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Three Meat Producers for a Hungry Portfolio

Leo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Long-term investors should always look for long-term macro trends in the market. Today, one of the most important global trends is the rapid growth of the global population, and the escalating demand for more food. Considering that the world’s population just topped seven billion, and the medium estimate from the UN calls for a population of ten billion by the end of the century, I’d say that basic food stocks, such as “protein processors,” are excellent buy-and-hold investments. Of these protein processors, which produce different types of meat, three companies are good bets for American investors - Tyson Foods (NYSE: TSN), Smithfield Foods (NYSE: SFD), and Pilgrim’s Pride (NASDAQ: PPC).

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Tyson is the world’s second largest protein processor of chicken, beef and pork. Smithfield Foods is the world’s largest pork producer, and owns operations in Latin America and Europe. Pilgrim’s Pride, which was formerly a U.S. company, is now a subsidiary of Brazilian food giant JBS. It is the largest chicken producer in the United States.

Stay safe, stay diverse

Of these companies, I believe that Tyson is the safest play on the rising demand for meat and poultry, due to its more diversified portfolio of products. Diseases - such as the avian flu, mad cow disease and the swine flu - all diminish demand for one kind of meat at certain times. Although these diseases often turn consumers away from one kind of meat, they rarely give up meat altogether. Tyson’s chicken, beef and pork operations are fairly balanced, and they all feed into its fourth segment, prepared foods.

Tyson is also expanding its product line with lower sodium, whole-muscle deli hams, new chicken wing flavors, and new products made from dark chicken meat. It is also upgrading its Houston lunch meat plant in an effort to address demand for healthier lunch meats.

Survival of the biggest

Tyson’s core strength is its size. The company has 3,390 chicken facilities worldwide, which include processing plants, feeding mills, farm houses and hatcheries. It also has 12 beef and 9 pork processing facilities.

By comparison, Smithfield operates 25 pork facilities in the United States and six international locations, while Pilgrim’s Pride runs 68 chicken-related facilities, 8 prepared/packaged food plants and three pet food factories.

All three companies are expanding overseas. Tyson currently generates 20% of its annual revenue coming from international markets. Smithfield's international exposure is at 24%, while Pilgrim’s Pride is at 12%. Tyson is concentrating on growing its presence in China, Mexico, Brazil and Europe. During its first quarter conference call, the company’s management stated that strong sales in Mexico and Brazil offset startup costs in China. Looking forward, Tyson expects international sales to grow 12% to 18% annually, far higher than its projected 3% to 6% top line growth in domestic markets.

All three companies also take full advantage of vertical integration - stacking different businesses on top of one another - to create a cost efficient production cycle. For example, farms and hatcheries may be purchased to be placed at the top, while meat processing facilities are added to the bottom.

Controlling expenses

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Transportation costs are one of the top expenses of meat producers. Meat has to be stored in cold storage facilities and sent through a network of distribution centers to ensure that they do not spoil. Tyson has the largest network of its industry peers, with 81 cold storage facilities and 17 distribution centers.

That vast network translates into lower transportation costs, which is the key reason that it is the largest provider of meat products to fast food (quick serve) restaurants in America. In addition, Tyson recently inked deals with Burns Logistics and Coca-Cola that have allowed the three companies to share their fleets and transportation networks with each other. This could cut fuel costs substantially over the next decade.

Improving margins

In the short term, however, gasoline prices are declining. Corn prices are also declining substantially along with gas prices, which should lead to cheaper feed for chicken, pigs and cows. These two factors should contribute to more robust margins in 2013. However, investors in Tyson and Smithfield should be wary of the current slump in pork demand and prices in China, the world’s largest pork market, which is no doubt related to the 16,000 dead pigs that recently washed up in Shanghai.

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Up to this point, Smithfield’s margins have been the strongest of the three companies. However, I believe that this position could change soon, due to waning pork demand in China and rising demand for poultry. Tyson, Smithfield and Pilgrim’s Pride have all tried to boost their margins with “value-added” meat products - such as pre-seasoned meats, or “speed-scratch” foods where consumers participate in the process of cooking a pre-prepared product.

The Foolish Fundamentals

A look at Tyson’s top and bottom line growth versus its competitors also reveals a positive trend for the company.

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Tyson’s profits have been stabilizing, in contrast to Smithfield, which has been posting decline earnings since early 2011. That means a slowdown in global pork demand isn’t going to take a bite out of Smithfield’s bottom line. Meanwhile, Pilgrim’s Pride has been steadily recovering from a nasty dip in profits, although its footprint is too small compared to Tyson and Smithfield. Pilgrim’s Pride needs to expand its international presence to escape the saturated and stagnant domestic market. Lastly, let’s stack up these three companies fundamentally to see which is the best value.

<table> <tbody> <tr> <td> </td> <td> <p><strong>Forward P/E</strong></p> </td> <td> <p><strong>Price to Sales (ttm)</strong></p> </td> <td> <p><strong>Price to Book</strong></p> </td> <td> <p><strong>Return on Equity</strong></p> </td> <td> <p><strong>Debt to Equity</strong></p> </td> <td> <p><strong>Profit Margin</strong></p> </td> <td> <p><strong>Dividend Yield</strong></p> </td> </tr> <tr> <td> <p><strong>Tyson</strong></p> </td> <td> <p><span><span><span>9.86</span></span></span></p> </td> <td> <p><span><span><span>0.26</span></span></span></p> </td> <td> <p><span><span><span>1.41</span></span></span></p> </td> <td> <p><span><span><span>9.91%</span></span></span></p> </td> <td> <p><span><span><span>40.05</span></span></span></p> </td> <td> <p><span><span><span>1.80%</span></span></span></p> </td> <td> <p><span><span><span>0.84%</span></span></span></p> </td> </tr> <tr> <td> <p><strong>Smithfield</strong></p> </td> <td> <p><span><span><span>9.91</span></span></span></p> </td> <td> <p><span><span><span>0.28</span></span></span></p> </td> <td> <p><span><span><span>1.14</span></span></span></p> </td> <td> <p><span><span><span>6.95%</span></span></span></p> </td> <td> <p><span><span><span>73.53</span></span></span></p> </td> <td> <p><span><span><span>1.78%</span></span></span></p> </td> <td> <p><span><span><span>None</span></span></span></p> </td> </tr> <tr> <td> <p><strong>Pilgrim’s Pride</strong></p> </td> <td> <p><span><span><span>7.75</span></span></span></p> </td> <td> <p><span><span><span>0.28</span></span></span></p> </td> <td> <p><span><span><span>2.53</span></span></span></p> </td> <td> <p><span><span><span>23.72%</span></span></span></p> </td> <td> <p><span><span><span>128.14</span></span></span></p> </td> <td> <p><span><span><span>2.15%</span></span></span></p> </td> <td> <p><span><span><span>None</span></span></span></p> </td> </tr> <tr> <td> <p><em>Advantage</em></p> </td> <td> <p><span><span><span>Pilgrim’s Pride</span></span></span></p> </td> <td> <p><span><span><span>Tyson</span></span></span></p> </td> <td> <p><span><span><span>Smithfield</span></span></span></p> </td> <td> <p><span><span><span>Pilgrim’s Pride</span></span></span></p> </td> <td> <p><span><span><span>Tyson</span></span></span></p> </td> <td> <p><span><span><span>Pilgrim’s Pride</span></span></span></p> </td> <td> <p><span><span><span>Tyson</span></span></span></p> </td> </tr> </tbody> </table>

Source: Yahoo Finance, 4/9/2013

Although Pilgrim’s Pride seems undervalued, its debt load is too high. Pilgrim’s Pride’s only has $68.2 million in cash, which is crushed under a $1.16 billion mountain of debt. Smithfield and Tyson are on fairly even ground in terms of fundamental valuation, but I believe Tyson will come out on top due to its aforementioned strengths in diverse products, international growth, and margin stabilization. In addition, it also offers a tiny, tiny dividend for patient long-term investors.

Leo Sun has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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