During the day on Thursday, the United States Department of Agriculture released new information that indicates that the inventory of certain grains and the expected plantings on American farms are substantially different from prior expectations. As a result, corn prices were down by the daily limit in trading in Chicago. Prices for wheat and soybeans also plummeted. Soybean meal also fell drastically. At the same time meat prices rose. Expectations are that the lower grain prices will continue for at least 8 or 9 months. This surprising development presents a major investment opportunity. Companies that are heavy users of grain will be the primary beneficiaries of this earthquake in the grain market.
Pilgrim's Pride Corporation is one of the largest poultry producers in America. Chicken feed is composed mostly of corn (65%) and soybean meal (24%) according to the Pilgrim's Pride latest form 10K, and it is the main raw material cost for Pilgrim's Pride. Cal-Maine Foods is one of the largest producers of eggs in the country. It, too, has corn and soybean meal as the largest component of its variable costs. Both of these companies will benefit greatly by a reduction in the cost of grain.
Let's start with Cal-Maine. A few months back, Cal-Maine suffered a marked decline in earnings which it blamed on unexpectedly high feed prices. During the drought last summer, corn and soy prices soared. As a result, Cal-Maine's earnings dropped well below expectations. Well now the opposite has occured. Corn and soy prices have dropped by about 5% just on Thursday alone, and they are likely to continue to fall. What this means is that the variable costs incurred by Cal-Maine will fall substantially and all of this cost reduction will fall directly to the bottom line. In its latest annual filing with the SEC, Cal-Maine says that feed costs are 71% of its total cost for egg production. A reduction of ten percent in feed costs would mean increased earnings per share of over $0.40 per quarter if everything else stayed constant. At the current P/E multiple of 11, this would translate into $1.60 per share per year and an increase in the value of the stock of just under $18.00 per share. That is nearly a 50% increase in the price of the stock.
Pilgrim's Pride is not as levered to grain prices as Cal-Maine for two reasons. First, Pilgrim's Pride sells chicken both in fresh and prepared form. Prepared chicken requires substantial labor input and it also commands higher prices. Overall, prepared chicken is less dependent on the price of feed than fresh chicken. Since close to 40% of Pilgrim's Pride sales consists of prepared chicken, the overall dependence on feed costs for profits is less. Second, Pilgrim's Pride also has an active program to buy grain futures and some derivatives to lessen the blow of any big increases in grain prices. These investments, however, will also reduce the impact of a drop in grain prices. Even so, if the decline in grain prices continues, it will give a big boost to Pilgrim's Pride profits.
Overall, the surprise announcement by USDA should pay big dividends to both Cal-Maine and Pilgrim's Pride. I support investment in both companies. If you are more cautious, I suggest that you watch the prices of corn and soybean meal for the next few days to see if the down trend continues before investing.
Cal-Maine: symbol CALM; last price $42.56; Dividend and yield $0.80 (1.8%); Earnings ttm $3.64
Pilgrim's Pride: symbol PPC; last price $9.19; no dividend; Earnings ttm $0.70
DISCLOSURE: I am long PPC and may soon be long CALM
Pilgrim's Pride Corporation is one of the largest poultry producers in America. Chicken feed is composed mostly of corn (65%) and soybean meal (24%) according to the Pilgrim's Pride latest form 10K, and it is the main raw material cost for Pilgrim's Pride. Cal-Maine Foods is one of the largest producers of eggs in the country. It, too, has corn and soybean meal as the largest component of its variable costs. Both of these companies will benefit greatly by a reduction in the cost of grain.
Let's start with Cal-Maine. A few months back, Cal-Maine suffered a marked decline in earnings which it blamed on unexpectedly high feed prices. During the drought last summer, corn and soy prices soared. As a result, Cal-Maine's earnings dropped well below expectations. Well now the opposite has occured. Corn and soy prices have dropped by about 5% just on Thursday alone, and they are likely to continue to fall. What this means is that the variable costs incurred by Cal-Maine will fall substantially and all of this cost reduction will fall directly to the bottom line. In its latest annual filing with the SEC, Cal-Maine says that feed costs are 71% of its total cost for egg production. A reduction of ten percent in feed costs would mean increased earnings per share of over $0.40 per quarter if everything else stayed constant. At the current P/E multiple of 11, this would translate into $1.60 per share per year and an increase in the value of the stock of just under $18.00 per share. That is nearly a 50% increase in the price of the stock.
Pilgrim's Pride is not as levered to grain prices as Cal-Maine for two reasons. First, Pilgrim's Pride sells chicken both in fresh and prepared form. Prepared chicken requires substantial labor input and it also commands higher prices. Overall, prepared chicken is less dependent on the price of feed than fresh chicken. Since close to 40% of Pilgrim's Pride sales consists of prepared chicken, the overall dependence on feed costs for profits is less. Second, Pilgrim's Pride also has an active program to buy grain futures and some derivatives to lessen the blow of any big increases in grain prices. These investments, however, will also reduce the impact of a drop in grain prices. Even so, if the decline in grain prices continues, it will give a big boost to Pilgrim's Pride profits.
Overall, the surprise announcement by USDA should pay big dividends to both Cal-Maine and Pilgrim's Pride. I support investment in both companies. If you are more cautious, I suggest that you watch the prices of corn and soybean meal for the next few days to see if the down trend continues before investing.
Cal-Maine: symbol CALM; last price $42.56; Dividend and yield $0.80 (1.8%); Earnings ttm $3.64
Pilgrim's Pride: symbol PPC; last price $9.19; no dividend; Earnings ttm $0.70
DISCLOSURE: I am long PPC and may soon be long CALM
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