How to Profit from a Game of Chicken

China is expected to block the import of U.S. chicken, potentially extinguishing one of the few bright spots for poultry farmers who have been struggling with high grain costs and low chicken prices caused by oversupply. China has imported 829 million pounds of U.S. chicken in the past 12 months, or 10.7% of all U.S. chicken exports, according to the Agriculture Department. 

A key trade group leader said he was told by several leading Chinese chicken importers that China wouldn't issue any more import permits for American chicken beginning July 1.

The U.S. Poultry and Egg Export Council says China's move could cost U.S. chicken producers $370 million in the next six months alone.

Difficult market conditions have already forced Pilgrim's Pride, the nation's largest chicken producer, into Chapter 11 bankruptcy protection. A heavy-handed ban on the part of the Chinese -- who are upset with Washington over several trade issues -- would be devastating news for Tyson Foods (NYSE: TSN), the Springdale, Arkansas-based producer of beef, chicken, pork and prepared foods.

Chicken, which accounts for a third of Tyson's revenue, has long been an erratic category. Net results for the segment range from a disappointing -1.8% loss last year to a stunning +7.0% profit in 2005.

The company's 2008 results, which break down earnings by product segment, showed chicken brought in $8.9 billion in revenue at a net loss of $115 million -- despite higher prices and higher volume. The first quarter of 2009 hasn't offered much hope for improvement, with a $104 million loss on $6.3 billion in sales. (The company only issues consolidated quarterly statements.)

Not only are its chicken results inconsistent, but Tyson's shares have been all over the map, as you can see from the chart below.

For the year, they've seen an impressive run of nearly +50% versus a slight +2.3% rise in the Standard & Poor's 500 Index. In the past three months, since April, shares have swung from as low as $9.78 to as high as $13.88. This is not a stock -- and this is not a market -- where any company is going to hold onto its recent gains when bad news like the trade blockade hits. The fundamentals -- that is, the earnings -- simply aren't there, and China is one of the leading consumers of U.S. chicken. Production was already expected to be down -3% in 2009; exports were already expected to decline -13%. Now this.

That's not to say there aren't some things to like about Tyson. Corn prices, which reached a high within inches of $8 a bushel last year, are now back below $4. As corn is a major input cost for poultry, these significantly lower prices will translate into dramatic savings for Tyson that will go straight back to the bottom line. And though China is no doubt an important trade partner, it's only one market. What's more, the ban is unlikely to be permanent. U.S. law has some restrictions on Chinese chicken (and on low-cost Chinese tires, of all things) and now China is retaliating. U.S. Trade Representative Ron Kirk and his Chinese counterparts can likely work out their differences.

But the nuances of the logical and inevitable progression of this little trade spat will be lost on the market, which is still in somewhere between manic mode and panic mode. When word of China's move hits the evening news, traders are going to dump Tyson.

And that's the opportunity. Tyson is a strong buy below $10 and a steal below $9.50. At $10, you can either hold it for the inevitable short-term bounce, say to $12, and capture a quick +20% gain, or you can hold on for Tyson's return to profitability as it capitalizes on dramatically lower input costs caused by halved grain prices.

The easiest way to profit from this Chinese government action is with a limit order specifying your bid on Tyson shares. That might be $9.50, it might be $10.25. If your price is accepted, you know the play: Hunker down and wait for a new trade pact or the panic to recede. If the shares don't hit your offer, then you live to fight another day.

-- Andy Obermueller
Staff Writer
StreetAuthority Investor Update

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Oshkosh Corporation (NYSE: OSK) was up 27% today after the Pentagon announced that the firm's new blast resistant, off-road ground force vehicles were the clear winners in a multi-billion dollar competition.

Oshkosh won the bid to build 2,244 vehicles for a deal worth over $1.06 billion.

-- IU Research Staff

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