Tyson Foods
/ (TSN-NYSE) / $17.00Note to Readers: This report contains substantially new material. Subsequent editions will have new or revised material highlighted.
Overview
Tyson Foods Inc. (TSN) is the world’s largest processor of beef, chicken, and pork products and the number one breeding stock poultry supplier in the world. It produces a wide range of fresh, value-added, frozen, and refrigerated food products marketed in the U.S. and in over 80 countries worldwide. Tyson operates in five business segments: Chicken, Beef, Pork, Prepared Foods, and Other. TSN’s Chicken segment is a totally integrated poultry company with operations consisting of breeding and raising chickens, as well as the processing and marketing of food and related products. Its Beef and Pork segments are involved in the processing of live fed cattle and hogs and the fabrication of dressed beef and pork into meat cuts, case-ready products, and fully-cooked beef and pork products. The Prepared Food segment produces fresh, value-added, frozen, and refrigerated food products. The company's products are sold to national and regional grocery and wholesalers, meat distributors, warehouse stores, military commissaries, industrial food processing companies, national and regional chain restaurants, hotels, export companies, and domestic food service distributors. The company has its headquarters in Springdale, Arkansas. Its website is http://ir.tysonfoodsinc.com. Tyson Foods’ fiscal year ends September 30.
TSN reported a difficult 1Q05. The continuing ban on U.S. beef at the Japanese border had a negative effect on the beef segment. The chicken business performed well, but a tougher pricing environment for pork had a negative impact on earnings. Cash flow from operations was strong and debts were reduced by $292 million. The company expects market conditions to remain challenging during the first half of FY05. However, the company expects significant improvements in the second half of the year.
Analysts have identified the following issues as critical to an evaluation of the investment merits of TSN:
Strengths/Opportunities / Weaknesses/ThreatsTSN maintains a dominant market share in chicken and beef and has leading exposure to foodservice. A robust pipeline of new chicken products for fast food chains will drive demand. / Weak beef: The beef segment remains a concern for the company as it is has a negative impact on sales and margins.
Analysts expect the export ban to be lifted by the end of FY2005. In addition, TSN has indicated that it expects Japan and Canada to lift their bans on U.S. stocks in the next two months. / TSN’s Dakota City labor contract is scheduled for renewal in August. Union workers at this plant have a history of strikes dating back to the 1970’s.
TSN has operations in all three proteins. Prices are rising faster than feed costs due to a combination of high domestic demand for protein and tight supply (due to industry discipline and declines in beef production). / Feed costs are rising rapidly. On a spot basis, TSN’s feed costs would have been $40 million higher were it not for the success of their hedging activities. Continued success of TSN’s hedging program is critical to company results.
TSN is driving EPS through improved efficiencies as well as its effective hedging program.
Sales
TSN reported 1Q05 sales of $6.5 billion. Chicken segment sales increased 8.7% year-over- year. The sales increase was primarily due to higher average selling prices, increased volumes, and product mix improvements. Beef segment sales decreased 10.8% year-over-year. The sales decrease was due to restrictions from BSE that were in effect for the entire first quarter in fiscal 2005. Restrictions caused by BSE led to lower international sales volumes and lower average sales prices due to the mix of products allowed for export. Domestic sales were negatively impacted by other competing proteins and increased domestic beef finished product supplies, which caused lower average sales prices, partially offset by an increase in sales volume. Pork segment sales increased 14.8% year-over-year. The increase in sales can be attributed to continued strong demand for pork products both domestically and internationally which resulted in a 21.4% increase in average sales prices, partially offset by a 5.5% decrease in volume. Prepared Foods segment sales increased by 1.7% compared to the same period last year. Sales were positively impacted by higher average sales prices, partially offset by lower volumes.
Most analysts opine that weak beef will have a negative effect on overall sales. One analyst (Harris Nesbitt) thinks that a saturated industry, softening U.S. beef demand and uncertainty over the reopening of Japanese borders will hit sales negatively. Another analyst (CSFB) believes that Canadian hog import growth will decline in FY05.
Margins
TSN reported 1Q05 operating income of $129 million, compared to $161 million year-over-year. Chicken operating income was negatively impacted by losses of approximately $23 million from the Company's on-going commodity risk management activities related to grain purchases. However, these losses were offset by approximately $11 million in decreased grain costs as compared to the same period last year. In beef, excluding $10 million received in connection with vitamin antitrust litigation in 1Q05, and BSE-related charges of $61 million recorded in 1Q04, operating income decreased $58 million. The decrease in operating income was primarily due to lower domestic cattle supplies and restrictions on imports of Canadian cattle resulting in higher live cattle costs and lower plant utilization levels. Pork operating income was negatively impacted by higher live prices. 1Q05 includes $2 million received in connection with vitamin antitrust litigation. Excluding plant closing related accruals recorded in FY05 of $3 million and fiscal 2004 of $21 million, prepared foods operating income decreased $12 million. The decrease in operating income was primarily due to increased raw material prices, which more than offset the increase in higher average sales prices.
One analyst (Merrill Lynch) opines that continued tight cattle supply continues to have a negative impact on beef margins. In addition the Japanese border remains closed to U.S. beef imports and is likely to be so until September at the earliest. The analyst thinks that this will make margin expansion much tougher. The analyst expects this division to be profitable in 3Q and 4Q but it will depend on the timing of border opening. Another analyst (Longbow) believes that the heightened commodity cost environment along with the increased advertising spending from TSN will lead to a significant earnings drop.
Earnings per Share
TSN reported a 1Q05 EPS of $0.14, compared to $0.16 year-over-year. EPS from operations was $0.11, compared to $0.32 year-over-year. Pretax earnings for 1Q05 include $12 million received from vitamin antitrust litigation, $8m million gain from the sale of company’s remaining interest in Specialty Brands, Inc, and $3 million of costs related to a prepared foods plant closing. The combined effect increased EPS by $0.03.
Management expects FY05 EPS to range from $1.05 to $1.30. Most of the analysts are reducing their EPS growth rate due to weak beef, low visibility, and rising costs.
Target Price/Valuation
Of the ten analyst covering Tyson Foods, 4 held positive rating, 5 gave neutral rating, and 1 gave negative rating.
Analysts’ 12-month price targets range from a high of $22 (D.A.Davidson) to a low of $14 (Harris Nesbitt). The digest average is $18.78. Two analysts have given valuation metrics. One analyst (D.A.Davidson) has taken a 14.7x FY05 EPS of $1.50 to compute their target price, while one analyst (Wachovia) has taken a 13.5x 2005 basis.
Long-Term Growth
Analysts estimate that Tyson Foods’ long-term growth rate will range from 7% to 10%, depending upon how successfully the company hedges itself against continuing price increases. So far, the laws of supply and demand seem to be working in favor of TSN but some analysts fear trends may turn around. Tyson enjoys the largest share in the chicken product market. One analyst (Merrill), however, notes that chicken margins have trended down and that beef is struggling. The Canadian beef operations are likely posting record profits given the border closures, but this will change as anticipation of the border opening leads to higher cattle prices in Canada. Pork margins continue to be negative. Another analyst (Prudential) opines that TSN faces challenges from higher hog costs in fiscal 2005. Procurement contracts are not fully known and the Prepared Foods and Pork segments may be pinched a little in fiscal 2005. A repeat of the Mad Cow scare (or another livestock disease) could hamper sales significantly.
The company’s balance sheet looks strong though the expected increased expenditure of $650 million-$700 million in FY05 is likely to leave TSN with less cash flow going forward. However, once the new case-ready plant and new R&D center are in place, capex can be expected to turn down entering FY 2006. The company paid down $242 million in debt during fiscal 2004 and currently has a debt-to-capital ratio of just below 44%. Value-added products ended the year accounting for 38% of total sales and one analyst (Stephens) believes the company will expand this to above 40% in FY05. Further, the analyst believes that if the U.S. border opens investors will look beyond the 2Q earnings and focus on the longer-term profit outlook, which should benefit from increased cattle supply from Canada.
Longer-term, Tyson Foods’ visibility depends on how well its products are accepted in international markets, future health trends, and the company’s ability to successfully hedge against price increases.
Individual Analyst Opinions
POSITIVE RATINGS
D.A. Davidson - Buy ($22): Report Date 2/18/2005
Deutsche Bank – Buy ($21): Report Date 2/18/2005
The analyst rates the stock Buy with a target price of $21. The analyst feels that the stock will remain under pressure due to earnings miss. The analyst is upbeat about the stock in the long-term.
FTN Midwest – Buy ($21): Report Date 3/3/2005
The analyst rates the stock Buy with a target price of $21. The analyst feels that if U.S. border remains close for a longer time it will have negative impact on the stock.
Stephens –Overweight ($20): Report Date 3/1/2005
The analyst has a target price of $20. Believes that the key reason to invest in TSN is improving beef conditions. Also believes that a better outlook for the company’s prepared foods, the strong Tyson brand, an improving product mix, cost savings and an attractive valuation should drive the stock.
NEUTRAL RATINGS
CSFB – Neutral ($18): Report Date 3/14/2005
Longbow – Neutral ($19): Report Date 1/31/2005
The analyst has a target price of $19. The analyst recommends the investors to stay in the sidelines until additional visibility can be gained into the company’s operations, particularly within the beef segment.
Merrill Lynch –Neutral: Report Date 1/31/2005
The analyst maintains their Neutral rating on the stock due to the current uncertainty in the beef business and the weaker than anticipated results.
Prudential –Neutral Weight ($17): Report Date 3/3/2005
Wachovia – Market Perform ($16 to $18): Report Date 2/23/2005
“We continue to be surprised at the discipline of producers in the current meat cycle. Despite lapping . . .high commodity costs and normalized chicken prices, producers have only grown . . .supplies in the low single-digits. . .”
NEGATIVE RATINGS
Harris Nesbitt –Underperform ($14): Report Date 2/1/2005
The analyst has a target price of $14. Believes that TSN’s price, which is above historical valuation, reflects an overly-optimistic view of the timing/impact of the Japanese and Canadian border re-openings.