basis over the same period.

Source: Yahoo! Finance

Regardless, both Sanderson Farms and Cal-Maine reacted strongly to the downside on Monday, July 10th, the trading day after the first weekend where corn prices were higher from last year. This occurred prior to July 12th, where the 2017/2018 annual update for world agricultural supply and demand estimates would be disclosed. This annual report is important as it pegs corn and soybean meal production and pricing based upon the June 30th acreage report.

The key observation from the reaction to increasing feed costs was Cal-Maine's substantial weaker stock price performance versus Sanderson Farms. Also of interest was Cal-Maine's lack of reaction once the July 12th report was publicized, upon which expectations for corn pricing increases were reduced. The stock remained weak for most of the day before turning positive. Sanderson Farms meanwhile was up strongly. Soybean meal prices were increased from the July 12th report, but as stated earlier, still have further to go before getting to a weekly YoY pricing increase.

There is a fairly simple explanation to the divergence between Sanderson Farms' and Cal-Maine's stock price action after the July 12th report. Both companies provide their respective breakouts for their feed costs. Sanderson does this directly through its feed in broilers processed line item while Cal-Maine only discloses its farm production costs; the company does provide its feed cost per dozen, which can be applied to its dozens produced.

Over the most recent trailing twelve-month (TTM) period, Sanderson Farms' feed in broilers processed as a percent of total net sales was 33 percent. This was nearly identical for Cal-Maine. However, the pricing market for chicken products has been much stronger than that of shell eggs.

Whole bird fryer pricing for the retail markets 27 and 25 percent year-to-date (YtD) for the national and eastern region geographies. YoY, prices were up 15 and 10 percent respectively. Chicken parts pricing has been even stronger than Sanderson Farms' retail side. Based on these pricing trends, Sanderson Farms' GAAP profit margin was over 7 percent for the TTM period.

For Cal-Maine, the egg shell market as reviewed through pricing has been much weaker. Despite consecutive weeks of late where pricing had improved YoY, the most recent trends have displayed a return to weaker results with YtD shell eggs down at -49 percent and YoY results down at -15 percent. This type of inconsistency will continue to weigh on Cal-Maine's performance.

Over the TTM period, Cal-Maine had a GAAP loss of -$50 million. During the most recent quarterly report, the company's profit margin stood at 1.3 percent, nearly 600 basis points (bps) below Sanderson Farms' TTM results. It is to this point that the markets became very nervous of a scenario of increasing feed costs.

Management has stated that historically, feed costs have ranged from approximately 60 to 69 percent of farm production costs. On a TTM basis, feed costs reflected just below 59 percent of the total. Management has also stated that increases in feed costs unaccompanied by increases in the selling price of shell eggs could have a material adverse effect on operations. Today, shell egg prices are about as low as they can get.

Summary

Over the past week, we got a dose of reality regarding sensitivities to a scenario where feed costs could rise. Investors should consider this as a lesson learned, unless of course, you are very well-versed in commodities with a history of the many cycles.

The July 12th report was positive for both Sanderson Farms and Cal-Maine. Corn prices may not increase as expected earlier in the week while soybean meal prices are likely to witness higher pricing. The good news is that last year's baseline for the remainder of 2016 is high enough to create uncertainty as to whether soybean meal prices will increase YoY.

Cal-Maine will be the greater beneficiary as the egg shell market continues to work out the supply issues. Investors should keep in mind that any extreme weather issues could still lead to increasing feed cost prices. Additionally, expectations for next year could also begin to impact pricing expectations. As always and most importantly, keeping an eye on chicken and shell egg prices based upon supply and demand is always the primary focal point.

Analyst’s Disclosure: I am/we are long CALM, SAFM. 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.