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Rising Population: Can Food Processors Deliver Profits?

September 12, 2013 | About:
Demand for farm products has steadily risen through the past 50 years as the population continues to grow, placing additional pressure upon producers to deliver. Also, health issues, rising supply costs and government regulation have recently curtailed profits. So, as demand for farm products increases and supply struggles to meet the increasing demand, what does the future hold for Archer-Daniels Midland (ADM), Leucadia National (LUK) and Tyson Foods (TSN)?

Mixed Results and a Strong Move

ADM’s future outlook differs according to geography and segment. For example, North American soy operations have performed slower than usual due to a market supply shortage. Meanwhile, corn operations´ tailwinds helped offset soy shortages, and South American operations worked at full capacity. However, the company struggles to find a steady positive cash flow.

The business strategy adopted by ADM is focused on acquisitions. Hence, the bid on GrainCorp is congruent but its impact on overall performance remains a mystery. According to the Victorian Farmers Federations, the firm has not convinced producers that new management will handle the grain system more efficiently. Nonetheless, government officials have given the green light promising concerned farmers a future assessment of the situation.

The acquisitions strategy has so far fared well for ADM, and is supported by massive processing and sourcing facilities, together with over 25,000 transport vehicles. More, GrainCorp is expected to push growth forward, allowing the ADM to start serving the Asian, African and Middle Eastern markets. Last, abnormal weather limited operations in North America, but health issues have not affected end-markets.

ADM has invested heavily across all geographies. And, management is set to roll the acquisitions strategy with upgrades across most assets. The investment is a strong claim for what the firm expects ahead of the road: profits. Trading barely below the industry average of 26.9 times earnings, and paying $0.19 quarterly dividends, the stock is fairly priced. Steven Cohen seems to agree with the idea that the company holds great prospects and bought over 3 million shares during the past quarter.

Returning to Calm Waters

Like other meat processors in the industry, Leucadia has been hit by higher cattle prices, international health pandemics and domestic macroeconomic slowdown. The negative impact has reflected in weak results for the last two quarters. However, analysts trust on its long-term acquisitions strategy of troubled small competitors as a growth catalyst.

The domestic real estate segment has been the slowest for Leucadia. However, the sector continues to show improving sings as the overall economy recovers. In other words, the worst of the bad season is over. The firm is also present in the medical products industry, where future outlook remains uncertain, because no economic moat has been dug.

Leucadia’s beef segment is under constant pressure as margins continue to diminish due to a rising bottom line. Most importantly, the sector continues to suffer the consequences of the avian flu. That is, many customer remain unreachable due to unfavorable government regulation, or because clients have preferred to change suppliers.

On the upside, Leucadia assesses its operations very tightly, dropping businesses as they become less profitable, while looking for new acquisition opportunities. The drop of its share on Fortescue and the merge with Jefferies are a reflection of the mentioned strategy. Such a business approach, complemented by a wide portfolio and market diversification, allows the firm to ease cyclicality.

Leucadia currently trades at 8.6 times its earnings, with a 75% discount to the industry average. Bruce Berkowitz of Fairholme Capital Management, Murray Stahl of Horizon Kinetics and Third Avenue Management have recently increased their positions. But, the most bullish sentiment has been shown by Capital World Investors when adding 4 milllion shares, to its previous 5,769,373 shares.

Good Present, Questioned Future

Management for Tyson Foods announced that future plans aim at international expansion. Profits are said to lie in bringing out-house chicken production under its wing, especially in the Chinese market. In the same vein, talks with government officials are already under way, in an attempt to secure plant expansion to fully integrate operations. At home, the company will focus on the beef and pork segment.

Tyson Foods’ international expansion focuses on the opening of a plant in Brazil and another in China. With these new assets, management intends to bring chicken rearing and processing under its control, while isolating locals in order to step up health controls. Let us recall, that mad-cow disease prompted a ban for its products in Japan, lifted only 10 years later.

At home, Tyson Foods’ operations continue to see margins drop as cattle and grain prices continue to rise. For example, grain costs related to pork rearing grew 20% year over year. The situation is compounded by relatively low traffic at restaurants, associated with a weak macroeconomic environment. Additionally, management will have to recover lost beef customers during the H1N1 flu pandemic.

On the customer side of the business, a health conscious public has driven a rise of demand for chicken. In the same vein, Tyson Foods expects to absorb that synergy through the introduction of a low-calorie segment, through a partnership with Hungry Girl Lisa Lillien. Moreover, management identified a trend in the popularity of Mexican food and has made acquisitions accordingly.

Tyson Foods currently trades at 15.5 times its earnings, packing a 41% discount to the industry average. The Tudor Group, led by Paul Tudor Jones, and SAC Capital, led by Steven Cohen, have at least doubled their positions. I do not feel so bullish since the Chinese asset is pending approval, and rising supply costs have shorthanded margins.

Conclusion

Higher demand for food products continues to push the industry. However, health issues, government regulation and rising supply costs have curtailed profits. I feel more comfortable with a commodities-based business like ADM, because of its size and proven acquisitions strategy. Additionally, government officials have seconded its operations, setting a pall over the firm.

Disclosure: Vanina Egea holds no position in the stocks mentioned.

About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website


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