Who would have thought the chicken business could be so complicated? It is, though, and major chicken producers like Pilgrim's Pride (NYSE:PPC), Tyson Foods (NYSE:TSN) and Sanderson Farms (Nasdaq:SAFM) know it all too well. The fine balance between supply, demand and the cost of chicken feed has been upended, and both companies have growing losses to confirm it. (To learn more about the increasing cost of raw materials, read Commodities That Move The Markets.)
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The bad news is, it's apt to get worse before it gets better.
Stuck in the Middle
Two key forces are taking a toll on chicken farmers. The first one is excessive supply. In 2010, chicken companies managed to not just post strong results, but record-breaking profits. As is so often the case, though, where there's money, so too will there be more competition. And in this case, too much. Frozen chicken inventories were up 13% in June on a year-over-year basis, as supply surged at the same time demand dropped. The supply/demand ratio has gotten so bad that the Department of Agriculture is laying out $40 million to absorb some of the excess supply, which it will turn around and donate to the nation's Feeding America programs.
Simply put, there's just too much chicken out there.
The other underpinning for the industry's woes are burgeoning costs of corn, which is used to feed chickens. Or, it used to be. For the first time in a decade, corn prices exceed wheat prices, and the high costs of corn have been such a burden that chicken farms are now adding wheat to the chicken feed, hoping to offset some costs.
The pros aren't looking for any relief anytime soon on that front, either; corn prices are expected to keep rising into 2012. (If you would like to add corn to your portfolio, see An Overview Of Commodities Trading.)
The impact on chicken companies hasn't just been theoretical, either. Sanderson Farms has reversed course between last year and this year, earning a record $6.07 per share in 2010, only to be on pace to post a multi-year record loss of $4.16 per share in 2011.
Pilgrim's Pride's swing from 2010 to 2011 hasn't been quite as dramatic, but the expected per-share loss of $1.81 for this year will be its biggest operating loss in a year. (Pilgrim's loss was actually bigger in 2008, though that was bankruptcy-related.) And, Pilgrim's Pride has been forced to close at least one plant so far.
Even Tyson - which isn't a pure chicken play - has seen its earnings crimped because of higher corn costs. Its chicken unit earned $186 million in Q2 of last year, but only $28 million in Q2 of this year.
No End in Sight?
As was said above, higher corn costs are predicted through 2012, while an abundance of chicken farms will keep the supply unhealthily high. Something will have to give soon, though, and shareholders aren't likely to like either solution.
The first resolution is to do nothing and continue to take losses. The second potential resolution is to cut production - less volume, but hopefully at higher per-piece prices; and more importantly, at a level that can produce profits again.
That's what some of these companies have already initiated. Sanderson is cutting its output by 4%, though the industry generally feels a 5-6% cut in production is needed to make the business viable again. Some feel as much as a 9% cut is necessary.
The problem is, the suggested decline in output assumes the demand will rekindle at higher levels. There's no assurance that the market is earnestly interested in chicken at any feasible price, however. Worse, even if the supply is cut, should corn prices continue to rise as expected, the production cuts may be a moot point. The costs of raising chickens could increase by more than the benefit of a newly limited supply.
No, it's certainly not a great time to be a chicken investor. (For more on the meat market, check out Learn To Corral The Meat Markets.)
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