Wall Street's meat elite

The bulls have been stampeding into livestock stocks.

By InvestorPlace Dec 7, 2012 3:05PM

Cowboy herding longhorn cattle near Fairplay, Colo. copyright Comstock, Getty ImagesBy James Brumley


IPLOGOIt's possibly the first time this has ever been written, but the truth is the truth, no matter how weird: The meat industry has been beating the daylights out of the market over the past four months.


Yes ... meat.


Tyson Foods (TSN) and Smithfield Foods (SFD) have rallied a respective 33% and 28% since Aug. 8, vs. the S&P 500's whopping 0.56% rally for that timeframe. 


Even though Hillshire Brands (HSH) and Hormel Foods (HRL) have lagged the other two big names in the meat business, their respective 11% and 12% rallies have still been far more fruitful than an index fund would have been.


The big gains prompt a myriad of questions, like, for one, why, and whether more of the same is in the cards.


More than anything, though, investors might be wondering which of these stocks (if any) to get into now, in the shadow of a sizable run-up.


Why?

There's not so much a bullish prompt for the meat industry as there is a lack of a bearish condition that was supposed to -- but never did -- materialize.


This summer's drought was particularly painful for corn growers. Since corn is one of the key grains used to feed livestock, it was widely assumed that cattle, hog and chicken farmers would either have to raise their prices or cut production (or both) to absorb those higher costs. As it turns out, U.S. farms were able to harvest more corn than expected, which in turn meant the pessimism surrounding meat producers was far more than merited; the recent rally reflects the dissipation of that fear.


In more direct terms, Smithfield survived the "Aporkalypse of 2012," never really struggling to maintain the bacon output many figured was going to wither.


More of the same?

Farming -- and livestock farming in particular -- is a funny business. Investors and the media tend to view it as static and predictable, which is why soaring corn prices earlier in the year convinced many that meat producers were going to get squeezed into submission later on in 2012. But there's more to it than that.


Sometimes there are lower-cost alternative feeds that may or may not be as impacted by a drought. Sometimes higher prices can be passed on to consumers, if the economy is strong enough.


Point being, it's dangerous to come to any static conclusion about the industry. A good crop -- or even just more rain -- in 2013 could make this year's corn crunch nothing more than a fading and irrelevant memory in the near future.


But, to the extent we can look at the future, yes, there's more upside in the cards for the meat industry. We have to assume rainfall will return to normal next year, and we have to assume all four of these names will reach their slightly elevated target growth levels in 2013.


If there's only room for one in a portfolio, however, which one should investors bite on?


Numbers don't lie

Smithfield Foods was the last of the four major meat companies to report last quarter's earnings, posting them Thursday, and they were good. Beyond a one-time accounting charge, the company earned 66 cents per share versus a year-ago number of 76 cents. On the other hand, earnings easily topped estimates of 44 cents. But is Smithfield the best of breed?


If earnings were the only measure of greatness, then Tyson Foods would be the top dog.

We've seen three earnings beats in the past four quarters from Tyson, and 12 beats in the last 16 quarters. Though the bottom line has ebbed and flowed a bit during that time -- from 2010's $2.19 per share to 2012's $1.91 -- TSN seems to deal with cost and price volatility almost strangely well.


Meanwhile, Hillshire Brands appears to have finally wrapped its hands around its challenges as of last quarter, earning 51 cents per share vs. estimates of 33 cents (and topping the prior year's 10 cents). However, Hillshire has been inconsistent on the earnings front, missing estimates more often than beating them. It's a sign the company might not have much of a cost-control plan in place.


Hormel Foods might have missed last quarter, but like Tyson, it has been eerily consistent with its earnings growth.


Thing is, even if they're solid, earnings aren't the only measure of greatness.


Best of the best

Smithfield Foods might be in the midst of celebrating Thursday's good news, but once the dust settles, traders likely will remember that the company's bottom line is erratic, and if nothing else, SFD shares are overbought right now. The same goes for Tyson, and though it superficially looks like it has value, the price/book value ratio of 1.18 is something of a red flag.


As such, Hillshire Brands and Hormel Foods are left standing as the last two contenders.

Neither is technically overbought, so newcomers don't have to worry about waiting for the right entry point. So, since it comes down to basic value, Hormel's the way to go.


Even without the reliable growth in its top and bottom line, it's pretty clear the company not only has a cost-mitigation plan, but a cost-mitigation plan that actually works; CEO Jeffrey Ettinger specifically mentioned it a couple of times in the last earnings conference call, and the long-term results confirm its effectiveness. Simultaneously, most of HRL's business lines saw sales growth last quarter, while other meat producers struggled on the revenue front.


In other words, whatever Hormel is doing, it's working. Though it costs a bit of a premium to step in at 14.7 times next year's forecasted earnings, this is one of those cases where you have to pay for quality.


As of this writing, James Brumley did not hold a position in any of the aforementioned securities.


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12Comments
Dec 9, 2012 11:36AM
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This article is mostly about packers and processors, not about farmers and ranchers. There is quite a difference.

However a few packers do own hog raising operations. I know Hormel, Cargil and Tyson do plus they contracts hogs to be feed.

Ranchers with broad cows w/calves should fair well this winter if the snow levels stay low and they can graze them till spring (in the corn stubble) w/hay bails available to supplement if needed.

However the feed lot operators which is a whole different business may have a harder row to tow.
Dec 9, 2012 10:53AM
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"Hillshire Brands" is one of two companies formed by the breakup of Sara Lee THIS year (I owned the stock and did very well with the split - whose shares I kept) and did NOT exist a year ago, so I don't know how the article can claim "earning 51 cents per share vs. estimates of 33 cents (and topping the prior year's 10 cents). However, Hillshire has been inconsistent on the earnings front, missing estimates more often than beating them."  It's only been around for one or two quarterly estimates!  The bakery business was essentially sold off to other companies - and that's where a lot of inconsistency was - although Hillshire kept the brand name for "Sara Lee Cheesecake," etc.
Dec 8, 2012 3:24PM
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Please note that the big "cornswaggle" was all about speculators running up the price of corn based on the POSSIBILITY of shortages in the fall. Then they got their shills in the media to constantly harp on the idea that the midwest drought was some kind of doomsday scenario, so that they could sell their corn futures for big profits after the artificial runup in prices.

 

If you were noticing, you could have played this yourself--at least the eventual run-down. (The runup is too fast and early.) The takeaway is to pay attention to the media, then do the opposite!

Dec 8, 2012 1:58PM
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Roadhouse.....You really don't invest in your future; Do you ??
Dec 8, 2012 1:09PM
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Shorthorn...Your take is pretty much spot on...

I've invested in some of these companies in the past, now only in Conagra(CAG), but I agree, the glut of cattle brought to Market....Lowered  the prices on the auction floor....And the packers and distributors reaped the benefits....Consumers only sometimes.

Along with the stock problem; Feedstock plays into all.

Hogs and chickens not quite so much, BUT have to lower prices to compete.

This is, usually only short lived, and most times recovery within less then 14-20 months, with time to finish out stock and bring to Market...Hogs/chickens/others much less.

Without further climate problems, processors have a short period of prosperity..

Persistent problems on the Farms/Ranches...Will cause all prices to skyrocket, above going prices now.....Like you I would think 1-2 Quarters of Corporate profitbility and then back to average numbers...But the dividends may be worthwhile...?

Dec 7, 2012 8:19PM
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My take on the increased profitability of these meat oriented businesses is that they are profiting from the drought.  Many farmers had to ship cattle/hogs to market as they either did not have the feed to feed them or could not justify the increased cost of feed to continue at their present inventory.  An influx of cattle/swine being shipped to market temporarily caused a glut in the market and therefore a decrease in meat prices which benefit these companies that in turn bought the meat.  When this glut works through the system, prices will rise and squeeze the profit margins of these companies.  Their 3rd and 4th quarter numbers will look great this year - not so good this year.  I wouldn't bet on these companies beyond the 1-2 quarters.
Dec 7, 2012 6:57PM
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Judging from the number of comments here, meat is pretty boring.
Dec 7, 2012 6:54PM
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Ask 20 people about the market, and you will get 20 different EXPERT opinions,none of which is worth jack bleep!  Have a very good day.
Dec 7, 2012 6:16PM
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All I can say in response to this is;


IT'S CALLED A CHRISTMAS TREE!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
Dec 7, 2012 5:12PM
Dec 7, 2012 4:40PM
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WTF.  The meat industry certainly porked the public based on their "Sky is falling" dire predictions. The public gets shafted again!
Dec 7, 2012 4:07PM
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"Beat the market: Invest in meat"

 

No wonder my 401K stinks.  I got the message all wrong.

I thought you were supposed to invest in the market, and.............oh never mind.

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