Companies that operate in commodity markets often require a bit of reverse psychology when it comes to their stocks. Invest in protein producers like Tyson (NYSE:TSN) or Smithfield (NYSE:SFD) when times are great, and you are likely to be buying into a peak. With that in mind, the lackluster performance of Smithfield in its fiscal fourth quarter, combined with some iffy market fundamentals, might make this a stock worth watching.

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

Disappointing Results to Close the Year
Smithfield's stock has been sliding around roughly since the start of the year, as investors have been jittery about pork prices, inventories, export demand and rising costs. That came home to roost this quarter, as Smithfield posted a meaningful miss.

Revenue rose 3% and missed the average Wall Street analyst by a relatively trivial (2%) amount. While hog production benefited from some premiums to market prices and sales rose almost 8%, fresh pork sales rose 3% as a decline in cutout offset higher volume. Packaged meat sales were up less than 1%, but more or less as expected.

Margins were the problem area. Gross margin fell about four points, and adjusted operating profit (excluding some insurance benefits) dropped almost by half. Fresh pork margins plunged, hurt by higher supplies and weaker demand. Packaged meat margins are actually solid and the company increased its "normalized" guidance. International margins were also surprisingly weak, but management didn't offer a lot of information on this one.

SEE: Profitability Indicator Ratios: Profit Margin Analysis

Is Cold Storage Going to Chill the Market?
One of the reasons for concern on Smithfield is the potential for imbalance between production and demand. The USDA's most recent report shows more pork in cold storage (over 650 million pounds) than at any time in the past four years, and the trend is currently moving up. Whereas storage levels typically peak in the late winter and decline through the year, it doesn't seem to be moving that way this year.

With margins softening, the assumption is that producers are going to trim back on production. That should be supportive of prices, but further declines in corn (a key input in feed) would also help.

SEE: Investing Seasonally In The Corn Market

Where's the Balance in Domestic and Export Demand?
The demand situation for pork, like most food products, is still in flux. Shoppers in the U.S. have been trading down from beef to pork and from beef and pork to chicken - not such a threat for a diversified company like Tyson, but more problematic for Smithfield. At the same time, export markets continue to get more competitive. While Brazilian and Argentine producers are more interested in beef and chicken, there are plenty of contenders trying to capture share in markets like China.

This is where packaged and processed food can help smooth things out. Companies like Hormel (NYSE:HRL), Kraft (NYSE:KFT) and Sara Lee (NYSE:SLE) (soon to be Hillshire Brands) can reap some advantages from lower production costs, and don't seem to experience as much elasticity on the supermarket shelf. To that end, it's worth pointing out again that Smithfield's packaged business is showing pretty good margin strength.

SEE: Profit By Understanding Fundamental Trends

The Bottom Line
It's hard to recommend that investors step in front of a stock where the sentiment is so negative, but these shares are getting a little more interesting. While it no doubt seems too simplistic, the reality is that buying Smithfield shares at a price/book value of below 1.0 usually works out fairly well. This isn't a stock to be bought and held for the long term, but with the valuation below that critical point, it's at least worth a closer look.

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

Related Articles
  1. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  2. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  3. Investing News

    Glencore Shares Surge in Hong Kong

    Shares of Glencore International, a leading multinational commodities and mining company, jumped by around 15% on London Stock Exchange, after the shares had gained about 71% earlier on the Hong ...
  4. Investing

    Have Commodities Bottomed?

    Commodity prices have been heading lower for more than four years, being the worst performing asset class of 2015 with more losses in cyclical commodities.
  5. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  6. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  7. Investing

    The Quinoa Quandary for Bolivian Farmers

    Growing global demand for quinoa has impacted Bolivian farmers' way of life. Should the American consumer be wary of buying this product?
  8. Investing

    5 Recession Resistant Industries

    No companies are completely recession proof, but some industries perform better in a weak economy than others.
  9. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  10. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  1. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  2. How do I use discounted cash flow (DCF) to value stock?

    Discounted cash flow (DCF) analysis can be a very helpful tool for analysts and investors in equity valuation. It provides ... Read Full Answer >>
  3. 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 >>
  4. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  5. 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 >>
  6. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>

You May Also Like

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!