12/15/2018

Valuation Driven Buy Idea: Tyson Foods, Inc. (NYSE: TSN)

Below is one of the companies that was a part of our Summer Quarterly Focus Buy List. This list is designed to highlight 5-7 new buy ideas every quarter that are attractively priced and have a clearly identifiable short-term catalyst. Our analyst team delivers a short report on each name as well as a custom model to help our clients with fresh buy ideas that have been researched and vetted.

Overview: Tyson is the 2nd largest producers of chicken, beef, and pork in the US, supplying ~20% of those protein demand in the US. In FY17, chicken accounted for 30% of Tyson’s total sales, while beef, pork, and prepared foods accounted for 38%, 11% and 20% of the total sales respectively. Separately, international business generated 12% of Tyson’s total sales in FY17, while food services and consumer products account for 33% and 51% respectively. Tyson’s chicken business is vertically integrated and the company manages the production process from beginning to end. Its pork and beef are spread business, and the company purchases livestock from various parties. Its prepared foods segment comprises both models with raw materials come from both internal and external sources. Tyson has been focused on achieving profitable and stable growth on a sustainable basis by implementing the following initiatives:

1) In 2012, management launched a growth strategy focused on increasing mix to prepared foods & value added products in the US. In 2014, the company significantly increased revenue mix from prepared foods by acquiring Hillshire. By 2015, its chicken business has only 15% of its revenues generated from commodity products and its prepared food has 0% of revenues from commodity sales.

2) For the domestic market, Tyson has focused on R&D to drive growth from innovation. Its innovation centers on 3 areas: continuous innovation in Core 9, extend iconic brands to adjacent categories, and build a unique snacking portfolio as snack is a fast growth category. (The Core 9 is composed of nine retail product lines in the Tyson®, Jimmy Dean®, Hillshire Farm®, Ball Park®, State Fair® and Aidells® brands.) In FY17, value added products volume grew 3% and Core 9 $ growth was 3 times the growth of food & beverage industry growth

3) Tyson has utilized acquisitions to boost prepared foods portfolio, the high margin, branded business. In 2014, Tyson paid $8.5 billion for Hillshire Brands, to become a leader in prepared foods. In 2017, Tyson acquired AdvancePierre and Original Philly Cheesesteak Company, the country’s leading producers of ready-to-eat lunch and dinner sandwiches, and leading producers of raw and fully-cooked Philly-style cheesesteak and appetizers.

Catalyst: Tyson lost nearly 20% of its market value YTD, mainly driven by investors’ fear of high freight cost and the ongoing tariff spats between the US and its trading partners.

1) High freight cost would negatively impact Tyson by $250 million in FY18 (the company is currently in Q3), but the company is offsetting the freight pressure through product price increases and additional cost reduction programs such as improving truck weights, lead time and continuous improvement projects. Tyson expects the freight cost impact to decline in Q3 and be close to full recovery in Q4. In addition, while the company will have a gap on cost recovery for the current FY of $155 million or $0.31 a share, comparison for freights will likely be easy in FY19, as the consensus estimates call for oil prices to decline significantly in ‘19 and ‘20.

2) China placing tariff on soybeans and corns has pushed their prices to decline by ~20% in the past 3 months. Previously, Tyson had forecasted a $100 million increase in feed cost for its Chicken business this year. It is likely feed cost will now become a tailwind to the company’s Chicken segment in the foreseeable future.

3) China and Mexico placing tariffs on US pork is a big blow to the US hog industry, as nearly 1/3 of US pork is exported. For Tyson, however, it exported only ~$450 million pork to China and Mexico in 2017, or ~1.5% of its annual sales. That said, a likely oversupply of hogs and ensuing lower prices in the rest of the year will pressure Tyson’s domestic pork business, pushing down margins. Regardless, pork is expected to account for only ~15% of Tyson’s FY18 profits, and any negative impact from the tariff should be manageable.

4) Overall, we feel Tyson’s latest weakness is an overreaction to challenges that are likely temporary. Nearly 65% of its business is in value added, branded chicken and prepared foods business, which gives the company more power to pass on higher cost to customers. In addition, the 2nd half of FY18 is seasonally strong for Tyson. Helped by a strong domestic economy and healthy consumer consumption, there is a good chance Tyson’s strength in beef, chicken and prepared foods will help offset any weakness in its relatively small pork segment.


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