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Actionable news in SAFM: Sanderson Farms, Inc.,

Don’t Be a Ham: Meat Stocks Are Looking Full

Illustration: Emily Bary for Barron's

It's easy to see why investors are so bullish, pardon the pun, on these stocks: Animal protein margins have climbed more than 1,000 basis points, on average, since the 2011 trough. Yet the good times can't last, he warns: Pork will see an "unprecedented" increase of capacity between 10% and 12%, with chicken up 6% to 8%. Both expansions should pressure prices and profitability.

This comes at a time when valuations are near a 25% premium to their historical levels, and that, combined with estimates that leave little room for error, means the stocks could take a hit.

As such, Colantuoni initiated coverage of Hormel (HRL) with an Underweight rating and $26 price target:

We forecast flat EPS over F2018/2019 (or 6% below consensus) given likely margin pressure in pork (40% of profits) owing to higher industry capacity, the ongoing turnaround at Jennie-O Turkey (20% of profits), and heightened competition across packaged food. In multiple scenarios, we see earnings meaningfully below our bearish base case, skewing risk-reward 2:1 to the downside.

He has Equal Weight ratings on Tyson (TSN), Sanderson Farms (SAFM) and Pilgrim's Pride (PPC).

More on those calls below:

We like TSN's ~6% free cash flow yield, renewed focus on M&A, and growing market share in prepared foods, although we struggle to see upside to consensus given incremental pork capacity and difficult chicken pricing comparisons. Favorable beef industry dynamics, 2-3% AdvancePierre accretion, and $200 Mn in savings (6% EBIT tailwind) should drive attractive F2018 EPS growth, but current chicken and beef margins look unsustainable in the out years.
We believe chicken margins will continue to benefit from benign feed costs over the long term, but we recognize that unusually strong prices this past summer create difficult comparisons for the commodity-oriented players. We rate SAFM and PPC EW given near-term margin pressure appears already captured by consensus, although we see risk-reward skewed to the downside given 6-8% capacity expansion and tail risks (NAFTA, line speeds).

Hormel and Pilgrim's Pride are lower today, while Tyson and Sanderson are up, along with the Consumer Staples Select Sector SPDR ETF (XLP) .


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