Morningstar | Commodity Chicken Challenges Lead to Soft 2Q for Pilgrim's; Reinforcing Our No-Moat Thesis
While we had tempered our near-term targets for no-moat Pilgrim's Pride, its soft second-quarter results lead us to plan a mid-single-digit percentage cut to our $31.50 per share valuation. However, the results do not materially alter our 10-year outlook for 3% sales growth and 11% adjusted EBITDA margins on average. Despite the valuation cut, we believe the shares are attractive, as we expect near-term headwinds to yield to opportunities borne of Pilgrim's broad portfolio and Mexican unit.Year to date, Pilgrim’s sales grew 6.7%, against a nearly 320-basis-point adjusted EBITDA margin dip to 9.8% compared with our 220-basis-point and 10.7% full-year profitability forecast. Management cited low commodity deboned large bird prices, with demand pressured as other meats received greater attention in retail and food-service promotional activity.
The results conform to our view that Pilgrim's returns are at the mercy of exogenous factors, leading to our no-moat rating. While we applaud management's diversification efforts (across bird sizes, contract structures, and geographies) and specialty product focus, factors outside its control still dictate profitability. On the cost side, feed accounts for 30%-40% of Pilgrim's cost of goods, while it also has little control over demand, as shown by second-quarter price pressure from other proteins, particularly pork, as trade barriers led to domestic oversupply. As such, we question Pilgrim’s long-term ability to outearn its cost of capital.
Still, we are encouraged by the firm’s disciplined, customer-led efforts to grow in more differentiated segments, including organic, no-antibiotic, and prepared items. Pilgrim's prepared foods success in Mexico is particularly striking, reaching a 35% market share. We expect Pilgrim's reputation for reliability and food safety, as well as its local market production, to propel results there, with Mexico serving as its vanguard for growth given market undersupply and rising incomes.
Pilgrims Pride is primarily engaged in the production, processing, marketing and distribution of fresh, frozen chicken products to retailers, distributors and foodservice operators. The company's primary product types are fresh chicken products, prepared chicken products and export chicken products. The company's fresh chicken products consist of refrigerated (nonfrozen) whole or cut-up chicken, either pre-marinated or non-marinated and prepackaged case-ready chicken. The company's case-ready chicken includes various combinations of freshly refrigerated, whole chickens and chicken parts in trays, bags or other consumer packs labeled and priced ready for the retail grocer's fresh meat counter.
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