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Tyson Foods Inc. (NYSE:TSN)

F1Q09 Earnings Call

Jan 26, 2009 9:00 am ET

Executives

Leland Tollett - Interim President and Chief Executive Officer

Dennis Leatherby - Chief Financial Officer

Donnie Smith - Senior Group Vice President of Poultry and Prepared Foods

Jim Lochner - Senior Group Vice President of Fresh Meats and Margin Optimization.

Rick Greubel - Group Vice President and International President

Jeff Webster - Group Vice President of Renewable Products Group

Ruth Ann Wisener - Investor Relations

Analysts

Christina Mcglone - Deutsche Bank Securities

Ken Zaslow - BMO Capital Markets

Christine McCracken - Cleveland Research Company

Ann Gurkin - Davenport & Company

Chris Bledsoe - Barclays Capital

Vincent Andrews - Morgan Stanley

Ken Goldman - JP Morgan

Robert Moscow - Credit Suisse

Tim Ramey - D. A. Davidson & Co.

Heather Jones - BB&T Capital Markets

Farha Aslam - Stephens Inc.

Operator

Welcome and thank you for standing by. At this time all participants are in a listen-only mode. (Operator Instructions)

Now I’d like to turn the call over to your host, Ms. Ruth Ann Wisener; ma’am, you may begin.

Ruth Ann Wisener

Good morning and thank you for joining us today for Tyson Foods’s conference call for the first quarter of our 2009 fiscal year. I want to remind everyone that some of the things we talk about today will include forward-looking statements. Those statements are based on our view of the world as we know it today which could change. I encourage you to look at today’s press release for a discussion of the risks that can affect our business.

Before we begin, I’d like to inform you that we will be using a new format for today’s call. First, we will hear opening remarks from our interim President and CEO Leland Tollett, followed by the financial report from CFO Dennis Leatherby. Reporting on our chicken and prepared foods segments will be Donnie Smith, Senior Group Vice President of Poultry and Prepared Foods. Reporting on our beef and pork segments will be Jim Lochner, Senior Group Vice President of Tyson Fresh Meats and Margin Optimization.

Also joining us today are Rick Greubel, Group Vice President and International President and Jeff Webster, Group Vice President of our Renewable Products Group. Although Rick and Jeff aren’t participating in the prepared remarks, they will be available to answer your questions in the Q-and-A portion of the call.

To keep the call to one hour and to insure everyone has an opportunity to ask a question, I ask you to limit yourself to one question and one clarifying follow-up. If you have another question, please get back in the queue. If we have any time remaining we’ll take additional questions in the order you queued up until we run out of time.

I’ll now turn the call over to interim CEO Leland Tollett.

Leland Tollett

Good morning. It’s good to be back. It’s been a few years since I’ve done one of these calls and I suppose we’ll know here pretty quick whether or not it’s kind of like riding a bicycle; I don’t think we’ll forget very much about it. We plan to give you some color around our first quarter results and what we are doing to manage our company as we look forward.

Most of our business is in good shape. The beef segment performed solidly until market conditions in December left it at break even for the quarter; but still, beef improved $68 million over the first quarter of ‘08. The pork segment continues to do very well as does Prepared Foods. I also like what I see with the international, our renewable products initiatives, but I am sure that the chicken segment is what your concern is today. As you know we’ve been challenged by losses associated with the grain positions as well as demand.

In early December when our demand began a noticeable decline, we took target production cuts at our locations most affected by current market conditions. While this does help us in our continuing efforts to balance supply with customer demand, the biggest opportunity for our company to succeed is in better execution of our domestic chicken business. We got away from the fundamentals and it hurt our competitive position.

Over the past several months, we worked hard and we’ve made improvements in the parameters that are important to us like labor, yield, general plant efficiencies and most importantly in our mix. We’ve also stepped up our efforts to improve the customer service, to help drive their business as well as our business.

Although our execution is better, we have a renewed sense of urgency to return our chicken business to profitability and to regain our position as best in class. We are concentrating on selling the whole bird rather than growing a chicken for its wings and its breast meat and expecting the export market to take the rest.

Now Donnie will give you more details on chicken as well as Prepared Foods. Jim will talk about the beef and pork business, but first let get a financial update from Dennis Leatherby.

Dennis Leatherby

Thank you Leland and good morning everyone. As stated in our press release in Q1 ’09, we lost $0.30 per share compared to a $0.10 profit in Q1 ‘08. Our quarterly results include $20 million for the lower-up cost or market adjustment in chicken, which is essentially pulling forward losses we would have otherwise realized in Q2 as we sell the product. Also, we had $19 million of foreign exchange related losses.

Our effective tax rate for the quarter was 56%. In general, the quarterly rate is calculated based upon the estimated effective tax rate, anticipated for the full year. The unusually high estimated fiscal ‘09 expected and Q1 actual rates are driven by several factors including, anticipated increases in valuation allowances relating to state and fore end net operating loss carry forward, as well as certain non-deductible expenses and losses.

The foreign exchange losses resulted from the rapid strengthening of the dollar this past quarter and its impact on dollar based payables and rentals. These items were partially offset by risk management activities. In that regard, our balance sheet exposures are monitored and when deemed necessary, associated risks are either eliminated by paying off the exposure or mitigated by appropriate hedging mechanisms.

A substantial portion of the loss in chicken came from hedging activities, and the results reflect negative $188 million impact for the quarter. About $50 million of the $188 million, relates to hedges for cost plus customers, which we will recover via product pricing in coming quarters. Another approximately $70 million is for fixed price contracts for which we expect future physical offsets. The remaining balance of approximately $68 million resulted from the unexpected drop in grain prices.

As for our other key financial measures, cash on hand at the end of the quarter was $166 million and total debt was approximately $3 billion, a slight increase from last quarter due to Dynamic Fuels receipt of $100 million in funding from the gulf opportunity zone bond issue. Total debt-to-cap at the end of Q1 was 38.6%. Capital expenditures for Q1 ’09, were $84 million compared to $100 million for Q1 ‘08.

We have reduced our outlook for fiscal ‘09 capital expenditures to under $500 million. Also please note we have another $85 million of restricted cash for the construction of the Dynamic Fuels plant, which is not included in our $166 million cash balance cited earlier.

Interest expense increased $10 million compared to the same quarter last year and totaled $63 million. Major components of this increase include a little more average debt, mark-to-market on an interest rate swap and financing fees associated with the credit amendments.

With we have a strong capital base and at the end of this quarter, our liquidity was $1.1 billion. I’d like to thank our bank group of more than 30 institutions for their continued, on going support of our company and their unanimous vote for our covenant amendment in December.

For Q1 we were in compliance with both of our debt covenant ratios. As you know, we are required to maintain our EBITDA to interest expense ratio at a minimum of 2.85 times and we ended up around three times. Our debt-to-EBITDA covenant allows a maximum of 4.5 times and we ended the quarter at about 4.2 times. We expect these ratios to improve in Q2 and beyond.

Despite the challenges we faced in chicken, I am very confident about the direction Tyson Foods is headed and where we will be in the future. Our beef and pork businesses are best in class, and our chicken business has improved considerably over the past six months especially and is well on it way toward again being best in class in the future.

Our Prepared Foods is solid and improving and I’m really looking forward to great results in future years from our renewable products and international investments. We are playing to our strengths, overcoming our weaknesses and doing what is needed to become a better, stronger company.

With that I’d like to pass it over to Donnie Smith, to report on the chicken and Prepared Foods segments.

Donnie Smith

Thank Dennis, morning everyone. Well, there’s no doubt the first quarter was extremely difficult for our chicken segment. We had a $286 million loss for the quarter with an operating margin of negative 12.8%.

As Dennis mentioned a little over $200 million of the loss is attributed to hedging losses and a lower of cost-to-market adjustment. If you adjust for those factors, our performance improved almost $80 million compared to the fourth quarter on an operating basis on increased volume of 4.7% versus the same quarter a year ago. Note that over half of the volume increase of chicken is attributable to international operations not domestic production.

We still have some forward grain contracts to work through that is going to impact our second quarter results, but we anticipate we’ll get past almost all the negative forward grain purchases by the beginning of the third quarter with the exception of those of our cost plus customers.

In recent weeks, we’ve seen industry indicators headed in the right direction. The USDA has reported that since mid November exits, slaughter pounds have been down on average, about 6% to 7% versus the prior year and [Albertson’s] boneless/skinless breast prices are up about 20% in the last couple of weeks. While this is good news, we can’t rely on industry fundamentals to get us where we need to be. We must stay focused on execution.

Our goal is to be best in class in poultry production and we’ve made tremendous progress on improving our live calls, our product mix, yields, plant efficiencies, flexibility, as well as our labor management. It’s a very much of back-to-basics approach to our operations. As you know we’ve been back on agro stats now for about a year and we’ve seen good, steady progress in operations profit moving from below average last spring to above average for the most recent period reported.

As for international chicken, demand is recovering as are prices. Liquidity is still a concern, and we see this in the inability of our customers to get letters of credit. Tight credit and the strengthening dollar have pretty much ruled out any short term chance of getting back to the pricing levels we had in Q4 of ‘08. However the inventories that built up during the last quarter, went through a slow for three or four weeks, are now being reduced back to targeted levels.

Within our newly acquired businesses in China and Brazil, existing operations were able to offset the start up costs of the green field plants which is what we had planned. Rick Greubel and his team are doing a great job of executing our strategy to build a multinational enterprise and we are all excited about the potential there.

There’s a lot of potential in renewable products too. In addition to the core rendering business, Jeff Webster and his group are making good progress across all of the renewable products platforms.

You’ve probably heard us talk about the energy platform on several occasions, but they’re working on multiple projects to convert nonprime product into our high margin initiatives. They are doing a lot of work around non-woven material made from feathers, they are doing work around pet foods, nutritional supplements, bio-plastics and the list goes on. Jeff’s group has a lot of interesting plans underway that are making a contribution to the bottom line that’s growing steadily.

Turning to the Prepared Foods segment, sales volume was up 3.7%, with an operating margin of 4.7% which is within the normalized range. We are very happy with the demand for our pizza toppings, bacon, ham, jelly products and private label lunch meats. Our Mexican original business had a record quarter as demand continues to grow for wraps, tacos and flat breads. All these items are well positioned for value menus.

In this economy, we continue to see customers turning to retail more often for their food choices and Retail Deli is an excellent opportunity to capitalize on new customer behaviors by offering alternatives to casual dining with our value-added and prepared foods item, with higher margins than food made from scratch. I know you’ve all heard us say it before, but having a diversified distribution channels for Prepared Foods and chicken, really serves us well as dollars shift among the various categories of food at home and food away from home.

The food service industry suffered in 2008 and will continue to suffer in 2009. Technomic is predicting flat traffic growth and negative real sales for food away from home. The period we are now in is the most challenging food service environment since Technomic began tracking data in the mid 1970s.

Full service dining has struggled the most although there are a few bright spots of major casual dinning chain customer, showing the same store sales increases. Limited service restaurants have weathered the economy well by driving traffic with new products and value type products that in many cases we’d help them develop.

We’ve had a lot of good news coming out of the retail channel in our chicken segment. We are doing very well in our efforts to regain our position and retail fresh chicken. Tyson branded chicken is exceeding category growth in both dollars and pounds. The value added category however is under a bit of pressure as some consumers look for less expensive options to stretch their budgets.

We saw the frozen convenience foods category grow staler in Q1 versus the 6% to 7% growth rate in the previous 52 week period. Fortunately, last fall we reduced the package weight across many of our products in this line, with the goal to keep our products well within reach of these consumers and prevent them from trading down or trading out of the category.

Before I turn it over to Jim, let me take a second and thank our team members for the great progress they’ve made as we strive to return our chicken business to profitability. All of our folks in poultry and prepared foods are focused, working on all the right things and I just can’t thank them enough for all they’re doing.

I’ll now turn the call over to Jim Lochner who’ll give you some details about our beef and pork segments.

Jim Lochner

Thanks, Donnie. Good morning. The beef segment broke even this quarter, as good October and November results were offset by a poor December. Still this was a big improvement over Q1 ‘08 when beef lost $68 million. A sharp decline in hide and international variety meat demand, coupled with falling fat and calo values, pushed the drop credit to its lowest level in at least 20 years. Calo values were slow to adjust and only recently declined to reflect the lower drop of credit values.

We’re also seeing soft demand for the more expensive cuts of meat as the casual and upscale dining segments are still experiencing reduced business. Chuck, round and ground beef demand remains adequate and continues to carry an abnormally high percentage of the cut out value.

Concerning cattle supplies, in our Q1, industry steer and heifer slaughter was 6.9% lower for December, over 9% lower as compared to a year ago. As a result, our capacity utilization was 75% for the quarter versus 78.6% for Q1 of ’08; however, our daily efficiencies and throughput improved dramatically.

If you look at cattle and feed numbers you’ll see heavier placement weights and lower placements over the last six months. This is partly because cattle have been spending more time in back grounding operations and less time in feed lots due to the economics around the cost of grain. Additionally, there were fewer imports in Mexican and Canadian feeder cow. However by our count, the actual reduced slaughter rate in October through December, coupled with reduced slaughter rates in July through September, substantially offset the reduced placement numbers. Regarding lake side, we’re still awaiting the final ruling from the competition bureau. There’s been no change in the situation since our last call.

Looking forward in the beef segment, it will take some time for hide and leather values to recover. There’s a large inventory of hides to work through, but we do not expect to see additional pressure on hide values and US hides are a preferred category world wide. Also, we’re optimistic about international variety meat demands recovery. Domestic demand for beef will largely depend upon the overall economy, but we expect to see a continued trend toward more ground beef, chuck and round meat demand versus steak cuts.

When the revenue declines it’s our job to generate a spec. We’ve been able to recover our margin over the last couple of weeks and believe the ingestment in live prices should hold as we move into the spring.

The pork segment had another good quarter coming in at 6% operating margin despite similar challenges as beef. Our year-over-year Q1 pricing cut out improved, but we processed fewer head and therefore less pounds. We feel very good about our execution and the relationship between our total cost and revenue and will continue to focus on maximizing values for our products and minimizing operating costs.

Our plants ran well, are well staffed and are cost effective. Pork variety meat demand has seen similar decline to that of beef, but we expect world wide demand for pork and pork variety meats to recover fairly quickly. We did see some influence from the Mexican destination challenge, but hog prices adjusted rapidly to the news.

The box versus combo shipment issues you probably heard about appear to be resolved, but we have a contingency plan in place, should we have to switch from combos to box shipments. The US liquidation was less than we expected; however that coupled with the reduction in Canadian born animals entering the US market, will result in fewer hogs available than in ’08, which is still adequate for us to manage margins towards the high end of the normalized range.

Capacity utilization for the quarter came in at 90% versus 94% for Q1 ‘08 and will continue to watch forward hog supplies and make adjustments accordingly. I have been very pleased with the fresh meat management team and their efforts to maximize revenue, control costs and manage growth margins. I will turn it back to Leland to close.

Leland Tollett

Thank you, Jim. Before we take your questions I want to relate to all of you listening, our analyst, our investors and our team members, that I have complete confidence in this management team. That’s why I asked Jim and Donnie to do the segment reports and that’s why I’ve asked Rick and Jeff to be here to answer your questions about international and renewable products.

I’m very confident we’ve got the right people running these businesses. They’re going to continue to execute our core strategies, because they are right for this company long term. I know you’re probably wondering or may be wondering how long I’m going to be here and what our succession plans are.

As I’ve said, I have great confidence in this team, which is why I think we can find the right person, within the existing talent pool here at Tyson’s. As for timing, I’ll be here as long as it’s necessary to get this chicken business turned around and to allow the board adequate time to select a new CEO. I don’t know how long that will take, but my goal is that it will be sooner rather than later. I enjoy being here again, but frankly I wasn’t all that tired of being retired. So this process is going to move as quickly as possible. It will be a very diligent process and we are going to do what’s best for this company.

I’m optimistic about the company’s performance going forward. With the decline in inputs and the momentum that we are developing, we anticipate returning to profitability within the next two quarters. I can tell you I like the energy I’m seeing from the people around here; there’s a spring in the step that I hadn’t seen in a good long while. They’re attacking the issues head on with a lot of confidence and they are making great process.

With that said I’ll turn the call back to the operator and we will answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Christina Mcglone - Deutsche Bank Securities.

Christina Mcglone - Deutsche Bank Securities

Jim, I have a question on the beef side. You ran through a lot of information, but I just want to make sure that I understand; with packer margins now turning positive, given the low drop credit, the fact that the choice elect spread is narrow, the cattle supply is tightening; how do you keep it positive? How is the outlook there strong?

Jim Lochner

I think, one key thing that’s different than what cala and feed reported; they reported a marketing number that was actually positive for December and if you heard my remarks when we look at the actual heifer slaughter data, December was 9% year-over-year less, and the quarter was 6.9%.

So we’ve had more available cattle that have come into January and February as the marketing and actual numbers are less than would be implied. So the key is right now that we’re running our business not oversupplying the demand and keeping ourselves in as good a balance as we can and we’ve seen these live cattle prices adjust accordingly.

Christina Mcglone - Deutsche Bank Securities

My follow-up is, in terms of reducing slaughter rates, is there any way to quantify the impact on your fixed cost absorption from running less per week?

Jim Lochner

The answer is yes and we have to always watch our volume versus our footprint capacity and when you do run less your fixed costs do come up. It varies by plan.

Operator

Your next question comes from Ken Zaslow - BMO Capital Markets.

Ken Zaslow - BMO Capital Markets

I’ll stick with the chicken side. It seems like from the press release you guys cut 5% production in December. The two questions that I would have would be; one is how do you see the demand outlook? And if so, if it’s going to be a little lower, does that mean that you’re going to still have year-on-year lower production going into ‘09?

Donnie Smith

Ken, this is Donnie; I’ll take that. We did see demand drop in December. Our visual trigger against that was inventories increasing, so we cut production. As we look forward, we’ve kind of stabilized from that run rate, but we’re actively, as you know always out growing our business. So, what we’ll do is, we’ll just watch what our sales pace is and when that sales pace shows up, that our inventories are stabilized and we’re back in good shape, then we’ll make the next decision. We watch that math every week. On your production question; based on what we’re planning now, our growth rate ‘09 over ’08, would be flat to maybe up 1%.

Ken Zaslow - BMO Capital Markets

Okay, but you said you stabilized at the lower level?

Donnie Smith

Say that again?

Ken Zaslow - BMO Capital Markets

You said you stabilized at the lower level, so you cut the 5%. So you haven’t pushed it back up. You left it at that level, whatever that lower 5% was; is that fair?

Donnie Smith

Yes. Sorry for the pause there, but thanks for clarifying your question. Yes, we have left production at that level.

Ken Zaslow - BMO Capital Markets

And the 0% to 1% is domestic or combined company?

Donnie Smith

Most of it. That is the domestic number.

Operator

Your next question comes from Christine McCracken - Cleveland Research Company.

Christine McCracken - Cleveland Research Company

I just wanted to dig a little deeper on the changes you’re making in the chicken business, specifically on yield and mix. Can you quantify at all how much of a margin benefit you could get from those programs over the longer term?

Dennis Leatherby

Christine, I don’t want to put a number on it, because I don’t think it’s something we can just plug into a model and get to, but I will tell you this. We’ve worked hard and steady on improving our mix, improving our yields. We are seeing our numbers in rating agencies like Agro Stats improve month-over-month. So we’re very much getting back to the fundamentals of our business. I like the progress that we see and I think you will continue to see good, steady progress in how we manage our business.

I think the big deal for us is managing it. As Leland mentioned in his comments, we are focusing on selling the whole bird. We are focused on every bird we grow, every pound we process and every product we sell, in improving our go-to-market strategy. So, can’t put an exact number on it, but we’re seeing steady improvement quarter-over-quarter.

Christine McCracken - Cleveland Research Company

Just in term of our mix then, because you’ve announced some plant conversions here lately, can you talk about why you’d move toward a larger bird? Is that part of that mix improvement? It seems to us that that’s a pretty saturated segment already and it’s not clear to me why you would move. I guess to a trade pack or in some cases maybe even a larger bird in the long run. Is it permanent impairment maybe of that fast food industry or can you just comment on that.

Dennis Leatherby

Frankly I like our mix of large birds. As we’ve talked about, we’ve converted a couple of complexes in this last year. I don’t think we’re; I guess to use your term over saturating that part of the market. We think we’ve got our big birds, the ones we are producing is a pretty good percent of our mix.

We are focused on doing a better job of taking trucks off the road and moving within plants and shipping more directly out of the plant and it may be in a whole bird form rather than putting, fronting the bird and putting boneless on the market, that type of thing. So those are the type things we are talking about as we talk about improving our mix.

Operator

Your next question comes from Ann Gurkin - Davenport & Company.

Ann Gurkin - Davenport & Company

I wanted to just ask your opinion on what do you think will reverse or strengthen demand for chicken. It’s been weak for some time, dropped off further in December according to you all. What is needed to get that demand back?

Leland Tollett

Improvement in the general economy would help a little bit. We’re still one of the most advantageously priced products on the market. So it will basically be an economy change I think, as we look forward.

Ann Gurkin - Davenport & Company

Okay. Then Leland you talked about urgency to get -- you’re sense of urgency will turn the chicken business to profitability. How long will you let the current plan run before you’ll make adjustments again?

Leland Tollett

We will adjust as we deem necessary, but I like the place we are at right now. I like the enthusiasm. I like the momentum we have got going and we believe we have our business aligned for the long term.

Operator

Your next question comes from Chris Bledsoe - Barclays Capital.

Chris Bledsoe - Barclays Capital

Just a quick follow up. If indeed the economy does improve and with that you could expect to see chicken food service demand pick up. I kind of feel like the downturn in the first place was maybe driven in a lot of ways by more of the cost side of the cycle rather than the pricing side of the cycle. So the feed costs kind of influence from fuel on to feed complex.

In the kind of pro-cyclical environment where demand is improving domestically or globally and we see the fuel complex bringing the grain complex up with it, chicken profitability, I’d expect maybe could come under pressure with rising feed costs. I’m just wondering if that’s kind of been at -- if whether we’re in a new paradigm that’s been sort of discussed internally and whether in some respects need to be more of a push to act counter-cyclically instead of pro-cyclically.

Donnie Smith

Let me comment on that real quick Chris. This is Donnie again. One of the things that we’ve done is we’ve turned this business around and really started focusing on getting us back to profitability.

We’ve reduced a lot of our dependants on long term fixed price agreements. We’ve shortened up the pricing cycle quite a bit across most all of our business segments and so we feel like we’re in a better chance now to react to the input side than certainly we would have been a year ago or more. I think that is key, but I’ll tell you, there’s a lot of opportunity in this business as we focus on our fundamentals to drive profitability and overall there’s plenty of money to be made here. We feel good about our business.

Chris Bledsoe - Barclays Capital

And then on the move to big bird deboning, I’m just trying to marry that with comments earlier about our focus on also whole bird. I guess I always perceived big bird deboning, by definition more of a cut up type of product and whole bird and especially in the international market, it’s more of a small bird type of venture. So I’m just trying to marry the two comments and maybe it’s just a misperception on my part.

Donnie Smith

Probably a syntax there. When we talk about whole bird, we think of it in terms of the entire bird. What we don’t want to do is, we don’t want to process the chicken and just worry about selling the tenders off of it or just worry about selling the wings off of it. We’ve began a little phrase around here, when that bird dies it dies all over and when we go to market we have to have a strategy to market the entire bird and I think we’ve been a little bit out of balance on that in our past, but we are getting laser focused on making sure that we’ve got the entire bird and its profitability in mind as we go to market. Does ma make sense?

Operator

Your next question comes from Vincent Andrews - Morgan Stanley.

Vincent Andrews - Morgan Stanley

Obviously, there was probably a pretty interesting competitive dynamic that checked-in in the quarter with one of the larger competitor’s filings. Could you discuss what you believe the negative impact of that was if any or any positive impact from it as well and how you see the competitive dynamics shaping up going forward in chicken?

Donnie Smith

Vincent I’ll tell you, we stay focused on our business. We are watching our demand and our supply. When we saw that getting a little bit out of balance late in Q4, we made an adjustment. I can’t comment on that type of thing.

Vincent Andrews - Morgan Stanley

Okay and maybe just as a follow-up to that, if things are in deed going to ultimately improve in chicken whether it’s because of the economy or the dollar or what would happen, what do you think a normalized level of profitability could be in this chicken cycle on the upturn?

Donnie Smith

We like to think of normalized earnings in our chicken segment somewhere in the 5% to 7% EBIT range.

Vincent Andrews - Morgan Stanley

So no change to that view?

Donnie Smith

No.

Operator

Your next question comes from Ken Goldman - JP Morgan.

Ken Goldman - JP Morgan

So, I guess my question is based on the macro economic conditions and a lot of people have been wrong over the past year, trying to forecast when a recovery happens. So let’s assume for a second that a recovery doesn’t really happen until 2010. So you have less demand for high cuts of beef, less demand for perhaps for pork and less demand for chicken breasts and all of that to me sort of points to maybe not a real strong recovery for your margins until middle of 2010, early March or so.

I know it’s impossible to predict that far out, but I’m wondering if you guys can help us understand a little bit about where the consensus number is compared to how you guys are looking at the year. You talked Leland about, maybe a return to profitability in the next two quarters. Does that mean in the March quarter you won’t be profitable? How are we on the street right or wrong in terms of our $0.28 consensus number?

Leland Tollett

Well, I don’t know that we want to get specific, but I can tell you that we are competitive. We are getting more competitive with all of the other companies. As Jim said we are very competitive in beef and pork. The numbers that we get from Agro Stat, from the Banc of America would indicate that we are much better competitive than we’ve been in the past and we are headed toward the top quartile if we’re not already there in some areas and we will just take our chances with competing with the best of them.

Jim Lochner

Let me add a little commentary on beef and pork. Our job is to try to get the relationship between the cost of goods which is life stock and the revenue against our total costs and so that revenue is revenue declines with weaker demand and the cost of cattle and the cost of hogs will follow it down. Our job is to maximize our revenue, maximize our mix and make sure that our costs are in line and so that spread tends to come back together fairly quick if the industry works very closely on watching its revenues. So that’s kind of the kind component in those two segments.

Ken Goldman - JP Morgan

That’s a fair point and I understand its spread business, but you do have fewer cattle, you do have fewer hogs, which should raise those prices up and you have less demand. That’s not a combination in general that you’d prefer. Is that fair?

Jim Lochner

The combination really again works in reverse too as revenues go up, cost of livestock goes up and it’s really the same answer of maximizing your revenue, keeping your costs in line and optimizing your total spread where you can. So, I always believe that the revenue overtime sets the livestock costs. So we just have to watch the supplies and make the adjustments accordingly.

Operator

Your next question comes from Robert Moscow - Credit Suisse.

Robert Moscow - Credit Suisse

I’ll go international. You made several investments overseas in some emerging markets and then you also have the Syntroleum JV. Can you guys give us some kind of estimate as to how long it will take for you to earn kind of a normal return on those investments and what could it add to your normalized EPS level? Thanks.

Rick Greubel

As we made the investments last quarter, the beginning of the first quarter here, particularly in Brazil and China we talked that these businesses would be a combination of existing operations as well as some start ups or green fields and so our plans through ‘09 is to utilize those existing business, prior operating businesses to by and large offset the cost of the green fields in China and the start up operations in Brazil.

So we are really looking at ‘10 to be the first year that we are going to see any contributions from those businesses from the standpoint of an earnings per share and then it’s going to be 2011 before we’re at kind of the full capacities in Brazil and in China that we discussed when we bought those businesses which was just to remind you, about 4 million birds a week in Brazil and about the same number, maybe just a little more than that in China.

So our target, just to remind you again is that these investments will at least make kind of a 20% ROIC measurement and that’s the hurdle that we use when we look at expanding or increasing the operations there, okay.

Robert Moscow - Credit Suisse

Okay. Well if that’s a 20% ROIC, can you give me a total on what the invested capital is and then maybe on a birds-per-week basis. Are the margins pretty similar to the US? Maybe we can put some more numbers around it.

Rick Greubel

Sure, just to give you a flavor for some kind of industry standards there and I’ll take the invested capital piece second in the industry margins first. Brazil has traditionally been, at least over the last five to seven years, more profitable than the US industry and we would expect that to continue. China is normalized margins are pretty similar to what we see in the US. The big benefit in China is the increasing demand.

As far as invested capital, it’s about $200 million in both of those geographies and in Brazil, more than half of that has already been put into place and in China we are still waiting on government approval for the Chin Chang joint venture which we expect to have in the second half of the year.

If you want, maybe I’ll let Jeff comment a little bit here on the renewable piece.

Jeff Webster

This is Jeff. Let me give you a couple of pieces on Dynamic Fuels our joint venture with Syntroleum. As we’ve said, the plant is on budget, on schedule for being mechanically complete by the end of the year. So think of that as end of December. So when we hit January next year we’ll go into start up and we should be at what I call normalized earnings by basically June of 2010.

What we said publicly is for Dynamic Fuels, the total joint venture. That should deliver between $35 million and $60 million in EBIT. Also to give you a feel for just kind of the wild ride of crude oil going from 70 to 140 and back down again, as a simple rule of thumb for you, this is basically a spread type of business.

If you look at the price at the pump of diesel, which lets say it’s 2.40 a gallon and you look at the price of our feed stock which is about $0.20 a pound or $1.60 a gallon, that spread of $0.80 times 75 million gallons would put you at high end of that range. So we’re very comfortable with where we are; on building the plant, on our schedule, on our budget and very comfortable with where the margins would be as well.

Robert Moscow - Credit Suisse

If you add these two pieces together you’ll probably get a minimum of about $0.20 a share of incremental earnings?

Dennis Leatherby

Well, Rob that would be speculating at this time and what we are going to try to do is manage the business as prudently, balancing the opportunity have on the demand side with the growth of our investments in those geographies. So we haven’t set a number out from the stand point of an earnings per share on the international operation.

Jeff Webster

Keep in mind Dynamic Fuels is a 50/50 joint venture. So our 35 to 60 EBIT range is a 50/50 with us and Syndroleum.

Operator

Your next question comes from Tim Ramey - D. A. Davidson & Co.

Tim Ramey - D. A. Davidson & Co.

Leland, the call is remarkably upbeat for the content of the quarter. I have heard “we feel good about our business”, I’ve heard “I like the place we are right now” and it just makes me want to just -- what’s changed I guess in the past three weeks or has anything changed in the past three weeks? Why do we feel good about the business? Why do we like the place right now if not too long ago it generated a $22 million EBIT loss before mark-to-market hedges or before hedging?

Leland Tollett

Well keep in mind Tim; I’ve been back here three weeks. The reason I like where we are right now is we are looking forward, not backward. We have our people in place that I am comfortable with. They’re energized; we’re out there beating the bushes getting new business. We’re improving some of the business that we got. So from that standpoint, that is what’s making me comfortable and optimistic.

Tim Ramey - D. A. Davidson & Co.

Okay. The change in production on chicken in December; I mean I’m having trouble. Maybe this is a question for Donnie, rectified or reconciling kind of the strategy of we’re not going to cut or we cut before and then we kind of get to the end of the darkest day when chicken margins are about to turn positive and we cut. How would you describe that Donnie?

Donnie Smith

Sure. Tim, we’ve said all last summer that we were matching our supply and demand and frankly that will continue to be our goal. When our demand and our supply got out of balance in December, then we made the appropriate adjustments and we’ll continue to operate that way. The inventory growth was our trigger against that. I mean that’s how we’ll decide on future cuts or increases. We will not decide based on the false premise that our supply reductions result in an overall supply reduction. The facts just don’t support that assumption. I firmly believe that we will create a lot more shareholder value, through improving our daily execution fundamentals than ever will with production cuts.

Operator

Your next question comes from Heather Jones - BB&T Capital Markets.

Heather Jones - BB&T Capital Markets

Two questions; one, your production cuts, are those coming from primarily weight or head count because we haven’t seen really a move in December in either exits or average weights. I’m just wondering if you can speak to that.

Dennis Leatherby

A little bit of both, but there again, to my point, sometimes it’s hard to see us in the exits number. So I think you just validated the comment I made to Tim. So, a little bit of both there and really Leland said in his comments earlier, we really took our cuts for our business seemed a little soft, where we were growing inventory. So, I don’t know, I’ve answered it three ways. That’s about it.

Heather Jones - BB&T Capital Markets

So some of your cut you’re saying in December was initially, you said was coming out of inventory. What did you say?

Dennis Leatherby

We made production cuts; some in our placements, some in weight, different places. We made the cuts in the areas of our business where we were recognizing some softness and the intention of the cuts at that point in time was we saw our inventory building, which it had had not done before. As an example, our inventories at the end of Q4 were lower than they were at the end of Q3, but at the end of Q1, our inventories were higher than at the end of Q4. That was our triggers that we needed to do something different.

So we made that production change and incidentally we are seeing our inventories starting to come down. So we feel good about our current sales pace and the fact that we made the right decision. Let me make one really important point here. We did not lose any market share in Q1, but in fact might have gained a little. Our customer demand dropped and we grew our inventory unexpectedly. Now, we chose to cut production rather than have to drastically lower our pricing to clear the inventory, during a period of traditionally soft demand anyway, Q2. So, that is where we ended up.

Heather Jones - BB&T Capital Markets

Okay and then my second question is, going back to the normalized margin comment, given the kind of improvements you’ve made as far as yield, mix, etc, and it sounds as if you have further improvements to make. Once industry supply and demand is matched, pricing improves etc, why wouldn’t your normalized margins be better than they were in prior cycles?

Dennis Leatherby

I’ll quote something Lehman told us the other day. Let’s get through break even before we start setting targets higher than that and we’re getting as close to that as we can, as fast as with we can. I don’t think I can sit here and predict with the kind of economic volatility we’ve seen around us and get comfortable calling what our future margins are going to be a few quarters down the road or that type of thing. It’s just way too early to make that call.

I will say this though; we are seeing industry fundamentals get better, but more importantly, we are seeing our fundamentals get better. So we’re going to continue and improve our core business and improve our competitiveness in this industry and then when the fundamentals recover we will like what we see.

Leland Tollett

Let me hop in a little bit. When we talked about mix and yield and plant efficiencies and that sort of thing, we were not as far off as maybe we have left the impression. As a matter of fact, we are very, very competitive. We were just not as good as I wanted us to be and as we look at the agro stats numbers, we are not out of joint cost wise, but we can’t save our self the prosperity. We have to get our product mix right and we’ve got to get the price out of the marketplace; that’s where we’re going to win.

Operator

You next question comes from Farha Aslam - Stephens Inc.

Farha Aslam - Stephens Inc.

For Jim Louvhner, could you just share with us why you think pork margins are going to couple with the above normal going forward as was in your press release and could you just discuss your availability of hogs and your outlook for export of pork?

Jim Lochner

Sure. First of all, the heard saw liquidation has reported in the last. The big crop report was 191,000. As you know, that’s the base supply chain. Now that was less than we expected to see, so you can convert that to roughly slightly less than 4 million hogs. So if you look at the kill in ’08, it was right around, just short of $115 million. So if we drop back lets say to 109 to 110, that’s roughly the same that we had in ‘07 where we were starting to see above and pushing into that higher normalized earnings. So I don’t see a major.

Even though we’re not going to have the peak supply we had in ’08, we’re not going to see a drastic reduction in supply and on pork exports and Rick can jump in and add a bit to this comment. They were extremely strong in ‘08 and we’re starting to see some interest upfront in replenishing. You have to always keep in mind one thing and that is the world’s supply of pork reduction is down and pork demand has a primary protein I don’t think is shifted downward to that degree, so there could be a supply shortage world wide. That’s the basic two premises.

Rick Greubel

Yes Farah, Rick here. Good morning. I would just add to Jim’s remarks there that there’s a couple of things to keep in mind with regard to pork exports, is that pork is still a good value globally relative to the other protein. Herds are down in the major production markets we have to compete against and we were able to negotiate an increase of doubling in the quota going to Russia.

We are already seeing the impact of that as liquidity comes back into these markets and demand as you know, protein consumption is highly correlated to GDP growth in most of the developing world markets that take our pork exports. All will see a positive GDP growth this year.

Farha Aslam - Stephens Inc.

Thank you and Jim just as a follow up; you had gains in both of your cattle and your hog divisions, could you discuss kind of where you stand with your mark-to-market versus your physical and kind of have you changed how you’re buying pork and beef going forward, so should we expect more gains going forward?

Jim Lochner

Let me clear up on the mark-to-market. We did change in Q3, forward purchase cattle and qualify that. That’s a qualified hedge accounting and before that was all mark-to-market. So on procurement, on forward bought cattle starting in Q3, the new transactions went on hedge accounting.

Keep in mind that there’s always a physical offset, so if we take a position, we have the physical inventory behind it. So, the mark-to-market differential from that transaction will be minimized simply because they’re more qualified for hedge counting. That may be confusing, but that’s really the answer on the majority of the beef hedges.

Farha Aslam - Stephens Inc.

Okay, so going forward we shouldn’t expect too much more benefit from mark-to-market?

Jim Lochner

Well, on the other side, forward sold product would not qualify, so there is always the potential for mark-to-market influence from those.

Farha Aslam - Stephens Inc.

And then in pork, you had a gain this quarter; are you buying pigs differently, because we’ve heard that farmer are trying to go out and sell their hogs forward to packers as much as possible.

Jim Lochner

We’ve not changed that, because the majority of that was on hedge accounting before and we have seen this general trend for producers really watching the forward CMEs and making a decision. So if we do take those positions again, we’ll end up being covered under hedge accounting.

Farha Aslam - Stephens Inc.

Okay. So we shouldn’t expect much gains or losses going forward.

Jim Lochner

Not in the pork segment, no.

Operator

And I would like to turn the call back over to your host, Ms. Wisener.

Ruth Ann Wisener

Thank you very much for your interest in our company and attending the call today and with that we’ll end the call.

Operator

Thank you for your participation. You may disconnect your lines at this time.

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Source: Tyson Foods Inc. F1Q09 (Qtr End 12/27/08) Earnings Call Transcript
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