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Tyson Foods, Inc. (NYSE:TSN)

Q3 2014 Earnings Conference Call

July 28, 2014, 08:00 AM ET

Executives

Jon Kathol - Vice President of Investor Relations

Donnie Smith - President and Chief Executive Officer

Dennis Leatherby - Executive Vice President and Chief Financial Officer

Analysts

Diane Geissler - CLSA

Brett Hundley - BB&T Capital Markets

Farha Aslam - Stephens

Adam Samuelson - Goldman Sachs

Akshay Jagdale - KeyBanc

Michael Piken - Cleveland Research

Ken Zaslow - Bank of Montreal

Operator

Welcome to the Tyson Quarterly Investor Earnings Call. I would like to remind the parties that their lines have been placed on a listen-only mode until today's question-and-answer session. Today's conference is being recorded. If you do have any objections, please disconnect at this time.

And I'll be turning the call over now to Jon Kathol, Vice President of Investor Relations. Sir, you may begin.

Jon Kathol

Good morning and thank you for joining us today for Tyson Foods conference call for the third quarter of the 2014 fiscal year. On today's call are Donnie Smith, President and Chief Executive Officer; and Dennis Leatherby, Executive Vice President and Chief Financial Officer.

I need to remind you our remarks today include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. I encourage you to read today's press release and our filings with the Securities and Exchange Commission for a discussion of the risks that can affect our business.

Today we announced the launch of public offerings of Class A common stock and tangible equity units. We will not be commenting on these offerings and will not answer any questions regarding those offerings on this call.

To ensure we get to as many of you as possible, please limit yourself to one question and one follow-up and then get back in the queue for any additional questions. I'll now turn the call over to Donnie Smith.

Donnie Smith

Thanks, Jon, and good morning, everyone, and we appreciate you joining us a little early today. As you saw in our press release, we had a record third quarter with an adjusted $0.75 a share. We did have some one-time issues that I'll talk about when we get to the segments. But otherwise, our results were in line with our expectations. We're pleased with the quarter. We're ramping up what will be our best year so far, and we're looking forward to starting 2015 which looks to be an outstanding year even before we add Hillshire Brands' great products, brands and people to Tyson Foods.

Before we get to the third quarter commentary, I'd like to say a few words about the Hillshire acquisition. Several of us had the opportunity to spend some time in Hillshire in Chicago and we're beyond impressed with their team. We're excited about taking their expertise and combining it with ours to create a Prepared Foods business with strong stable margins and steady growth. As we execute our Prepared Foods strategy, we're estimating the impact of the synergies with Hillshire along with the cost savings and production efficiencies associated with the plant closures that I'll say more about shortly that will be more than about $225 million in fiscal 2015 and should exceed $500 million by the end of year three.

We expect the acquisition to be accretive in fiscal '15 and substantially accretive thereafter as we generate synergies. We plan to continue to delivering on our 10% EPS growth target in 2015, and we want to use our strong cash flows to delever the balance sheet quickly.

While I'm excited about the prospects of Tyson and Hillshire coming together, we must stay focused on the fundamentals that got us in the position to make this acquisition. So let's take a look at our segments, because we had some issues and there's room for improvement. The Chicken segment had a 6.9% return on sales in Q3. Pricing was down 1% due to the untimely and unfortunate events that resulted in the loss of volume in our high-margin value-added products. In February of this year, we experienced a fire at one of our fully cooked processing plants. Fortunately, no one was injured. But the damage to the infrastructure was more serious than we had originally thought. And our ability to supply products suffered. The mechanical repairs are now complete and the plant is back to producing normal volumes.

Additionally in Q3, a second sizeable fully cooked processing plant experienced a series of operational issues and the volume in supplies has been significantly impacted. New equipment has been ordered and is being installed and we expect to be back at full production volume in the early weeks of our fiscal Q1 of '15. On our Q2 call, you'll remember that I mentioned that we're completely out of fully cooked capacity in our Chicken business, which is why we weren't able to move production to other facilities following either event. So we've endured for long sizeable production shortfalls in one of our highest revenue, most profitable business during a time when high-priced beef and pork accelerated the demand for chicken.

These temporary disruptions and the resulting actions we took with customers have and will cost us between 1.5% and 2% return on sales in Q3 and Q4 in our Chicken segment. In FY '15, we'll be back to our full productive capability and we'll have additional fully cooked capacity coming on line in the spring. So our Chicken segment is expected to fully recover and deliver a 10% return on sales in 2015.

Moving on to the Beef segment, which had a 2.4% return on sales. The quarter got off to a slow start, but finished strong as the summer grilling season brought robust demand despite record high pricing. And even with those high prices, we were successful in promoting our premium branded beef programs. Our commitment to operational excellence and revenue-enhancing programs continues to work well. People often forget that a business with the 2% return on sales can still generate a pre-tax ROIC of 15% if you maximize the efficiency of your assets to turn your capital quickly, which is what we do.

Looking on to 2015, we expect next year to look a lot like this year from a cattle supply and an operating margin perspective. Heavier weight cattle are expected to continue to come into market and we're starting to see signs of heifer retention, but we're seeing adequate supply of cattle in our regions. The beef industry is becoming a combination of several small geographic marketplaces. Cattle continue to be moving to the feed lots in the grain belt. So it makes sense to have plants close to the feed lines, as we do.

Turning to the Pork segment, we had a record third quarter with a 7.2% return on sales. We've managed the supply challenges created by the PED virus very well. We were able to move supply among our facilities, adjust orders and maximize revenue. In fact, our volume was up 5% versus the same quarter of year ago, and demand remained strong as indicated by pricing that was up 26%. Looking ahead into fiscal '15, four factors indicate that we should have an adequate supply of hogs, portending another solid performance from that segment.

Futures prices indicate the industry is expecting more hogs later this fall. Hog weights are already very heavy and we would expect that to continue. PED seems to have slowed through the warmer months, but of course may reappear as we head into winter. And finally, lower price corn may incentivize some level of expansion into 2016.

In the Prepared Foods segment, first, let's address the negative return on sales of 5.5%. We incurred a $49 million impairment charge related to the three plant closures we announced Friday. Although it's always a difficult decision to close a plant let along three, it was necessary to improve our capacity utilization and streamline our cost structure. We aren't eliminating any sales volume from the closings. We're simply shifting the mix to more efficient facilities, because it's imperative that we are cost competitive in these predominantly private label and foodservice categories. Also in the Prepared Foods Q3 results were higher raw material cost of $95 million. Although this is typically recovered in future quarters, we're working on reducing the lag in our formula pricing to help our earnings correlate more closely with moves in the input cost.

Parts of legacy Prepared Foods segment are performing extremely well and the outlook for 2015 shows considerable improvement. Additionally, we expect to realize substantial synergies from the combination of our Prepared Foods business with Hillshire. Synergies are expected to come from operational improvements, purchasing and distribution. And when combined with the plant closure cost savings and efficiencies, it will be more than $225 million in fiscal 2015 and should exceed $500 million by the end of year three. We'll be looking at revising the normalized range for the Prepared Foods segment after the transaction closes.

Finally, the International segment had a negative 4.1% return on sales. Sales volume has improved and operating losses were cut in half from Q2 to Q3. Demand in China is in the early stages of recovery, but it's slow and as indicated by the recent news of another food scandal still vulnerable to food safety concerns. While a negative short-term demand, these events continue to reinforce the validity of our business model in China, which emphasizes biosecurity, supply chain integrity and food safety. We're currently seeing better supply balance resulting from a drop in grandparent stock imports, which will be supportive of pricing in 2015. As for our business, we're now processing 100% company-controlled birds and have eliminated market birds entirely from our supply chain.

Also regarding our International segment, we announced this morning that we're selling our operations in Mexico and Brazil to JBS for $575 million. Although these are good businesses with great team members, we haven't had the necessary scale to be a market share leader in either country, which is our preferred position. The sale represents an attractive price and the proceeds will be used to pay down debt associated with the Hillshire acquisition.

Now to wrap up my thoughts on Q3 and fiscal '14, despite the challenges in our Chicken segment and Prepared Foods segments, we believe we'll still generate an adjusted EPS of at least $2.78 a share in FY '14, which is more than a 20% growth over last year. Just to clarify, that excludes any earnings or costs associated with Hillshire. FY '15 is setting up to be another record year for sales, operating income and EPS. We'll have a better idea of how we'll look on our November call, but initially we expect Chicken margins to be at or above 10% as we get past the issues in the two value-added plants I told you about and we see the benefits from around $400 million in lower feed ingredient cost. We think these import margins would look similar to FY '14.

Prepared Foods margins should be much stronger as we run a sound legacy business and integrate Hillshire into Prepared Foods segment. We're excited about the synergy prospects as we execute our Prepared Foods strategy and anticipate more than $225 million in synergies in 2015 and $500 million by the end of the third year. The International segment's operating income should improve by about $50 million. We're expecting to continue our trend of at least 10% EPS growth. And we anticipate Hillshire being accretive to earnings next year and substantially accretive thereafter.

And now let's go to Dennis for the financial update.

Dennis Leatherby

Thanks, Donnie, and good morning. We had a second setting third quarter. Our topline revenue growth was 11% over Q3 a year ago and quarterly sales again surpassed the $9 billion mark. We continue to execute our growth strategy as evidenced by increased sales volumes in Chicken, Pork and Prepared Foods. Total company adjusted return on sales was 4.2% and adjusted operating income was $407 million or $351 million prior to the adjustments described in our press release.

Our adjusted earnings of $0.75 per share is a record for our third quarter and represents a 9% increase over adjusted EPS of $0.69 in Q3 of '13. Our GAAP earnings this quarter were $0.73 and we also provided a reconciliation in our press release. Year-to-date adjusted EPS is $2.07 or a 33% increase compared to last year's $1.56 adjusted EPS coming from continuing operations. We achieved an adjusted 12-month pre-tax return on invested capital of just over 20% compared to 17% for the prior-year period. Operating cash flow through three quarters was $543 million after funding $479 million in additional working capital as we grew our business.

We spent $144 million on capital expenditures for the third quarter and $437 million for the first nine months of fiscal '14. This outpaced our depreciation and amortization by $55 million as we continued to invest in projects that not only result in improved productive capabilities, labor efficiencies, yields and sales mix, but will also increase our ability to innovate and introduce new products to our customers.

During the third quarter, we did not repurchase any shares under our share repurchase program. This was a conscious decision to maximize liquidity for the upcoming Hillshire Brands acquisition. As a reminder, since May 2011, we have repurchased just over 50 million shares at an average price of about $24 per share. In order to facilitate deleveraging, we currently do not plan to repurchase shares other than to fund obligations under our equity compensation programs.

Our effective tax rate in Q3 was 16.8%. On an adjusted basis, this rate was 31.2%. Net debt-to-EBITDA for the past 12 months was 0.6 times. And on our gross debt-to-EBITDA basis, this measure was 0.9 times. Including cash of $587 million, net debt was $1.2 billion. Total liquidity was just over $1.5 billion, remaining above our goal of $1.2 billion. And gross debt remained at just over $1.8 billion.

Year-to-date net interest expense was $72 million, down 30% from a year ago. Average diluted shares for the quarter were 356 million. This reflects the dilutive effect of options and warrants of $3 million settled earlier in the quarter. Consistent with our Prepared Foods strategy, we will close three plants to improve capacity utilization and streamline our cost structure. We expect the closure of these facilities will result in significant cost savings and production efficiencies, but will be revenue-neutral as the sales volumes of these closed plants will be absorbed by capacity at existing facilities.

Additionally, our Prepared Foods segment will benefit from the addition of a great business in Hillshire Brands. We will achieve significant synergies from operational improvements, purchasing and distribution. For fiscal 2015, we expect the impact of the Hillshire brand synergies along with the cost savings and production efficiencies associated with the plant closures will positively impact our Prepared Foods segment by more than $225 million and should exceed $500 million by the third year following the close of the acquisition.

Additionally, as announced today, we've entered into an agreement to sell our chicken operations in Mexico and Brazil for $575 million. This transaction is expected to close in the next few months and we plan to use the sales proceeds to delever following the Hillshire Brands acquisition.

Now here're some thoughts on the full year for fiscal '14 and some thoughts on fiscal '15. Please note the outlook for fiscal '15 does assume that the Hillshire acquisition will close in fiscal 2014. Additionally, the fiscal '15 outlook also factors in the sale of our Mexico and Brazil operations along with the synergies expected from the Hillshire acquisition and the closing of the three Prepared Foods plants. We expect revenues of approximately $38 billion for fiscal '14, which is 10% growth over fiscal '13. Revenues for fiscal '15 are expected to grow 11% to $42 billion.

Net interest expense should approximate $130 million for fiscal '14, including the financing for the Hillshire Brands acquisition. For fiscal 2015, we expect net interest expense of $290 million, reflecting the full impact of the financing. The adjusted effective tax rate should be around 34.5% for fiscal '14 and is expected to be around 36% for fiscal 2015. CapEx is expected to be $600 million to $650 million for fiscal 2014 and for fiscal 2015 CapEx is expected to approximate $900 million as we not only look for projects that improve productive capabilities, labor efficiencies, yields and sales mix, but to also implement projects that drive efficiencies between Tyson and Hillshire Brands for future growth.

We expected diluted shares in Q4 of approximately $356 million prior to the equity offerings we launched this morning. You can refer to our pro forma information filed earlier today for the potential additional shares. We still believe we'll generate at least $2.78 adjusted EPS, which is more than 20% growth over fiscal '13. This excludes any earnings or costs associated with the Hillshire acquisition.

Fiscal '15 is setting up to be another record year for sales, operating income and EPS. Chicken margins should be at or above 10%. Prepared Foods margins should be stronger as we integrate Hillshire and realize the benefits of the significant synergies and other operational improvements within our legacy Prepared Foods business as we execute our Prepared Foods strategy. The International segment should improve by $50 million. And as a result, we expect at least 10% EPS growth and the Hillshire acquisition to be accretive in 2015 and substantially accretive in future years.

Our priorities for excess cash are significant deleveraging from the strong combined cash flows of Tyson and Hillshire, capital spending to improve and grow our existing businesses, acquisitions to fulfill our growth strategies around value-added products in International, and returning the cash to shareholders through share repurchases and dividends all while ensuring we maintain plenty of liquidity.

To wrap up, with the operational disruptions and other significant challenges we faced throughout the quarter, we still maintained focus and delivered another record quarter with adjusted earnings per share of 33% for the year. We believe the fourth quarter should be almost as strong and we are confident we can deliver on our targets.

That concludes our prepared remarks. Kelly, we're ready to begin Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Diane Geissler, and she is with CLSA.

Diane Geissler - CLSA

I wanted to ask about the US chicken operations and the operational issues that you had during the quarter. When you look at that, in particular the second plant where you said you had to order machinery, it's not going to be back up online until, I guess, the first quarter of fiscal '15, did that cause you to go back and look at all of your other facilities, because I know you went through a period when grain prices were very high that you had cut CapEx, et cetera? Just a little bit nervous about being so close to complete capacity utilization that if you have one outage, it causes such a problem. And then the second question I have is just relating to the new segment reporting where you're stripping out International. Can you give us an idea about what you think the domestic business should carry on a normalized basis in terms of the margin there?

Donnie Smith

Yes, we have been through all of our facilities. And a couple of things that we'll do differently, we'll move some of the retail fully cooked capacity among other plants, which will add a little bit of buffer in preventing these types of things from happening again. Also, we have pinpointed all of the locations where we can and should over the next few incremental quarters put in fully cooked capacity. We'll have two more lines that will come on right after the first year, so call that about Q2 of FY '15. And frankly, we need that capacity early in that fiscal year.

Also, on your second question, when you carve out international in the Chicken segment, I think for '15, we feel very good about being at or above 10%. And we're at the point where we're rethinking our normalized range for chicken. It's a little bit early with all that we've got going on in that segment in this quarter till we get all of our productive capability back up and all of that to do that. But we're rethinking that and we'll be talking about that in subsequent quarters.

Diane Geissler - CLSA

So maybe just as a follow-up to that, I think your previous range was 5% to 7%. I guess what I'm trying to ask here is your guidance for fiscal '15 at 10%-plus would be above a normalized range for the US operation?

Donnie Smith

Yes, certainly.

Operator

And our next question comes from Brett Hundley from BB&T Capital Markets.

Brett Hundley - BB&T Capital Markets

My first question is just on the Prepared Foods segment and the language that you guys gave for 2015. Can you discuss at all the synergy portion from Hillshire? Does that take up a majority of that $225 million? Is it half? Can you just speak to that and also speak to whether you're taking into account rebound in Hillshire business if in fact PED comes off and some of those costs abate?

Donnie Smith

So your second question first is no. And on your first question, think about the legacy Tyson Prepared Foods synergies being a little over half of that $225 million. So you can see it's fairly balanced. There's a lot of opportunity there. And those synergies are around operational efficiencies, purchasing, supply chain efficiencies, those types of things. So we feel really good about our ability to capture those.

Brett Hundley - BB&T Capital Markets

And then just my second question is back to your legacy Chicken business. Donnie, with the drop in feed, can you just talk a little bit about your approach going forward? Do you think that you guys would become a little bit longer as it relates to your procurement of feed and just again going back to the confidence that you have that Chicken margins can be even up again year-on-year for 2015? I appreciate it.

Donnie Smith

Yeah. So two things. Number one, on our commodity procurement strategy, we really won't change that very much. I mean we always look for opportunities when they present themselves to use options to help us with some of the commodity volatility. But we're pretty conservative when it comes to grain. We want to make our money growing, processing, marketing and selling chickens. So on the other part, I'm going to say how to think about chicken going forward, so we're leaving a good bit of money on the table in Q3 and Q4. So that then will be captured. And then as we continue to grow value-added, our case-ready chicken business is doing very, very well as breast chicken at retail becomes much more popular with consumers, particularly in light of the really high beef and pork prices, so we've got to expand that part of our business and we'll be working on that as well.

So we feel very comfortable with our '15 outlook in terms of what we're doing with our mix and how we view our underlying cost structure. The one question that some investors want to know about is, okay, what about chicken supply. And as we look at that, we don't see that there will be a meaningful increase in chicken supply until around the 4th of July or so next year. So if you look at all of that combined, that sets us for a very good '15 for us.

Operator

Our next question comes from Farha Aslam from Stephens.

Farha Aslam - Stephens

A quick question about your 10% earnings guidance growth for next year. Is that kind of off of that $2.78 base that you're discussing, because Donnie, your comments were that you're very confident about 10% growth? And Dennis, your comments about the fourth quarter implied about a $2.78, $2.80 year. But consensus is at $2.90. I just want to clarify the outlook that you're providing.

Dennis Leatherby

We keep saying we expect to do at least $2.78 so be expecting the 10% growth over that.

Farha Aslam - Stephens

And then in terms of the Hillshire synergies, I mean that step-up versus your initial $300 million comment is pretty material. And I was just wondering in particular as you got under the covers basically on Hillshire and got a deeper read, what makes you confident about that significant bump-up in synergies?

Donnie Smith

So when we look to combining our legacy Prepared Foods business and Hillshire together, the businesses are very complementary and the more time that we now have gotten to spend with some of the Hillshire folks as we begin planning the integration, it's pretty easy to see that there's going to be significant synergies in supply chain arena and logistics and operational efficiencies and those kind of things. Plus we had an early conversation about latent capacity and the footprint. And so as we work through that, what it made sense to do is to unfortunately close those three locations and then move that production into more efficient facilities that frankly had better supply chain cost as well. So when you combine all of that together, that's how we got to at least $225 million number. We feel really good then about adding to not just the legacy deal continuing to improve after that, but certainly with the Hillshire synergies combined being able to build that on up to at least $500 million range.

Farha Aslam - Stephens

And will some of those $500 million be captured in your Pork division as you source that product internally more and more, that supply?

Donnie Smith

No, we do believe there's great value end-to-end in Pork and Prepared Foods. But we're just talking about the synergies that will be reported in the Prepared Foods segment.

Operator

Our next question comes from Adam Samuelson from Goldman Sachs.

Adam Samuelson - Goldman Sachs

A little bit more detail on the forward chicken supply outlook. And, Donnie, I was hoping you could comment on your own order book at Cobb and how you see that order book playing out over the next year, year-and-a-half in relation to kind of future growth in pullets and chickens in US.

Donnie Smith

As I said on one of the previous questions, what it look like to us in terms of the pullet supply coming to the market as far as the building the breeder herd or flock, it looks like to me the increase in broiler meat on the market would appear at about somewhere mid-summer, so call it 4th of July. And I think that before that, it's just physiologically impossible to get a whole lot more supply on this market.

Adam Samuelson - Goldman Sachs

And then on the confidence in the Chicken margins next year, I mean excluding some of the operational issues that you had this year, looks like fiscal '14 would have been somewhere in the 8% to 9% range for the whole year. Is the improvement then just solely on feed with stable pricing or is there something else there beyond the feed costs that give you the confidence in the margin expansion?

Donnie Smith

As you look at the environment, you got to believe that beef prices in terms of price situation, you're going to have a similar environment next year as this year. As you get into pork, it looks like to us that more hogs are going to be coming to the market in the fall. With grain prices coming down, you're likely to see a little bit of finished hog expansion perhaps in the latter part of our fiscal '15. So that's just a great environment there in the pricing structure. The parts of our business where the demand is growing are in profitable parts of our business, our fresh chicken business. And unfortunately because of the operational issues, our value-added business is seeing great demand. As you saw during the school season in the winter a lot of demand for fully cooked retail products, so as we get our capacity back on line, that looks like it will be another great year for us.

So you're really talking about three things. Yes, you're going to have a favorable grain environment. You're also going to have a favorable market environment structurally in terms of chicken and its relative pricing to beef and pork. And the parts of our business where we're seeing the greater demand are the parts of our business where we have good margins.

Operator

Our next question comes from Akshay Jagdale from KeyBanc.

Akshay Jagdale - KeyBanc

So first question is on the '15 guidance. I'm trying to reconcile two things. One is at least 10% EPS growth implies around, I think, $3.06 or $3.05 in EPS if you take $2.78 as the base. And then if I look at your operating income guidance for Chicken and the other segments, I'm getting to much higher consolidated EBIT growth. Obviously the interest expense is going up. But when I factor all of that in, including the estimate that you've given on the share issuance this morning, it looks like 10% EPS growth is very conservative. I'm getting to closer to 20%. I mean can you give us some help? I know there's some things you can't comment on. But the EBIT guidance seems to be well in excess of what you're calling sort of 10% growth. So can you just help me out a little bit there?

Dennis Leatherby

It's early for us coming out of Q3, right? I would agree that our earnings guidance is conservative, but that's because we're early. So here's how we think about that. So let's just talk in ballpark terms, okay? If you look at how you view where this year is going to end up, if you look at the last 12 months, it's like a 1.6% in operating income-wise. You can back in using at least the $2.78. And then if you take 10% return on sales on our Chicken business, that's going to be worth an incremental $200 million or so. If you look at Hillshire's earnings, you got to be thinking about an incremental $400 million or so. The Prepared Foods synergies will be $225 million. International will improve by about $50 million or so.

You're right on the interest expense and it's probably a little early to talk about that in too specific a detail other than we're estimating pro forma is about $2.90. So then you use 36% tax rate and adjust for the new shares. And I think you got the math.

Akshay Jagdale - KeyBanc

And second question is just a follow-up to, I guess, what Farha was saying. The $500 million synergy number is impressive in itself in terms of just increasing it from $300 million so fast. But can you just help us understand eventually what impact might this acquisition have on your Pork business? And also, does it have the potential to positively impact the Prepared Foods portion of the Chicken business? And ultimately, are those two factors that will really in your mind make this a really successful acquisition versus an okay one?

Donnie Smith

Well, we certainly believe this is going to be an extremely successful acquisition. If you look at the Pork segment, end-to-end, and we look at end-to-end value creation, we see a lot of opportunity there. I would hasten on to say it's a little bit too early. We see Hillshire a little bit today, but not very much. So we'll need to get through the deal itself and then be able to drill down on that a little bit more. But that certainly seems like that there should be two benefits, one, a stabilization of earnings between the two segments and then there should be some opportunity end-to-end to capture even more savings. So that's how we're looking at that.

Akshay Jagdale - KeyBanc

Can you give us some guidance on D&A for '15? And I'm assuming a share count of between 405 million and 410 million. Is that roughly correct?

Dennis Leatherby

Akshay, I can't comment on the share count. That's related to the equity offering. As Jon said upfront, we can't comment on that. But if you do have the information out there, help you with the calculation. As far as D&A goes, think about $700 million or so.

Operator

And our next question comes from Michael Piken from Cleveland Research.

Michael Piken - Cleveland Research

Just want to get your thoughts on what your expectations are for the industry in terms of taking the normal seasonal fall cuts. Do you expect people to sort of take the normal levels? Or do you think with the margins being as strong as they are that we might see people hold on their pullets a little bit longer?

Donnie Smith

I can only comment on what we're doing. Typically we'll pull out a couple of days in the fall for placement cuts for the holidays. This year, because frankly, we've dug a pretty deep hole in our value-added business. We are going to need to back off what we typically do just a hair to make sure that we've got the raw material supply to be able to run what then will be all of our fully cooked lines running full, because we've got to build back the pipe and we've got to build some incremental inventory for promotional activity next year because of the situation that we've caused with our customers this year. So I can only talk about what we'll do. And that's not a significant increase in production. What I just said is just we're going to need some incremental particularly breast meat to keep running our FP lines full.

Michael Piken - Cleveland Research

And then you mentioned in your prepared remarks that you're no longer buying breast meat the open market. Is that sort of a long-term strategy or would you expect to kind of switch back once you get everything ramped up back to the old strategy of buying on the open market?

Donnie Smith

I don't remember that being said. And if it was said, it was said by mistake, because we're still buying not only breast meat, but we're buying some tenders. And frankly, Michael, one of the customer-related issues is if you're shortened on the FP, you sure don't need to have full service and full order fill in their fresh offering, particularly as important as that is today in light of how beef and pork prices. And so frankly, we've been buying some whole birds and we've been buying some other parts to take into our tray pack plants and frankly run that on overtime. Now that's not a favorable economic position, but we're going to fix our fully cooked issue. And when we do, we don't want to make customer any angrier than they already are about not getting their orders. So we've made a decision to take very good care of them in all other lines of business, so that we can quickly recoup from the FP side. So yes, we're very much out in the marketplace, buying raw material.

Michael Piken - Cleveland Research

And then lastly just shifting over to the Pork side of the business, obviously you did very well in the face of PEDV. I mean I guess if you could just talk about sort of some of the factors. Has this been sort of all demand-driven or was this some operational things you did right and sort of what are your expectations for kind of going forward? I know you said PEDV, it's too early to call, but it sounds like you're expecting supplies to alleviate. Any other color you can provide on how you're able to do so well in pork would be helpful.

Donnie Smith

We think that what we'll see about for the year will be about 5% less hogs. Now we're at the point where we are seeing, I guess, the biggest supply dip. But I also want to say that on the national numbers if you take out North Carolina and Oklahoma, then the supply dip for the industry is really only about 3%. And so most of our hog operations are in Eastern Nebraska and Iowa. And so we have a very good grasp of the supply situation around us. What our team did to manage that, number one, we worked very closely with our customers on those items that are sold off-site by the each instead about a pound, knowing that with a little bit cheaper grain basis in the Midwest, hog producers were going to be able to put a little bit more weight on the hogs, which thankfully they put considerable more weight on the hogs, which has offset some of the volume in things like hams and that type thing.

But now with bellies or ribs, we've worked with our customers very closely to manage those promotions. Secondly, we have very good relationships with our hog producers, most of whom we've been doing business with for years. We've stayed very close to them. And we're able to dial in the supply fairly specifically at least to the point that we can move hogs between facilities in order to spread out the production runs and give ourselves the best opportunity to service our orders. So when you combine those two things, our team really, really did a great job.

In terms of fresh pork supply and demand, the demand for pork is up significantly. We know the pounds are going to be down just because we're not producing them. But in the last four weeks ended in May, pork pricing just in that last four weeks at retail was up 23%. So the demand for pork is very strong. Frankly, the demand for beef and chicken is very strong. It's just chicken has been the only one to really be able to supply some portion of the demand. So if you look at ground beef pricing for the four weeks ended, you're up 12.5%. Fresh beef was up 10.5%. Chicken was up another 4.5%. And like I said, fresh pork was up 23%. So the demand for protein is really strong.

Operator

Our next question comes from Ken Zaslow from Bank of Montreal.

Ken Zaslow - Bank of Montreal

Just starting off, just so I understand the guidance for a second, you have about $100 million less chicken profitability and you have higher interest expense and less share repurchases. Is that kind of what I'm hearing?

Dennis Leatherby

When we said $130 million for '14, that was inclusive of the initial Hillshire financing. When we talk about the $2.78, though, it's still up the old run rate that we described before of about $95 million or $100 million.

Ken Zaslow - Bank of Montreal

But still, you're keeping your guidance. So you did stop your share repurchases, which is probably another $0.02 to $0.03. And you had about $100 million that you're going to lose in your chicken profitability because of operational issues. And you're still hitting the numbers?

Donnie Smith

And the other thing to perhaps not miss there is in Q3, we absorbed $95 million in incremental Prepared Foods raw material cost that we did not recapture all of that in our pricing structure because of the way our pricing works. By the way, that's up $160 million for the year. And so there was the $50 million write-off in Prepared Foods, but there was also the inability because the markets were still going up to capture any raw material costs. So if the markets will stabilize, then that capture will happen in future quarters. Now we're doing what we can to shorten the lag. But it takes a while to work through that. So I think that's another important thing to keep in mind.

Ken Zaslow - Bank of Montreal

So your base number is actually higher than what you're saying and then you expect to grow 10% off that. Is that a fair way of also thinking about it a little bit?

Donnie Smith

I think the easiest way to look at that is what we've said was our EPS guidance would be off where we land this year. But I think we can see that there's upside potential to that. We're just talking about this now in our Q3, which normally we don't talk about that too much until November. So I think what we're trying to say is we've got a pretty conservative baseline of growth with upside to that.

Ken Zaslow - Bank of Montreal

Then my two follow-up questions. One is you obviously have a better clarity to the cost savings. What did you find out that gives you any confidence or change your view on that? Obviously, you probably had one or two meetings with the Hillshire folks. Can you talk about that and exactly why you came up with a different synergy number?

Donnie Smith

You're exactly right, Ken. We would have this assumption about a particular category and let's say some category and purchasing. And so we have a quick conversation and you find, you know what, that's probably not right. But here is another category where we didn't think there might be very much savings, there ends up being more. When we look at capacity utilization, when we look at transportation and logistics savings around, we have a different basic tenet around our distribution model. And so being able to combine that and get fuller trucks and both refrigerated and frozen been able to shorten the distance of the raw material travels to the manufacturing plant that we can figure out how to do a network optimization model to streamline that all the way to the customer, those are some of the things as we started these conversations that get popping up, that makes us feel really good about what we see going forward.

And two, our very use in our synergy number is really, let's call them, hard synergies. Call it savings and supply chain savings and purchasing savings and that kind of thing. When you start thinking about the innovative capability, new product development, sales growth, efficient map spending and brand spending, there is a lot of incremental value that will be created through this acquisition. On the front end, especially before the deals are even closed, we want to only talk about those hard synergies that we can report back on every quarter.

Ken Zaslow - Bank of Montreal

And then my last question is you didn't talk about hog supply and impact. Again, I guess PED virus. But I'm actually thinking about the hog production margin. I know you're not in the business of hog production. It seemed to be pretty great if not at near-record levels. I would assume that there would be some expectation of expansion over the next two to three months. What's your take on that? And then how is that factored into your expectation, because I'm assuming you don't expect (inaudible) prices to be at $90.

Donnie Smith

So here's the way we're thinking about that, Ken. First, a hog producer that did not have PED is having an outstanding year. Unfortunately, many have had PED, and obviously that's a devastating loss to those farms. If you go back into the early spring, there was a potential to lock up really decent margins hedging. And so a lot of guys put on hedges and their margin calls have been significant. And so frankly the farm banks have been, I think, a little hesitant maybe so far until these producers are able to clear that hedge in Chicago, the margin issue in Chicago, by selling out the hogs. They've been a little bit hesitant, as we understand it, to talk much about expansion. But in my opinion, as you get on into the fall, assuming of course that we don't (inaudible) that we have a decent corn crop, there's going to be a compelling financial case for a lot of these hog producers who have healed in a lot of their balance sheet to be able to add some finishing capacity and move forward.

And I think the finishing capacity is probably the capacity to spend on is probably the cheaper to spend. And so that gives us confidence that with the biosecurity precautions that producers have taken, they're seeing incremental benefits in other diseases that they typically work with during the year too. So that gives us confidence that we're going to see the hogs up about 2% or so next year.

Operator

And our next question comes from Akshay Jagdale from KeyBanc.

Akshay Jagdale - KeyBanc

Thanks for taking the follow-up. First one is on Chicken. So there's two questions. A 10% margin would be obviously the highest. Not only annual margin, but I think, even on a quarterly basis, we haven't seen 10% from your Chicken business, at least in a while. So help me understand why that's not only possible, but perhaps conservative and something you're confident in. And secondly, what happens when chicken supply does pick up? In terms of the range, where are we now in terms of bottom of the margin range for Tyson, because we could argue and debate what the top end is, because you haven't really pushed that up as much as we would have thought? But certainly I think you've proven that the bottom end is higher. So when chicken supply does pick up maybe in 2016, what's the worst we could see from the Chicken business?

Donnie Smith

So let's think about '15 first. Obviously we're leaving money on the table with our production issues. Then so if you just pull that $100 million or so in and then we're going to have grain down, say, $400 million, and remember the parts of our business where we're seeing the greatest demand is the parts of our business where we have the best margin structure, rightfully so. And so when you put all three of those things together, I think it's pretty easy to see that if you do 10% on $11 billion business, that's pretty easy math.

Now let's think about going forward into the latter part of '15 and on into '15. So because we are working hard to maintain our investment-grade rating to keep a grade capital structure, we're going to have the available cash flows to be able to keep spending on our business and we intend to do that and we've got several projects in chicken where we can continue to spend money and generate cost efficiencies. And I think we've done pretty well over the last three or four years proving that we can do that. I think over a four-year average, it'll probably be like 25%-ish on our CapEx all in. So we know how to spend efficiently to gain cost improvements.

Second thing, we'll continue to grow our value-added business. Frankly, the only thing keeping us from selling a whole lot more value-added is our productive capability. So we're getting all of that fixed, more case-ready. Case-ready chicken is growing at retail, because we have decent pork prices. I think that will continue for several years and we'll continue to add capacity into that offering. By the way, we'll grow our no-antibiotic-ever line of predominantly fresh chicken. So we've got opportunity there.

What we strive for, Akshay, is a more stable business model. We have birds in all of the major bird-size classes. And we strive for variable pricing models to be able to deliver consistent growing earnings over time. And we spend a lot of time getting this business under us. Unfortunately we've had that production issue in the last half of this year. But once we get that behind us, I think we've got a great future going forward.

Then if you look at the rest of the business, our case-ready beef and pork offering will continue to grow. Of course, we're adding Hillshire, great capabilities there, plus all of the synergies there. We should see adequate pork supply. We'll start seeing some improvement in our international business. We'll see benefit from our legacy Prepared Foods benefits as we get the production footprint right and stabilize the raw material.

So when you combine all that, that's a great story going forward that will carry you beyond '15 on into the '16-plus. And besides that, keeping that investment-grade rating and then rapidly delevering this debt, we have multiple growth options open to us in the very not-too-distant future. And that's important to continue the Tyson story upfront.

Operator

Thank you. And I'd like to turn the conference call back over to Donnie for any closing remarks.

Donnie Smith

Thanks, Kelly. Hey, before we go, let me just reiterate a few key points. Number one, we expect to continue our trend of at least 10% EPS growth next year. We anticipate Hillshire being accretive to earnings in 2015 and substantially accretive thereafter. We think our Prepared Foods segment synergies will be over $225 million as we execute our Prepared Foods strategy in 2015 and $500 million by the end of the three years.

So thanks for joining us today and we hope you have a great day.

Operator

Thank you. That does conclude today's conference call. You may all disconnect at this time.

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Source: Tyson Foods' (TSN) CEO Donnie Smith on Q3 2014 Results - Earnings Call Transcript

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