Inflation and Feed Prices

The continued rise in bond yields yesterday was caused in part by concerns about the pace of inflation of China. Prices rose 3.4% last month, driven by an 8.3% increase in food prices. The cost of pork, a staple of Chinese diets, was a primary driver of the inflationary prices.

So what does the price of pork in China (sorry, I did not see any data on the price of tea) have to do with the Zacks Industry Rank? It reflects broader trends within the agricultural sector.

Last week, pork, and beef, producer Smithfield Foods (SFD - Analyst Report) topped lowered fiscal fourth-quarter profit expectations by two cents with earnings of 35 cents per share. Revenue and earnings growth were held back by hog production results. Although prices per hundredweight were 15% higher, circovirus and higher feed costs had an adverse affect. A shortage of pigs and higher feed costs were also the culprit behind the higher pork prices in China. SFD is a Zacks #3 Rank (“hold”) stock and is classified in Food-Meat Products.

The higher feed prices are not only impacting pig farmers, however. The higher costs are also making it more expensive to operate dairy farms. Dean Foods (DF - Analyst Report) warned yesterday that “raw milk prices will reach all-time highs by the third quarter”. Making matters worse for the company, DF also is facing an oversupply of organic milk. As such, DF cut its full-year forecast for adjusted earnings to a range of $1.52 to $1.58 per share. The revised guidance comes about a month after CEO Gregg Engles predicted profits would be at the low end of the company’s previous EPS guidance of $1.72 to $1.78 per share. Four brokerage analysts slashed their projections in response to the latest update, causing the full-year consensus estimate to drop 16 cents this week to $1.55 per share. DF is a Zacks #5 Rank (“sell”) stock and is classified in Food-Dairy Products.

The upside of higher costs for livestock feed is that it helps to create more demand for fertilizer. During the past 30 days, three analysts have raised their forecasts on Potash Corporation of Saskatchewan (POT - Analyst Report). The current full-year profit projection of $2.95 per share is seven cents higher than the average forecast of a month ago and 22 cents above the consensus estimate of two months ago. One brokerage analyst did recently trim his forecast, but his revised prediction of $2.99 per share is still four cents above the consensus estimate. POT is a Zacks #1 Rank (“strong buy”) stock and is classified in Fertilizers.

Investors should note that not all meat producers are succumbing to higher feedstock prices. Tyson Foods (TSN - Analyst Report) has been able to charge more for beef and both TSN and Sanderson Farms (SAFM - Snapshot Report) have realized higher poultry prices. Therefore, the issue of higher feedstock costs is directly related to a company’s ability to charge more for their products. Obviously, higher food costs result in inflationary pressures, as is occurring in China.

On Monday, Nucor (NUE - Analyst Report) warned that the second-quarter profits would be in the range of $1.05 to $1.15 per share; brokerage analysts had been forecasting earnings of $1.37 per share. NUE blamed hedge buying among customers during the first quarter, caused by volatile scrap metal prices, for causing weaker demand in the second quarter. The company also cited described as “challenging” sheet metal conditions this quarter. According to NUE, weaker demand in the automotive and residential construction markets as well as imports from China are adversely impacting prices.

Brokerage analysts have start to slash their forecasts for both second-quarter earnings (the consensus estimate now stands at $1.13 per share) and full-year profits. The consensus estimate calls for 2007 profits of $5.31 per share, 14 cents less than a week ago.

Earnings estimates are not falling for several other steel stocks, however. Rather, analysts are largely sticking to the positive revisions they have made over the past 60 days for companies such as AK Steel (AKS - Analyst Report), Schnitzer Steel (SCHN - Snapshot Report) and Olympic Steel (ZEUS - Snapshot Report). Even Quanex (NX - Snapshot Report), which operates in similar markets as NUE, recently provided optimistic guidance. Steel-Producers contains a total of six Zacks #1 Rank (“strong buy”) stocks and four Zacks #2 Rank stocks.

Given this backdrop, it appears that NUE’s lowered guidance reflects company-specific issues. This said, steel inventories have been volatile. High stockpiles at steel service centers created downward pressure on estimates at the beginning of the year, but by the end of the first quarter, inventory levels were not the issue. Instead, earnings were generally bullish and brokerage analysts have been raising their forecasts. Therefore, while the outlook may be generally bullish, those investors who are risk-adverse should keep a close eye on the overall trend of forecasts for the group.

The number of estimate revisions continues to drop for stocks within the Zacks Rank universe. Using a four-week rolling period, a total of 4,145 estimates were revised last week (2,109 positive revisions and 2,036 negative revisions). This compares to the peak of 13,077 estimate revisions during first-quarter earnings season. The good news is that the revisions ratio is slightly above one, meaning there are more positive revisions than negative revisions.

I expect this trend of fewer estimate revisions to continue throughout June. Brokerage analysts have been less likely to adjust their forecasts between earnings seasons. This is a trend that has been amplified during the past two quarters and given the continuing uncertainty about the pace of economic growth, there is little reason not to expect this trend to continue.

What does this mean for the markets? Simply, the lack of positive estimate revisions is one less catalyst to move stocks higher. This is part of the reason the equity markets have been reacting to the sharp rise in treasury bond yields.

Zacks Premium and ZacksElite subscribers can view the Zacks Industry Rank List at http://www.zacks.com/zrank/zrank_inds.php. This interactive list allows you to see all of the companies, and their Zacks Rank, within more than 200 industries. Shown below is the Zacks Sector Rank List, which shows the trend in estimate revisions on a broader scale.

Charles Rotblut, CFA is a senior market analyst for Zacks.com. He can be reached at crotblut@zacks.com

*A small portion of the estimates reflect FY08 earnings estimates for companies whose fiscal years end at a month other than December 2007 or January 2008.