EUR 850.00 For Business Accounts Only

Morningstar | As a Challenging Year Ends for No-Moat Pilgrim’s, we see Reasons for Optimism; Shares Attractive

We don’t expect to make a significant change to our $29 fair value estimate for no-moat Pilgrim’s after the company reported a disappointing fourth quarter, in which weak U.S. (68% of revenue) and European (20%) results more than offset strong performance in Mexico (12%). Revenue growth of 1.6% and a 4.5% adjusted operating margin were both slightly below our 2.4% and 5.3% expectations, respectively. Factors largely outside of management’s control (low pork prices crimping demand for chicken, drought in Europe driving up feed cost) pressure results, which is the basis for our no-moat rating. However, management is focused on the factors it can control, shifting production from commodity products to NAE (no antibiotics ever) and certified organic, capturing synergies with its Moy Park acquisition, and increasing the efficiency of its operations, which we think is prudent.

There is reason for optimism in 2019 as feature activity for chicken has improved in both U.S. channels (retail and foodservice), and management stated that the seasonal demand typically seen after the holidays is stronger than normal, as the market responds to attractive chicken prices. The firm cited an increase in features in both wings and tenders. Both cuts had been priced at five-year lows for much of 2018, but prices on tenders began to lift in October while prices of wings rebounded in January, which bodes well for margins on these products going forward. Breast prices remain at five-year lows, but the firm cited planned feature activity for this cut in the summer, which should improve demand and therefore prices and margins. However, we believe tariffs will keep pork prices depressed in 2019, essentially capping the prices of chicken, a competing protein, moderating the pace of margin improvement. As tariffs are lifted in 2020 with the expected USMCA trade deal, this pressure should be alleviated, helping Pilgrim’s U.S. margins return to the 8% normalized level in 2020 and beyond.

Despite a difficult 2018, our long-term thesis for improved profitability in the European market appears to be on track as Pilgrim’s market share gains with key customers remain ahead of plan, synergies are on track, and the firm is implementing several operational improvement projects, such as better whole-bird utilization and maximizing plant efficiencies. We continue to expect that margins in this region can improve from the current 3.9% to a sustainable 5.5% in the next few years.

Mexico continues to deliver attractive annual returns, with the segment reporting an 8.8% adjusted operating margins in 2018 (versus 10.6% in the prior-year period), topping the U.S.’s disappointing 3.9% (790 basis points of contraction). While the Mexico segment can experience volatile margins from quarter to quarter, (and in fact reported an operating loss in the third quarter) the tighter chicken supply in the region generally allows for the market to come back into balance rather quickly, as it did in the current quarter. We expect similar results for 2019 with Mexico margins gradually increasing to 9.5% as the company steadily increases its mix of prepared foods while decreasing commoditized fare.