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Morningstar | Sanderson faces pressure amid low competing protein prices.

Although Sanderson Farms remains an efficient processor, its performance is still largely at the mercy of the commodity markets without the benefit of a sustainable competitive advantage. The third-largest U.S. chicken company with 8% market share in 2017 (versus 20% for Tyson and 16% for Pilgrim’s), Sanderson competes in a low-margin industry with few opportunities to differentiate its core products from those of its peers. However, Sanderson should continue to benefit from rising demand for fresh, higher-protein foods as well as low feed costs.Sanderson focuses on the large-bird and tray pack categories, leaving the low-margin (though more stable) small-bird segment aside. We believe this strategy should continue to pay off in strong markets; however, a down market could leave Sanderson exposed to diners trading down to fast food (which prefers small birds). While we expect the industry to perform well over the years ahead due to consumers’ increased appetite for protein and chicken’s attractive cost and nutritional profile, ground beef remains a formidable substitute, particularly as normalizing herd sizes led to moderating beef prices in 2016 and 2017.As with its peers, much of what drives profitability is beyond management’s control. Avian influenza outbreaks among table egg and turkey flocks led to export market access disruptions in fiscal 2015, and factors as diverse as weather and trade policy can cause significant swings in grain prices and inventories (around 60% of Sanderson’s cost of raising a live chicken is feed). Because operating margins are tight--we expect a 6% average over the next decade--processors’ economics can change quickly and significantly; for example, Sanderson posted its highest return on invested capital of the decade in fiscal 2014, just three years after its trough in fiscal 2011. Furthermore, Sanderson’s operations and sales are somewhat regional, with most of its activities--and its exposure to demand trends and flock health factors--focused in the southern and western United States.