Playing Chicken With Chickens

If you wanted to buy chicken stocks like Sanderson Farms (NASDAQ:SAFM), GoldKist (NASDAQ:GKIS), or Pilgrim's Pride (NYSE:PPC) at the absolute depths of pessimism, you might have already missed your chance. But to be fair, it's tough to pick stocks at the bottom, and reaching for falling knives is a good way to earn a nickname like "Stubby."

By any stretch of analyst hyperbole, this was a tough quarter at Pilgrim's Pride, and management isn't suggesting that we look for an immediate turnaround. Revenue dropped 8% this quarter, and the problem is almost completely on the pricing side. Overseas fears of avian flu have led to less chicken consumption, and that has caused chicken supplies to swell -- which, in turn, hurts prices. How much so? Well, according to information provided by the company, breast and leg prices are down about 30%.

With lower prices and revenues but higher feed costs, margins have taken a hit as well. Gross margins took a significant chopping, and the company reversed its year-ago operating profit into a loss. Likewise on the net income line.

As I said, management isn't looking to make anybody feel warm and fuzzy about the near-term prospects for the chicken industry. As I had feared for a little while, chicken producers have added too much capacity -- at least in the context of today's much lower overseas demand. In response, the company is unilaterally cutting its slaughter rate, cutting back on capital expenditures, and looking a little harder at cost containment and efficiencies.

Here, in a nutshell, is part of the trouble with agriculturally sensitive stocks. There's just so much that can go wrong and/or contrary to initial expectations. Producers (including Tyson (NYSE:TSN)) thought they had a better bead on demand and supply and hadn't added too much capacity. Wrong. The USDA projected that feed costs would be lower this year. So far, that's been wrong, too. And does anybody out there wanna bet that if avian flu comes to our shores, we'll all respond in a rational and scientifically supportable way? Yeah, I didn't think so.

These are tough times for most protein producers. And while very selective stock picking in the chicken sector could be profitable over the long haul, I'm more in tune with the pork side of the meat counter these days. But whether they all recover or not, let's all make sure we remember at least one lesson -- much as industry participants talk about becoming less cyclical and learning from the past, cyclical stocks are that way for a reason.

For more farm-freshness, peck at this further Foolishness:

• Pilgrim's Pride Gets Clucked
• Chicken Run: Value Manager's Dream?
• Tyson Gets Gored

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).