Food Stocks That Will Weather the Drought

Sharply higher prices in all grades of beef along with pork and chicken are also on the way, as livestock farmers are sending their animals to slaughter much earlier in the year than usual, because they know that feedstock later this year will be scarce and so pricey that it will be hard for them to turn a profit.

Some food-processing companies will be able to manage through this challenge by using hedges on raw materials prices to maintain profit margins, and also by passing on costs to customers. But smaller firms are likely to have a tougher time implementing those strategies and will likely suffer.

Their prospects for industry players will also change based on other intangibles, such as the length of the drought and the chances that droughts will become a long-term trend brought on by climate change.

But opportunistic investors with good timing have the chance to profit. "This sometimes-boring, sometimes-high-risk industry can sometimes be very rewarding," writes Thomson Reuters' Alpha Now analyst John Kozey, in an Aug. 14 research note. "When the drought finally breaks, that's the moment that investors will want to begin viewing food-processing companies as potential investments -- although their timing will be crucial.

"If you think this drought has staying power, companies that have signs of compressed margins and other hallmarks of a weak balance sheet or other credit issues should be avoided," he said.

Smaller food processors and those most exposed to raw-materials prices are dealing with that prospect now and it is showing up in their share prices. Poultry processor Sanderson Farms's(SAFM) shares are down 23% over the past three months, while Smithfield Foods(SFD) , the world's largest pork processor, has seen its shares lose 20% of their value this year.

Even some of the larger firms have been hurt by the anticipation of higher raw-materials prices. One of the largest agricultural-commodity companies, Archer Daniels Midland(ADM) has seen its shares slump 19% over the past three months.

Beef and chicken giant Tyson Foods'(TSN) stock has tumbled 23% this year. It reported fiscal third-quarter earnings this month that were off 61% versus last year, and the company lowered its revenue estimate for this year by $1 billion to $33 billion, citing weakening demand for some more expensive products as consumers have become price sensitive.