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Playing Chicken with Chicken Stocks

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...chicken prices are likely to hit all time highs after the Avian Flu passes

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I am preparing for the battle mentally before it starts. I am laying out a plan for a chicken stock play – Sanderson Farms (SAFM). SAFM raises, processes and markets chicken. The stock is down from $45 in July 2005 to about $21; trading at 6 times last year's earnings and at 10 times expected 2006 drastically revised down earnings. A lot of value guys are intrigued by SAFM and other chicken stocks. But I will not be buying them just yet.

The first thing investors should do when looking at commodity stocks (chickens are not different from oil, copper, aluminum and other commodities) is to see where the commodity prices are today versus where they've been in the past. Despite the very possible scare of Avian Flu, chicken prices are either average in nominal terms or slightly below average in real terms. Considering that Avian Flu is the biggest scare to date, these are not low prices. If Avian Flu comes to the U.S., and according to Homeland Security folks it is just a matter of time, chicken prices are likely to make all time lows. The earnings estimates will be revised from current levels to nothing, and I believe that the chicken stocks will follow the fate of the chickens, they'll get slaughtered and probably take a dive into the abyss. And this is what I'll be waiting for to pick them up.

I like Sanderson Farms better than Pilgrim's Pride (PPC) because of the stronger balance sheet. SAFM has very little debt and PPC has roughly 20% debt to assets, at the same time SAFM had much better return on assts than PPC. The balance sheet will be extremely important as it provides staying power. These companies will be losing money for some time, thus their balance sheet will be their source of life.

The short-term downside risk is huge if the Avian Flu is found in the U.S. However, once the Avian Flu is discovered and dealt with (and it will be dealt with), chicken stocks should recover their losses and lot more. In fact, chicken prices are likely to hit all time highs after the Avian Flu passes as, for a while, a lot of supply will be taken off the market.

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No positions in stocks mentioned.

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