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Sizing Up the Drought's Impact on Tyson Foods

The market may be ignoring the boost in profitability that could occur with a bountiful 2013 crop.

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Grain prices skyrocketed in recent months amid droughtlike conditions in the Midwestern United States, which are expected to result in the lowest crop yields since 1995. In the near term, higher corn and soybean prices will challenge the cost structures of meat processors, as grains represent a disproportionately large percentage of their production costs. Despite these headwinds, we think long-term industry fundamentals are relatively unchanged. The market has punished the shares of meat processors like  Tyson Foods (TSN) over concerns about the drought's impact on short-term earnings. While there are still risks, we believe Tyson's current share price merits attention from investors.

Drought Conditions Are Real, but Margin Pressure on Meat Producers Should Abate
Since meat processors rely heavily on grains to feed animals and the drought sent grain prices to record highs, we expect meat processor margins to come under pressure over the coming quarters. Just when it looked like commodity inflation was easing, drought conditions across the Midwest sent average grain prices soaring more than 20% since May and nearly 3 times above their 50-year historical average. While the drought's full impact is difficult to estimate, it is clear that 2012 crop yields came in well below expectations set at the beginning of the planting season, and grain prices are likely to remain elevated over the near term. (The U.S. Department of Agriculture currently estimates that weighted average corn prices will be $7.10-$8.50 per bushel for the crop year ended August 2013.)

Ken Perkins does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.