PPC big haircut, solute blast for exit GKIS position earlier

**jianyunli** Tue Jan 03, 2006 9:17 pm

PPC big haircut, solute blast for exit GKIS position earlier
Pilgrim's Pride slashed it's outlook today, stock price down more than 20%. GKIS is also down 8 USD from $22 since blast exited this position, really did a great job. Salute!

Another thing, blast, since you can confirm with great confidence that the environment is against childen industry, maybe we could establish a small short position earlier when you exited, that is a nice 36% return so far.

**ghg777** Sun Jan 08, 2006 11:30 pm

Some Places to Learn More About PPC (and SAFM)
Just wanted to let you know I've written several posts on PPC and SAFM on my blog. These posts include links to other posts and comments on Shai Dardashti On Grahamian Value, Value Discipline, and other blogs.

My original post (which also ran at Shai's blog) was a simple suggestion that SAFM was a better buy than PPC:

http://www.gannononinvesting.com/2006/01/on_chicken_stocks.html

More recently I wrote a post "On The Great Chicken Debate" which includes links to several good posts on SAFM and PPC:

http://www.gannononinvesting.com/2006/01/on_the_great_chicken_debate.html

There are a few posts that are much better than mine and I encourage you to read them. If you go to Shai Dardashti on Grahamian Value, Value Discipline, or Gannon On Investing, you'll see various posts and comments on these chicken stocks. I hope these links are helpful; it is certainly an interesting topic.

**blast_investor** Mon Jan 09, 2006 1:24 am

Hi ghg777,

Great blog articles on your site.

Shai asked me before on GKIS here in this forum (just search "GKIS" to get that thread).

You can read my past sell rational on GKIS here:
http://www.blastinvest.com/value-investing-newsletter/06_15_2005.htm

I also studied SAFM and PPC together with GKIS half year ago and I did not like SAFM or PPC. SAFM and PPC were not cheap then. They are down a lot from then, but I would still avoid all the chicken stocks including SAFM even today. The sell rational on GKIS can be applied to PPC or SAFM as well.

Chicken business is cyclical business. Price to past one year earning is not important. If we use average earning or free cash flow over past 5 to10 years for PPC or SAFM as basis of valuation, the chicken stocks (including SAFM) are not that cheap.

Considering the pending business down cycle, stock price of PPC or SAFM, or GKIS all have much room to drop further. Chicken stocks are not safe as long term investment. The printed low PE numbers in Yahoo Finance are very deceiving indeed.

**blast_investor** Mon Jan 09, 2006 1:43 am

Re: Some Places to Learn More About PPC (and SAFM)
Here is quote from Value Discipline's article "Oh no..not chicken again!".

Quote: The value that the stock market has accorded SAFM on an enterprise value basis (reflecting market cap plus debt less cash) is only 2.65 times the free cash flow generated over the last five years.

I have not done recent analysis on SAFM, just use above data as it is, "2.65 times the free cash flow generated over the last five years. ", that is about 13 times of average free cash flow per year.
SAFM does not have debt, this is same as 13 times price to free cashflow.

13 p/FCF is not very cheap. For a commodity stock like SAFM, the fair value is around 8 to 10 times P/FCF. There is a lot more downside risk there even if SAFM is cheaper than PPC on this metrics.

**ghg777** Mon Jan 09, 2006 7:28 am

P/E ratios of Cyclical Stocks
I agree any one P/E number is deceiving. It can be difficult to evaluate these stocks, because you want to look at a period of earnings/cash flow over several years (a cycle). However, the farther into the past you go the farther you get from the company that exists today.

I don't own SAFM, but I am interested in watching the situation. If avian flu concerns are in the headlines more often in the months ahead there could be some reaction in these stocks.

Your point about the regular fluctuations in earnings depending upon the cycle within the industry is an important one. I mentioned this at one point where it was said earnings coverage is ample at PPC. It is today, but a few years back it wasn't - likewise, a few years from today, it may not be once again.

**nodoodahs** Mon Jan 09, 2006 2:40 pm

Here's the EPS data.

FYEAR SAFM PPC
2005 3.51 3.98
2004 4.57 2.05
2003 2.75 1.36
2002 1.43 0.35
2001 1.36 1.02
2000 -0.26 1.27
1999 0.5 1.58
1998 0.71 1.81
1997 0.03 1.49
1996 -0.12 -0.16

Someone, please, educate me. Which years are the cycle? Maybe I've having trouble spotting it, but shouldn't two stocks in a "cyclical" industry have high and low EPS over the last ten years that kinda/sorta coincide? Or is supposed to be a 10-year or longer cycle? Exactly what drives the chicken cycle? I didn't think chickens could cycle, what with their skinny little legs and all!

SAFM sells over 100 prepared food items that range from soups to frozen foods to restaurant supply, in addition to chicken. Their geographical reach is limited, but not so limited as to pigeonhole them as a one-state wonder. They have a small export market, but even without export, they have zero presence in the U.S. northeast, which gives the company plenty of room to grow. And they're spending the money to grow! Building of new facilities has hampered the FCF over the last year and impacted EPS as well.

Blast, do you use average EPS over the 5/10 year period, or did you use average margins over the period, and apply to the projected revenues? SAFM has a long-standing history of growth as well as room to grow, and capx being spent on growth. Average EPS would be appropriate for a stock that did not grow revenue appreciably, but 9-11% revenue growth over the last 10 years, with one hiccup in 2005, is quite impressive, IMO.

The price of the stock may yet go down further with flu concerns, but even if you make money shorting SAFM over the next few months, you should strongly consider it as a long and watch the technical action for signs of accumulation or short-covering.

**ghg777** Mon Jan 09, 2006 3:21 pm

Chicken Cycle
Good questions. This is the best I can offer:

Here’s some data from 1996 – 2002 to help illustrate the process. I didn’t get into leg quarter prices and all that. I just wanted a quick illustration. (There may be some issues with the calendar year - I didn't look into that. But, the idea is to look at three years or so at a time anyway, so that shouldn't be a big problem).

Chicken Boom: 1996 – 1998
Chicken Bust: 2000 - 2002

Gross margins

PPC

1996: 6.2%

1997: 9.0%

1998: 10.2%

1999: 13.7%

2000: 11.1%

2001: 9.7%

2002: 6.5%

SAFM

1996: 4.0%

1997: 5.5%

1998: 10.0%

1999: 8.0%

2000: 4.3%

2001: 11.2%

2002: 10.8%

Annual average wholesale price for boneless, skinless chicken breast in Northeast (per pound)

1996: $1.76

1997: $1.72

1998: $1.83

1999: $1.57

2000: $1.36

2001: $1.36

2002: $1.34

**nodoodahs** Mon Jan 09, 2006 3:50 pm

While you state that 2000-2002 was a chicken breast, er, excuse me, bust, or is that white meat, .... but I digress ... it's fascinating to note that during those years SAFM's EPS was climbing and PPC's EPS was declining. Also at Jan 2000 SAFM was at a split- and dividend-adjusted price of 4.64 while at Dec 2002 SAFM was at the split- and dividend-adjusted price of 13.06. 200% total return is not what I'd call a bust.

I still don't see a chicken cycle. Sorry.

I like to buy companies. I don't particularly care much for shopping by industry, or not shopping by industry. My exception is if I already own a good portion of something better in the same industry, then I discard the company from my screener.

If regular investors and value investors don't like chicken, I know I am really onto something and should probably double down.

**blast_investor** Tue Jan 10, 2006 12:57 am

I highlighted the negative earning below. Clearly, both SAFM and PPC had 2 negative earning year in past cycles. It is pretty cyclical. and both cycle coincide well and both bottom triggered EPS loss. Stock market is very ugly to earning loss news.

Actually, I would prefer to use operating profit or EBIT earning before interest and tax to see the cycles. Opearting margin % is also a nice way to look at past cycles. EPS sometimes is distorted due to one time charge and earning management from company. But overall the normalized averaging result should be very similar.

Growth in a stock like SAFM or GKIS or PPC is not worth that much. It is just re-investment into Capex. Over-investment into Capex can generate higher revenue, but it also can trigger harder over-supply and harder hit in a down business cycle.

nodoodahs wrote: Here's the EPS data.

FYEAR SAFM PPC
2005 3.51 3.98
2004 4.57 2.05
2003 2.75 1.36
2002 1.43 0.35
2001 1.36 1.02
2000 -0.26 1.27
1999 0.5 1.58
1998 0.71 1.81
1997 0.03 1.49
1996 -0.12 -0.16

Blast, do you use average EPS over the 5/10 year period, or did you use average margins over the period, and apply to the projected revenues? SAFM has a long-standing history of growth as well as room to grow, and capx being spent on growth. Average EPS would be appropriate for a stock that did not grow revenue appreciably, but 9-11% revenue growth over the last 10 years, with one hiccup in 2005, is quite impressive, IMO.

.

**blast_investor** Tue Jan 10, 2006 1:10 am

Re: Chicken Cycle
Nice data below. "Bust" maybe too harsh word to use, but it was indeed down cycle in those years.

Wall Street is notorious in reacting to news of shrinking earnings.

The play book for cyclical stocks is well published. For example, Peter Lynch disclosed his rule of thumb on cyclical stocks: buy cyclical stocks when PE was high in down cycle, and sell low PE cyclical stocks when PE was low around 10 in top cycle.

PE range around 8 is not safe for cyclical players at or near top of cycle. So far, I can not see how SAFM can escape cyclical risk of chicken business.

SAFM may have better growth in the past, but SAFM is smallest company among big chicken 3. SAFM revenue is only half of that GKIS and 1/5 of that of PPC. It is easier for smaller company to grow. The growth is not worth that much any way in my opinion.

ghg777 wrote: Good questions. This is the best I can offer:

Here’s some data from 1996 – 2002 to help illustrate the process. I didn’t get into leg quarter prices and all that. I just wanted a quick illustration. (There may be some issues with the calendar year - I didn't look into that. But, the idea is to look at three years or so at a time anyway, so that shouldn't be a big problem).

Chicken Boom: 1996 – 1998
Chicken Bust: 2000 - 2002

Gross margins