How Grain Prices Will Move Food Stocks

 | Apr 18, 2013 | 4:30 PM EDT
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Wholesale food prices will fall this year, the emerging consensus says. In 2012, the worst U.S. drought in 50 years devastated harvests, and a drought in South America hit the soybean harvest hard. But commodity traders are looking for grain prices to fall in 2013 and 2014.

Exactly how that plays out for food stocks depends on where a company is in the food chain.

For example, meat producers -- beef to chicken -- should benefit from falling feed costs. Since beef and pork producers cut back on the number of animals on their farms in response to rising feed costs, and because it takes a while to rebuild cow and pig populations, producers will see falling costs and rising prices while farmers rebuild animal populations.

Chickens, as raised on modern factory farms (which like it or not is how most of the world's chicken is produced), have a much shorter rebuilding cycle (eight weeks to produce a market-ready chicken in some poultry factories). This means that chicken producers will not only get the benefit of falling feed prices this year, they will be able to pick up the protein slack created by the longer production cycles of beef and pork.

You're probably familiar with the big U.S. chicken names such as Tyson Foods (TSN) and Pilgrim's Pride (PPC), but my favorite chicken play is actually Mexico's Industrias Bachoco (BACHOCOB.MM in Mexico City and a thinly traded (IBA) in New York). The company sits just across the border from the huge U.S. market, and it has done less to diversify into non-chicken protein than its U.S. peers.

Falling grain prices are a plus for fast-food restaurants such as McDonald's (MCD), but higher beef and pork prices aren't. Eventually, lower grain prices will lead to lower meat prices, and that should help restaurants with falling costs -- I'd say in the second half of 2013. In the near term, though, I'd look to companies that will see the benefits of lower grain costs without the penalty of higher meat costs.

My suggestion here is again from Mexico: Gruma (GRUMAB.MM in Mexico City and a decently liquid (GMK) in New York). Gruma is the world's largest producer of corn and wheat flour tortillas.

I'd be careful with the shares of the big global food companies here. Companies such as Nestle (NSRGY) and Danone (BN.FP in Paris and (DANOY) in New York) will get the benefit from falling grain prices, but they'll take a hit this year from the one food commodity that has been soaring in price: milk. Thanks to a terrible drought in New Zealand, global milk production looks to be down this year, and milk prices are up.

The price of whole milk powder climbed to an all-time high of $5,313 a metric ton on March 19, according to Fonterra Cooperative Group, the world's largest dairy exporter. Fonterra (FSF.NZ in New Zealand) itself saw a 33% increase in earnings in the first half of 2013, but it projects slower growth in the second half. I like the stock as a long-term play on increasing demand for safe milk in Asia as incomes rise in those economies.

I like the long-term global story for companies such as Nestle and Danone and Abbott Laboratories (ABT), which have big exposure to demand for milk and baby formula in China. I'd use any short-term dips in these stocks on any earnings miss driven by higher milk costs to begin or add to positions.

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