Tyson Foods - The Real Beef?
The beef-related story that many investors will be reading about today involves the creation of the world's first lab-grown hamburger in a venture backed by Google (GOOG) co-founder Sergey Brin. From a stock market perspective though, investors should be concentrating on the results issued on Monday by Tyson Foods (NYSE:TSN).
Actually to take a step back, part of the rationale in developing lab-grown food is because of the mega-trend that Tyson Foods also sees. Contained in one of their recent presentation documents was this interesting slide:
So what exactly does Tyson Foods do? As shown below they are one of the leading American companies across the protein food chain, including a range of linked prepared foods on sale to consumers.
As shown above, Tyson has the leading position in chicken and beef production and is number two to Smithfield (SFD) in pork (Smithfield was recently subject to a bid from Shuanghui International of China which is currently going through anti-trust appraisal).
Livestock production has historically been a volatile business as fluctuations in pricing can lead to a disproportionate impact on production levels which then leads to further pricing fluctuations and so on. The stock market has historically put a low multiple on earnings and pricing fluctuations like this.
Any change would show up in prices first. Are we starting to see pricing discipline come into the protein markets? This chart from a Tyson presentation suggests it is possible:
Looking through the just-released Tyson Foods Q3 numbers, this trend has continued. Across all four divisions of the company (chicken, beef, pork and prepared foods) prices rose in Q3 year-on-year between a range of 2.9-6% and chicken sector margins were at an all-time high. This is impressive.
Donnie Smith, Tyson's CEO and President, reiterated progress on this front on the conference call and also highlighted the benefit of having a prepared food business too.
Our folks have done a great job in the last 12 to 15 months or so of changing our pricing portfolio to give us greater stability. And that's what we're constantly looking for is more consistent and stable earnings growth, and our business model is structured to be less volatile than the pure commodity players.
But what about higher prices inducing new supply? Donnie Smith also gave some reassurance on this front:
Solid demand and Chicken's relative low pricing compared to the other proteins, should be a very, very good year for Chicken. By the way, probably layer on top of that international improvements as well. So if you look at Beef and Pork, the current supply's set up next year to be as good as this year and maybe even a little bit better. In Prepared Foods, we're investing in growth platforms.
This makes me wonder if - finally - the consolidation in the number of producers across the livestock markets is improving the pricing dynamics. This could be further accentuated if Smithfield is taken over and its new owners place more focus on supplying more to the domestic Chinese market, at the margin.
Additionally lower corn prices will give a costs tailwind. On the conference call the Tyson management commented that
as raw material prices go down, then we get the benefit of that in the subsequent quarter
The mention of international opportunities also highlights another opportunity for the company in which, they confirmed during the conference call, would be profitable for them during this financial year.
This chart nicely summarizes their continued push-out in the international chicken markets.
Protein demand, of course, is rising fastest in the emerging markets due to rising populations and changing diets as wealth increases. The international business is a good ongoing opportunity.
A few observations now on the balance sheet. Using the Q3/9m numbers, which were published on Monday, free cash flow will annualise at just under $400m. As net debt stands at $1385m (or under x1 ebitda) the balance sheet is strong and interest cover is over ten times, therefore the company has been recycling this free cash into buying back shares. Year-to-date they have bought back $100m worth of shares at an average price of $25 a share. They can afford the repayment of $458m worth of convertible bonds which are due in early October without a big problem.
Tyson Foods shares are up strongly over the last year and have also responded well to the Smithfield bid
Typically I do not get excited about shares that have already doubled in the last year but I believe we are at a paradigm shift in how shares in Tyson Food are perceived. At 9x this year's EV/ebit despite the aforementioned good share price performance there is still room for this share price to go higher. Rolling the numbers forward a year to reflect the company's hoped for 10% earnings increase and raising the target rating to x10 EV/ebit gives around 20% upside.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in TSN over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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