Tyson Foods: Big Upside Found In Chicken
Summary
- Big upside of ~30% due to market overreaction.
- Consumption of chicken and protein-based foods in the U.S. and China is strong and increasing.
- Profitable business due to falling costs.
Buying opportunity found in market sell-off
Sometimes the equities market does not correlate fundamentals of a business to the stock price. When situations like these happen, buying opportunities come up. Tyson Foods (NYSE:NYSE:TSN) represents a buying opportunity now. The market sold off the stock around 8% amid a lawsuit filed last month in federal court in Illinois by U.S. food distributors, against Tyson Foods Inc, Pilgrim's Pride Corp (NASDAQ:PPC), Sanderson Farms Inc (NASDAQ:SAFM) and Perdue Farms on wholesale chicken price manipulation. Tyson's stock price has not bounced back to its last high since the lawsuit filing in late January 2018. Despite the sell-off, Tyson has shown strong fundamentals and intentions on cutting down costs through acquisitions, expected to result in cost synergy benefits of $200 million. According to the database IBISWorld Tyson Foods is a market leader with market share of about 14% in a robust and matured meat industry. Tyson Foods is a great value idea for investors who want to own stock of a stable business with great profits, and a robust dividend backed by strong free cash flow.
Look at exhibit 1 for market reaction among poultry producers:
Exhibit 1: Market sell-off in late January
Source: Chart was retrieved from the Bloomberg terminal.
Tyson Foods was down nearly 4% following the lawsuit on January 31, 2018, eventually selling off 8% year-to-date. There has not been a verdict on the case as of February 2018.
Lawsuits are nothing new to Tyson. We can look back to history where there was another push to prove collusion in prices back in November 2016.
Exhibit 2: Sell-off of 14% due to litigation based on price collusion conspiracy.
Source: Chart was retrieved from The Bloomberg terminal with a time period of October 2016 to February 2017.
When Tyson was sued in 2016, even the Securities and Exchange Commission initiated an investigation but later withdrew all effort because of the lack of evidence.
Following the 2018 litigation, Tyson Foods spokesman Gary Mickelson said, "Follow-on complaints like these are common in antitrust litigation." He also said, “Such complaints do not change our position that the claims are unfounded."
Stronger Fundamentals than Competitors:
With free cash flows of $1.53 billion for FY 2017, Tyson Foods is generating much more cash than its direct competitor Pilgrim’s Pride. Pilgrim's Pride generated $461 million in free cash flow for the same fiscal year.
Food processors saw an increase of 7% year-over-year in profit margins of sales as price for grains used to feed birds such as soybeans and corn have decreased 28.63% in a 5 year period. Tyson Foods is expected to see an increase of annual 9% growth in profit margins for FY 2018 and FY 2019 as cost of goods sold decrease. Refer to exhibit 3 and 4 for prices of the main ingredients used for chicken feed. Chicken feed is a cost that Tyson incurs and not the grower.
Poultry Profit Boom
Profits have been booming as soybeans and other commodities have plummeted in price at a 5 year change of 28.63%.
Exhibit 3:Over $2 billion in profits in FY 2017 and expected to increase 9% as percentage of sales.
Source: Bloomberg News on Chicken Consumption.
Post-2011, profits have steadily increased, with Tyson being the most profitable in the industry.
Profits are a result of falling ingredients in chicken feed supplied by Tyson to chicken growers.
Exhibit 4: Price of soybeans has decreased 28.63% over the past five years and it is expected to remain flat for 2018 based on futures quotes.
Source: Market Insider: Soybeans price commodity.
Soybeans went from an all time high of ~$16 to ~$10 in 2018.
Tyson Foods is not only taking the most profit out of all players in the industry, but also it is cheaper than competitors when looking at the trailing twelve month price to earnings ratio.
Exhibit 5: Trailing twelve months price to earnings ratio at the lowest over a one-year period.
Source: Trailing twelve months price to earnings chart.
Trailing twelve months price to earnings ratio dropped to 9.98x at the same time the stock price dropped as a result of the over-done sell-off followed by the speculative lawsuit filed against meat manufacturers. This reaffirms that Tyson Foods is trading at a discount in comparison to the past year.
Tyson Foods is also great for income investors that are looking for a track record of a constant increase in dividends.
Exhibit 6: Increase in Dividend Payout and Dividend Yield:
Source: Tyson Foods Dividend Yield (Twelve trailing months).
Dividends have been increasing over the past five years. Current 12 month dividend is $0.97.
Multiples reaffirmed Tyson Foods is the best deal out of the entire industry. Tyson Foods is trading at a discount relative to the industry when comparing price to earnings ratio:
Exhibit 7: P/E comparison relative to the industry average.
Source: Charts created by author with data extracted from the Bloomberg Terminal.
An upside of 23.26% is found when calculating the estimated stock price for Tyson Foods by multiplying the industry average P/E of 17.98x and Tyson’s twelve trailing months earnings per share of $5.52.
Tyson Foods is also trading at a even grater discount when an earnings per share discount model is used:
Exhibit 5: Earnings per Share Discount Model:
Source: Charts created by author with data extracted from the Bloomberg terminal.
Tyson Foods is also expected to have a constant growth in annual revenue in the next coming years.
Strong Demand in Beef Exports to the Chinese Market:
In terms of U.S. dollars, beef is the largest revenue source, accounting for nearly 40% of total sales or about $15 billion in annual sales for FY 2017. This is an advantage that Tyson Foods possesses over its competitors which are heavily dependent on chicken as a revenue source.
According to the U.S. Department of Agriculture’s Foreign Agricultural Service, beef and broiler meats imports to China are expected to grow at an annual rate of 11% and 7% respectively. This is of great importance because China is the world’s second largest beef and seventh largest broiler meat importer.
As the United States regained access in May 2017 to export beef and poultry to China, herd inventory has increased. Exhibit 2 shows China’s forecast of strong beef demand that serves as a key driver of imports. Exhibit 8 shows key drivers of Chinese beef demand according to the Foreign Agricultural Service/USDA.
Exhibit 8: China's expected increase in beef imports:
Source: China's meat and poultry import forecast 2018.
Strong Poultry Demand in the United States
It seems like Americans are eating more chicken than ever. Per-capita consumption will jump to a record 92.4 pounds this year, up 15% since 2012 according to the U.S. Department of Agriculture. This forecasted increase in demand should help drive revenues. Sanderson Farms, a poultry manufacturer, expects industry production to increase 3% annually from 2019 to 2021. To accommodate for the expected demand, Tyson will open its first new chicken plant in two decades, opening in 2019 in Tennessee.
Valuation
I used a discounted cash-flow model to come up with a target price of $109.37 and an upside of 30.36%.
Source: Output Analysis was obtained from a discounted cash flow model analysis that forecasted five years out. The discounted cash-flow model was created by author.
Source: Assumptions chart was created by author.
Proforma to obtain expected unlevered cash-flows for years 2018 to 2022:
Source: Proforma obtained from discounted cash-flow model created by author.
My assumptions are based on guidance provided by management in the last earnings call. Annual revenue is expected to grow 6% in FY 2018 due to the acquisition of AdvancePierre Foods a pre-packaged food company. I left COGS, SGA, D&A, tax rate and CapEx constant because the company is at a mature state with organic revenue growth of about 3% year-over-year.
Potential Risk
I do not know what is the dollar amount of the lawsuit. I am assuming the ongoing litigation is going to drag for many years, making the present value of the dollar amount rather small for Tyson Foods. Also, political climate and tariffs imposed by Asia gives uncertainty to the future of growth. A breakout of avian flu might represent risk to the supply of chicken as well.
Fluctuation of commodity prices can be risky for the profitability of the company.
In conclusion, Tyson Foods is the item on sale in the meat industry. Tyson Foods has become highly profitable and has improved its margins resulting in generation of free cash flow. Whether you want to buy a stable company or a stock that will provide you with income through dividend payout, Tyson Foods is your choice.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (11)
On a per Sales dollar basis, PPC generated more FCF.
