Pilgrim's Pride (ticker: PPC) reported Q2 fiscal 2011 earning before the bell on Friday Morning (July 29th, 2011). They posted a much wider-than-expected second quarter loss of (0.60) vs. (0.23). That is almost 200% more of a loss than expected. Granted their net revenue was up, $1.92B vs. $1.81B Est. but if you are selling chicken at a lower price than it cost you to produce it, is that really considered a positive? The stock price opened considerably lower, as I would have expected, but then promptly spiked up over 4% above the previous close as the conference call was in progress. After the conference call the stock price faded for the remainder of the day and manage to finish down only 3.23%.
The company blamed higher feed costs and low demand for the massive earnings miss. The conference call, in my opinion, did nothing to indicate that they had a comprehensive, feasible plan to swing this company into profitability. They seem to be caught flat-footed by rising feed costs and low demand. Management said they were surprised by lack of demand but they expect to raise prices to offset the higher costs. Basic economics says that raising prices in the face of low demand and stiff competition is not a winning strategy.
Announcement of the closure of its chicken-processing plant in Dallas, Texas, seemed to be received by investors as positive news. Closing the plant will cut costs but, in my opinion, reducing the company’s size and laying off workers in the face of falling margins and demand is not a sign that the company is succeeding.
Another inexplicable reaction by shareholders was the response to a July 21th product recall. A recall of ready-to-eat chicken products before they reached grocery stores due to potential contamination from Listeria Monocytogenes did not adversely affect the stock price. In fact, the price per share actually ended up 11% on the day of the announcement. The favorable reaction was due to the fact that the company took action quickly and decisively to protect consumers. This favorable reaction was somewhat baffling to me. How is almost selling contaminated product to consumers view as a positive. Coupled with the fact that thousands of pounds of product had to be destroyed and written off as a loss.
CEO Bill Lovette explained the heavy losses by saying, "Our second-quarter financial results reflect the significant challenges facing our industry this year from the combination of record-high feed costs, weaker-than-expected consumer demand and an oversupply of chicken." He also confirmed that they were caught by surprise at the low demand by saying, "At this time of year we are usually benefiting from stronger market pricing and increased demand from both foodservice and retail, but to date neither that demand nor pricing has materialized."
The Q and A part of the conference call did nothing to bolster my confidence that management actual had a turn-around plan in place. When asking about the burn rate of $350 million of credit they had left. The analyst stated that they had burned through $247 million in the 1st half of year and asked if it was fair to assume that at this pace they would burn through the remaining credit in 9 months. Their answer was, “well, we don’t expect that.” Yet they didn’t give a clear picture of how they would avoid burning through their remaining credit, and, if they did manage to slow the burn rate, how much longer would their current credit line last? When asked whether they would consider, “Walking away from unprofitable business.” The answer was, “It would be foolish to take unprofitable business with a fixed price and we don’t intend to do that.” So, based on that statement, would it be safe to assume they have been foolish in their pricing policy up until now but don’t intend to be foolish anymore?
I think the reaction to the Q2 earning was extremely mild. Based on current market conditions and the huge miss, I would have expected a 15-20% drop in the stock price. My take away from the conference call was that they were caught flat-footed by increased feed cost and low demand. Their company policy has been to foolishly under-price their products at a fixed price, essentially selling it at a considerable loss. Their plan is to not be foolish anymore. The questions is, with low demand and over supply, can they really raise prices? I’m sure Tyson Foods, Inc. would be more than happy to scoop up any business that Pilgrims Pride is willing to walk away from.
When you compare Tyson Foods P/E ratio of around 7 to Pilgrim's Pride bloated P/E ratio, which hovers around 80, I think its quite clear who is winning the chicken wars.
Disclosure: I am short PPC.