Let's examine what we think Tyson (NYSE:TSN) is worth in this article and whether shares are timely for new money. But first, a little background to help with the understanding of this article, and how we think about new money. At Valuentum, we think a comprehensive analysis of a firm's discounted cash-flow valuation and relative valuation versus industry peers is the best way to identify the most attractive stocks at the best time to buy (at any given time -- the new money).
This process culminates in what we call our Valuentum Buying Index, which ranks stocks on a scale from 1 to 10, with 10 being the best. The Valuentum Buying Index also includes a timeliness indicator. Essentially, we're looking for firms that overlap investment methodologies (good value, good momentum, etc.), thereby revealing the greatest interest by investors -- the most buying potential. We think this is how seasoned investors look at assigning 'new money' to ideas. They assess underlying valuation support and then pinpoint their entry and/or exit points.
At the core, if a company is undervalued both on a discounted cash-flow basis and on a relative valuation basis and is showing improvement in technical and momentum indicators, it scores high on our scale. Tyson Foods posts a Valuentum Buying Index score of 7 on our scale, reflecting our 'fairly valued' DCF assessment of the firm, its attractive relative valuation versus peers, and bullish technicals. We compare Tyson Foods to peers Dean Foods (NYSE:DF), Hormel Foods (NYSE:HRL), and McCormick (NYSE:MKC). We like to include firms that register high ratings on the Valuentum Buying Index to the actively-managed portfolios and hold them until they register low ratings.
Our Report on Tyson Foods
• Tyson Foods earns a ValueCreation™ rating of EXCELLENT, the highest possible mark on our scale. The firm has been generating economic value for shareholders for the past few years, a track record we view very positively. Return on invested capital (excluding goodwill) has averaged 18.1% during the past three years.
• Tyson is one of the world's largest meat protein companies and boasts one of the most recognized brand names in the food industry.
• Tyson Foods' cash flow generation and financial leverage aren't much to speak of. The firm's free cash flow margin has averaged about 1.9% during the past three years, lower than the mid-single-digit range we'd expect for cash cows. However, the firm's cash flow should be sufficient to handle its low financial leverage.
• Although we think there may be a better time to dabble in the firm's shares based on our DCF process, the firm's stock has outperformed the market benchmark during the past quarter, indicating increased investor interest in the company.
• Commodity cost fluctuations can make earnings quite volatile. We think investors should be cognizant of the potential for earnings volatility in this regard.
Economic Profit Analysis
The best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital (NASDAQ:ROIC) with its weighted average cost of capital (OTC:WACC). The gap or difference between ROIC and WACC is called the firm's economic profit spread. Tyson Foods' 3-year historical return on invested capital (without goodwill) is 18.1%, which is above the estimate of its cost of capital of 10.8%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT. In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely
outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Tyson Foods's free cash flow margin has averaged about 1.9% during the past 3 years. As such, we think the firm's cash flow generation is relatively MEDIUM. The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. At Tyson Foods, cash flow from operations decreased about 17% from levels registered two years ago, while capital expenditures expanded about 25% over the same time period.
Our discounted cash flow model indicates that Tyson Foods's shares are worth between $30.00 - $48.00 each. The margin of safety around our fair value estimate is driven by the firm's MEDIUM ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. Shares of Tyson are trading north of $40 at the time of this writing.The estimated fair value of $39 per share represents a price-to-earnings (P/E) ratio of about 24.8 times last year's earnings and an implied EV/EBITDA multiple of about 9.1 times last year's EBITDA. Our model reflects a compound annual revenue growth rate of 3.7% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 7.6%. Our model reflects a 5-year projected average operating margin of 5.8%, which is above Tyson Foods's trailing 3-year average. Beyond year 5, we assume free cash flow will
grow at an annual rate of 2.6% for the next 15 years and 3% in perpetuity. For Tyson Foods, we use a 10.8% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $39 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values. Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for Tyson Foods. We think the firm is attractive below $30 per share (the green line), but quite expensive above $48 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate Tyson Foods's fair value at this point in time to be about $39 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the firm's current share price with the path of Tyson Foods's expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $53 per share in Year 3 represents our existing fair value per share of $39 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Pro Forma Financial Statements
In the spirit of transparency, we show how the performance of the Valuentum Buying Index has stacked up per underlying score, as it relates to firms in the Best Ideas portfolio: