I'll admit it: Over the last few months, I've had occasion to feel nervous about my underperform CAPScall on Pilgrim's Pride (NYS: PPC) . For a while, it seemed like I had perfectly timed the bottom, with the stock rising a whopping 51% from my initial CAPS pick. Pilgrim's Pride had managed a very successful rights offering and the market fundamentals went against me, with the price of corn falling year-over-year and the price of chicken rising. I even briefly asked myself if I had been wrong.
But then, sadly, one of my other predictions came true, and everything fell into place for Pilgrim's Pride to start hurting. Just a couple of months ago, the United States Department of Agriculture released its "World Agricultural Supply and Demand Estimates" report for May, forecasting a record corn crop that would bring prices down to $4.20 per bushel. I noted at the time that the USDA often underestimates the high for the year by a wide margin, and the unusually warm and dry winter this year would likely carry through to summer. Farmers are facing a record drought instead, and analysts are predicting one of the worst yields in the last decade.
Thank the market for small mercies
Pilgrim's recently reported earnings, but the quarter only ended in late June, right around the time corn started getting expensive, so it is hard to say exactly how the company is being affected so far.
It is possible to say that Pilgrim's has two things working for it moving forward, though. The first is that, while the price of chicken hasn't increased nearly as much as corn prices recently, it has been steadily climbing over the last year, while corn had been steadily falling. The current corn-to-chicken price ratio is only about as bad as it was early last year. While that was an incredibly bad time for poultry farms, at least this isn't anything new.
The other good news is that Brazilian corn is still comparatively cheap. Pilgrim's Pride and fellow livestock company Smithfield Foods (NYS: SFD) have both started making deals to buy corn from Brazilian farmers and ship it north. It's likely that Tyson Foods (NYS: TSN) , which recently revealed a steep drop in profits and lowered full-year sales guidance, will also start making similar deals, and even Japan is said to be shifting to Brazil.
However, according to TheWall Street Journal, Brazilian corn is currently about $55 cheaper per ton, and it can cost $30 to $40 to ship it to the United States. That leaves a thin margin to exploit, and with Brazil producing far less corn than the U.S., it's likely the steep increase in demand will lead to higher prices and erase any arbitrage opportunity.
While it lasts, though, Pilgrim's is likely to benefit the most, through its Brazilian parent JBS, whose massive scale gives it access to some of the cheapest and most efficient shipping routes. Brasil Foods (NYS: BRFS) is also probably enjoying the opportunity to repair its margins, which have suffered from a declining Brazilian Real exchange rate.
So what's the forecast for Pilgrim's?
One of my favorite Nicolas Cage films is The Weather Man, possibly the second most underrated film in his oeuvre after Season of the Witch. As the eponymous weather man, he asks his station's meteorologist if it is definitely going to snow on a particular day, and the man replies that it's just a guess. "It's wind, man," he says, "blows all over the place."
I think that quote applies as much to the markets as to the weather, especially when the two get deeply tangled. Pilgrim's has fallen more than 50% from its high just a couple of months ago. Will it keep falling? Probably, as long as corn keeps rising, and the drought doesn't seem likely to end soon. But do I know for sure? It's the market, man. Blows all over the place. What I do know is that I'm happy to take my 25-point profit in CAPS before it gets washed away in the rain.
Add Tyson Foods to My Watchlist.
Add Smithfield Foods to My Watchlist.
Add Pilgrim's Pride to My Watchlist.
Add BRF Brasil Foods to My Watchlist.
The article Is It Time to Take Profits on Pilgrim's Pride? originally appeared on Fool.com.
Fool contributor Jacob Roche holds no position in any of the stocks mentioned. Check out his Motley Fool CAPS profile or follow his articles using Twitter or RSS. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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