In October of 2012 I recommended purchase of Tyson (TSN) at $16 in the face of a drought situation. Then I said, "In investment analysis (as well as in agribusiness), the assumption is that there will be a return to normal. Therefore, Tyson should be bought, based on its normalized earnings potential and on the assumption that normality will return." But now the opposite is true. Earnings and valuation are above a normalized level and it is time to sell the stock.
For normalized earnings per share, I used the low end of Tyson management's estimate ranges of the normalizable operating income to sales ratios for beef (2.5%, 42% of total revenue), chicken (5%, 33% of revenue), and pork (6%, 18% of revenue) which gave me a conservative estimate of $1.93 per share, though the high end, which I did not use, was $2.75.
At the end of January 2013, I stated that Tyson was efficiently valued at $23 as some winter snows and the expectation of more ground moisture in the western Corn Belt was a positive. A Merrill Lynch analyst also then initiated a buy recommendation on the stock while using EPS estimates that were above normalized levels and I felt good about a 35%+ appreciation in the stock.
The stock price continued upward, as the US corn crop started to look pretty decent. Additionally, the announced acquisition of Smithfield Foods by Shuanghui International and avian influenza (sanitation in production) in China focused investors on opportunities in pork and chicken in China over the longer term. Some spillover from the rally in branded consumer staples stocks was another plus.
Rolling forward normalized earnings two years at a 4% growth rate results in a $2.09-$2.97 normalized EPS range based on management's previous estimates. Being realistic about most management's comments, and realizing, importantly, that all three proteins are very unlikely to operate at the top of their normalized ranges in any given year, I think $2.09 and the midpoint of $2.53 are the EPS numbers to focus on now for 2014.
To value the stock I use a standard MBA school 3 stage EPS growth model. My risk free rate is the long Treasury plus 50 bps to counter the now declining quantitative easing by the fed, equaling 4.2%. I have cut my risk premium assigned to Tyson from 7.0% (which was never really justified by operational or financial risk, but only by incorrect market perception) to 6.5% because of developments in China over the past 18 months and continuing investor disappointment with CPG company growth expectations that I believe are leading to a more rational attitude toward Tyson, something I expected to evolve over the longer term, but not over the past 6 quarters.
Using a 1.5% terminal growth rate for EPS, Tyson at $36 per share discounts an 8% five-year growth rate, higher than the Street consensus of 7% and the 4-5% that I believe is reasonable. Alternately, using a Street consensus estimate of $2.80 fro FY14 and $3.00 for FY15, the stock discounts the Street consensus 7% growth rate. Either way, TSN is a cyclical stock with largely unpredictable forces (as to timing) that bear on its earnings. The best time to exit is at fair valuation, and valuation has gone beyond that level (a 5% five year growth rate in $2.53 implies a $31).
A final note on unpredictable earnings: My approach to all commodity agricultural stocks is to keep my eye on normalizable earnings, and deserved valuations on those earnings. Long experience has shown that trying to predict quarterly earnings, and even earnings inflection points, is an absolute waste of valuable analytical time that can be used elsewhere. There are too many completely unpredictable effects on earnings. So, while some avian disease seemingly will mean that chicken will not be in oversupply for at least six months, it is a bad risk reward tradeoff to keep holding the stock.