Investing in commodities is hard enough, but investing in those companies that produce intermediate commodities stuck between uncontrollable cost and uncontrollable prices is even more difficult. Stocks like Sanderson Farms (Nasdaq:SAFM) can definitely outperform in periods where protein supplies are scarce and/or costs suddenly drop, but it's difficult to make long-term money in stocks like these.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

Good Expense Control Boosts Fiscal Q2
Sanderson Farms stock has been doing pretty well lately, as protein producers like Tyson (NYSE:TSN), Pilgrim's Pride (NYSE:PPC) and Sanderson push through higher prices for chicken and investors expect a robust corn crop to lead to lower production costs.

Sanderson's fiscal second quarter was largely as expected in most respects. Reported revenue jumped 24% this quarter, with net poultry revenue up nearly 27%. The company's volume sold jumped nearly 11%, helped in part by a new facility, while the company increased realized prices by 15%. That latter number is better than that seen at Tyson or Pilgrim's Pride, and was definitely helped by a doubling of wing prices and strong pricing in leg quarters (which is usually fueled by overseas demand).

Sanderson posted an as-expected improvement in gross margin, with gross margin moving from breakeven a year ago to early 10% this quarter. Better capacity utilization certainly helped, as did a four cent-per pound decline in feed costs.

Where Sanderson really outperformed was at the SG&A line. Holding a tighter line on SG&A helped the company reverse a year-ago operating loss and drove a 15% beat in earnings per share.

SEE: Understanding The Income Statement

There is Only so Far the Good News Can Go
Conditions at Sanderson Farms were better than expected this quarter, and expense control is the sort of reproducible good news that investors should really value. What's more, the company filed an 8-K earlier in 2012 regarding its bonus program that suggests 2012 should be a decent year (given the company's history of setting high, but attainable, goals in its bonus program).

Still, investors need to have some caution here. There's only so far that any of these companies can push pricing. Shoppers are already turning away from costlier groceries and substituting cheaper goods like processed foods and private label. Chicken may be the protein of last resort, but its not price inelastic. Likewise, restaurant traffic continues to flow towards QSR outlets like McDonald's (NYSE:MCD) and Yum Brands (NYSE:YUM) and that can limit pricing power as well.

On the cost side, the weather isn't cooperating with the cheap corn thesis that investors were hoping for earlier this year. It's still early, but investors should keep an eye on the crop reports.

SEE: Earning Forecasts: A Primer

The Bottom Line
I have a hard time getting too excited about domestic protein producers. The expected recovery in chicken margins does seem to be materializing, and the stock is up strongly from the fall of 2011. Still, these are deeply cyclical markets and it's hard to push a fair value target much beyond the mid-$50s.

SEE: 5 Must-Have Metrics For Value Investors

On the flip side, I think there is better growth and capital gains potential in companies more leveraged to processed/packaged/branded product growth (like Hormel (NYSE:HRL)) and those companies levered to take advantage of growth in protein consumption in emerging markets like Russia, Brazil and China.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Investing

    Build a Retirement Portfolio for a Different World

    When it comes to retirement rules of thumb, the financial industry is experiencing new guidelines and the new rules for navigating retirement.
  2. Options & Futures

    Analyzing The 5 Most Liquid Commodity Futures

    Crude oil leads the pack as the most liquid commodity futures market, followed by corn and natural gas.
  3. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  4. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  5. Markets

    Why Gluten Free Is Now Big Business

    Is it essential to preserving your health, or just another diet fad? Either way, gluten-free foods have become big business.
  6. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  7. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  8. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  9. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. Benchmark Crude Oil

    Benchmark crude oil is crude oil that serves as a pricing reference, ...
  5. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  6. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!