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Morningstar | Mixed 1Q for No-Moat Pilgrim’s; After Significant Rally, Shares Only a Touch Undervalued

We expect to take our $29 fair value estimate up at a low-single-digit clip after no-moat Pilgrim’s results, in which the U.S. market sharply recovered, even as Mexico and Europe lagged our forecast. However, after the stock’s 75% run this year, we’d suggest investors await a more significant margin of safety.

The U.S. recovery is well underway, with improved chicken demand lifting U.S. revenue 2.3% compared with last year’s 0.2% decline and our fiscal 2019 estimate of 1.5% growth. We expect to inch this estimate higher after the firm shared that customers are shifting features toward chicken, due to the volatility of pork stemming from African swine fever. U.S. operating margins of 6.1% were slightly above our 5.8% annual expectation and improved from last year’s 4.2%. We expect to modestly increase our margin forecast as we suspect benefit from lower feed cost will persist.

Revenue in Europe fell 5.4% as the segment cycled last year’s 18.6% gain, driven by share gains at a key customer. We do not expect to make a material change to our 4% fiscal 2019 estimate. However, the region reported a 2.5% operating margin, below last year’s 4.3% and our fiscal estimate of 4.8%, as it faced higher input costs. The firm reiterated conviction that over the long term this business should report 8% margins. While we think that may prove challenging, we expect margins to climb to 5.5% in 2020 and beyond.

Mexico reported a 9.7% revenue decline as it lapped last year’s 27.2% gain driven by short-term market dislocations. We do not expect to revise our 3.5% forecast for 2019 and beyond as long-term trends remain in place. The region’s 2.9% operating margin fell materially short of our 8.5% annual estimate and last year’s 8.8%, as higher supply and weaker demand materialized in the quarter. But the firm reports these trends have already reverted to normal, and we plan to maintain our estimates for this business as quarterly performance in this region is notoriously volatile.

Pilgrim’s shares have surged 75% year-to-date as China’s African swine fever has continued to spread and 10% of China’s hog population has been culled to prevent further spread of the disease. The U.S. Department of Agriculture predicts that by the time the disease is controlled, up to 30% of the herd will be destroyed. Pilgrim’s benefit from this epidemic is two-fold. First, the pending pork shortage increases the demand for U.S. and European protein exports, and pork and chicken prices have risen in response. Second, the reduced China herd size has caused soybean meal prices to drop materially, as it is used in pig feed. While we anticipated chicken prices would increase in response to the epidemic and have modeled as such, the benefit of lower soybean meal prices provides upside to our U.S. margin forecast, where the product is used as a primary ingredient in chicken feed.

Newly named CEO Jayson Penn articulated his plan to accelerate the firm’s focus on increasing the company’s mix of prepared foods over commodity products. He highlighted the firm’s Just BARE brand of organic and natural chicken products as ripe for distribution, both at retail and in the foodservice channel. While these efforts may help to stabilize Pilgrim’s margins, we do not believe that this shift will