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Corn’s Collateral Damage

Posted: Jun 26, 2008 13:37 PM by Matthew McCall

Tickers in this Article: PPC, TSN, SFD, COW

The price of corn has doubled in the last nine months, which is creating a difficult situation for poultry producers and meat-related companies. The farmers who raise poultry are directly affected because corn makes up a large part of chicken and turkey feed. As the price of corn increases, it must be passed on to the meat production companies and eventually the consumer. The sudden increase will be felt by consumers around the world as the weekly grocery bill surpasses that of last month.

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How will all of this affect individual stocks in the months to come?

The Rise of Corn
Over the last nine months the price of corn has doubled to a new all-time record high, nearly $8/bushel. There are numerous reasons for the run-up in corn, but the most popular culprit is the ethanol mandate introduced by the government.

For example, in Missouri there is a law that says Missouri gasoline must be blended with 10% ethanol if the biofuel is cheaper than regular gas. The idea of using our food supply for fuel may sound great in theory, but in actuality it has done nothing to lower the cost of fuel and in the end sent food prices higher. As the emerging markets continue to expand, it will create more demand for food and with limited land to plant crops, I think the food shortage will be the real concern in years to come. (For more on these global issues, read The Biofuels Debate Heats Up and Peak Oil: Problems And Possibilities.)

Poultry Producers
There are a number of meat producers here in the U.S. that have been hit hard from the rising cost to feed their livestock. Let's have a closer look at some of the casualties.

Pilgrim's Pride (NYSE:PPC)
Pilgrim's Pride is the nation's No.1 chicken producer. MarketWatch recently reported that the company said the cost of producing a live chicken has increased by 65% over the last two years. As far as expenditures on grains, the company announced it will spend an additional $800 million in 2008, above and beyond the 2007 costs. Since hitting a high of $40 in August 2007, the stock has fallen about 65% to a low set in mid-June 2008. Now that the company is trading near a five-year low, there are speculative buyers looking for a value play, but it is dangerous to catch a falling knife.

Tyson Foods (NYSE:TSN)
Tyson is one of the largest chicken producers in the U.S. The company hasn't sidestepped the selloff; falling about 40% from the July 2007 high to the June 2008 low. In mid-June, Fitch Ratings cut its issuer default rating to 'BB+' from 'BBB-', thus putting Tyson's debt into junk status. Unlike Pilgrim's Pride, Tyson has had issues in the past with its stock performance and has flirted with the $13 area several times over the last two years. Each time the stock has been able to bounce, but it did not have to deal with record corn prices in the past. Tyson said it will spend $600 million more for grains in 2008, double the amount of last year.

Hormel Foods (NYSE:HRL)
Hormel is best known for its SPAM product, which is a mixture of what I like to jokingly call "mystery meat". Hormel is a top turkey producer in the U.S. as well as a major pork processor. After trading just below an all-time high in May 2008, the stock fell 15% as rising grain prices weighed on the bottom line. The one silver lining is that SPAM could become a food of choice as Americans look to a less expensive version of meat.

Investing in Livestock
Credit Suisse calculated that PPC would have to increase its chicken prices by 23% to counter the rising grain prices. Unfortunately there is not an easy way for the average investor to invest in poultry. However, the introduction of exchange-traded funds, livestock investing is accessible. The iPath Dow Jones-AIG Livestock ETN (NYSE:COW) is composed of two livestock futures, lean hogs and live cattle. From April through mid-June, the ETN has risen over 10% as the meat producers fell.

Bargain Shop or Stay Away?
When stocks are at or near multi-year lows it will attract a certain breed of investor looking for a bargain. The bullish case for the meat producers is that corn is at a high, and things cannot get any worse from a feed perspective. On the flipside, trying to predict a bottom can be dangerous, and unless the crops begin improving, the rise in corn can easily continue.

By Matthew McCall

Matthew McCall is the president of Penn Financial Group, LLC, a registered investment advisor. He also publishes two newsletters, The ETF Bulletin and The PFG Letter as well as other educational material. As a registered investment advisor, he manages clients' investments based on their specific goals and objectives.

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