- The protein supply chain is temporarily broken.
- Tyson, along with many other protein processing and production companies, has seen unprecedented closures, worker absenteeism, and high costs to ensure safety.
- The shift to strong consumer grocery/retail demand has greatly offset the loss of foodservice demand, though the next few months will still be tough.
- The stock has taken a bit of a bad beat, in that it has gotten crushed in a short term, though the long-term prospects are promising.
- This idea was discussed in more depth with members of my private investing community, BAD BEAT Investing. Get started today »
Prepared by Stephanie, Analyst at BAD BEAT Investing
Tyson Foods' (NYSE:TSN) stock has been falling along with the market thanks to the COVID-19 crisis. Dealing in proteins, Tyson has been hit particularly hard as a company. Let us be clear, meatpackers and employees of protein processing plants have been hit hard with COVID-19 infections. Many producers have had to shut plants, sanitize, send employees on temporary furloughs, and more. Making matters worse, with big declines in restaurant demand, the space has been squeezed. Essentially, there will be limited supply of Tyson's products available in grocery stores until it's able to reopen its facilities that are currently closed. The supply chain is broken. Farmers across the nation simply will not have anywhere to sell their livestock to be processed. Millions of animals will be depopulated because of the closure of Tyson's and other protein companies' facilities. This Time Magazine article summarizes the issue nicely.
In terms of a stock, a better price approaches for Tyson as the just-reported earnings reflected pain, and it is likely Q3 will be even worse. Issues we once really dug into like feed and labor costs are now trivial in relation to the health and safety of workers, and the nation. Given the fear of product shortages, the main consumer concern would be a surge in prices. While we expect prices to rise a bit in the interim, Tyson is of the position that total protein volumes will actually be higher in both Q3 and Q4 in comparison to a year ago, despite the plant closings grabbing headlines at the moment. Obviously, we have to worry about the coronavirus completely impacting demand, and we continue to expect supply issues to continue for the coming weeks, though the full financial impacts are not known on the global business at this time.
All of that said, if you are a long-term investor, the stock has taken a bit of a bad beat, in that it has gotten crushed in a short term, though the long-term prospects are promising, despite the current issues. We think that, if this stock dips to the low $50's or high $40's, despite the tough situation, it would be time to buy.
Revenues have been growing at Tyson, in part helped by acquisitions and in part by organic growth. Despite a major headline print that missed expectations, revenues still grew. Take a look at revenue growth over the last few years:
Source: SEC filings, graphics by BAD BEAT Investing
Revenue momentum is positive, and investors should take note. Even if earnings are cut down this year by the crisis, say, to even $4 a share (unlikely) for the year, value would remain somewhat attractive, in our opinion, at 13x forward EPS and growing sales, which lead to an attractive 0.9 enterprise value to sales ratio. But assigning a proper valuation to almost any company, especially those hit hard by COVID-19, is tough. Handicapping performance in this tough situation is difficult. The stock sold off following the headline results which were pretty mediocre this quarter, and with a cloudy outlook with coronavirus, we think the Street's uneasiness will give the savvy investor a chance to turn this recent loser into a winner.
While revenues came up slightly short on the top line versus consensus projections, sales still grew. For many quarters, Tyson has exceeded our projections, and so while a revenue miss is concerning, it was slight. We were looking for revenues of approximately $11.0 billion, and at $10.89 billion, Tyson missed our expectations by $110 million, while missing consensus by $120 million. Yes, this is a miss, but year over year, the company saw sales that were up 4.3% in Q2. Helping drive post-earnings stock selling was that expenses were high, leading to a weaker-than-expected EPS.
We anticipated increases in the expense category. We were concerned margins would be pinched a bit if input costs were too high. Rising sales are nice but only if they translate to stronger earnings. Make no mistake, in the last two months, we have witnessed a huge shift in demand away from restaurants and into grocery stores, with issues exacerbated temporary plant closures, reduced team member attendance, and supply chain volatility as a result of the virus. The cost of sales was up 6.7% to $9.87 billion from $9.25 billion last year. With a 4.3% rise in sales and a comparable 6.7% increase in cost of sales, gross margins were hit hard. Gross profit was down 13.6% to $1.02 billion versus $1.19 billion last year.
After factoring in selling and administrative expenses (which were down 7%), operating income plummeted 21% to $501 million from $635 million last year. Overall EPS was $1.00, a 15% increase from $1.16, but if we adjust back in restructuring costs and facility issues, we see adjust EPS of $0.77:
Source: SEC filings, graphics by BAD BEAT Investing
Adjusted EPS was actually down 36% from last year's $1.20. Make no mistake, we anticipated better performance based on our revenue projections and considering the trends in protein prices. That said, the lower-than-expected revenue growth drove a lower-than-expected EPS, as we were looking $1.05-1.10. To understand where some of the strengths and weaknesses lie, we find it prudent to examine each contributing segment, both protein and prepared foods.
The chicken segment is usually volatile, thanks to the movement in poultry prices and feed costs. This segment was about flat from a year ago. Tyson saw sales volume that was down 1.5% while pricing was also up 1.2%, year over year. The company saw sales of $3.397 billion versus $3.407 billion last year for chicken products. These sales were met with higher expenses and led to a decline in adjusted operating income, which fell to $99 million versus $150 million last year, which was somewhat surprising.
Sales volume decreased due to lower volume from the rendering and blending business. Sales volume increased, though, if we look at things on a six months basis for H1 2020, primarily due to incremental volume from a business acquisition in the first quarter of fiscal 2019, partially offset by lower volume from the rendering and blending business. Average sales price increased in the second quarter and in fiscal H1 2020 due to lower rendering and blending sales, which carry a lower average sales price, largely offset by broadly weaker chicken pricing as a result of market conditions.
Beef remains the largest contributor to the top line. However, this is the one commodity that still concerns us, as too high a price can hurt demand. The price of beef really has been rising quite heavily for the last 5 years, though pricing fell just a touch from a year ago. In Q2 2020, the average sales price for Tyson's beef products dipped by 0.3%. Demand was higher as volumes rose 2.7%. This volume led to sales rising to $3.979 billion versus $3.884 billion last year. Despite the rise in revenues, higher operating costs outstripped the gain, and adjusted operating income fell to $109 million from $156 million. So, what happened here? Well, sales volume increased due to stronger demand for beef products but decreased in H1 fiscal 2020 due to a reduction in live cattle harvest capacity as a result of a fire last quarter.
The pork segment saw solid sales increases. The segment saw an increase in sales of 8%. Sales rose thanks to an increase in volume of 2%. This was compounded by a huge 6% increase in pricing. As such, revenues jumped here, and this was a bit ahead of what was expected. However, big rises in operational costs in the second half of the quarter led to pork operating income falling to $93 million from $100 million in last year's quarter. Sales volume increased due to increased domestic availability of live hogs and strong demand for pork products, especially in the consumer products and export sales channels during the second quarter. Average sales price increased in the second quarter due to higher livestock costs and stronger export markets.
Turning to prepared foods, sales were up marginally. They came in at $2.08 billion from $2.03 billion a year ago. Average sales prices were up, but volumes decreased ever so slightly. Sales prices jumped 2.7%, while volume fell just 0.1%. Like all aforementioned segments, prepared foods saw compressed margins. Operating income narrowed to $191 million from $249 million as margins fell from 12.3% to 9.2%. Growth in volume across the consumer products channel was offset by a reduction in the foodservice channel and other intrasegment sales channel shifts. Average sales price increased due to favorable product mix and the pass-through of increased raw material costs
For fiscal 2020, we need to keep an eye on all the USDA reports, of course. The company pulled margins guidance due to the inability to forecast costs and the length of the COVID-19 crisis. We know that USDA indicates domestic protein production (beef, pork, chicken and turkey) should increase approximately 3%, or maybe 4%, from fiscal 2019 levels, but we expect export markets should absorb the increased production. Below is management's segment guidance:
Beef - We expect industry fed cattle supplies to increase approximately 2% in fiscal 2020 as compared to fiscal 2019. For the remainder of fiscal 2020, we expect ample supplies in regions where we operate our plants and for profitability to remain strong.
Pork - We expect industry hog supplies to increase approximately 5% in fiscal 2020 as compared to fiscal 2019. For the remainder of fiscal 2020, we expect decreased livestock costs as compared to the same period in fiscal 2019 and export markets to become more available.
Chicken - USDA projects a 3-4% increase in chicken production in fiscal 2020 as compared to fiscal 2019; however, more recent data indicates that chicken production for the remainder of fiscal 2020 will be lower than those projections. For the remainder of fiscal 2020, we do not believe pricing will improve, and we do not expect increased demand in consumer products to completely offset the expected decrease in foodservice.
Prepared Foods - We anticipate some COVID-19-related disruptions in the availability of raw materials. Additionally, we expect overall raw material costs to decrease through the remainder of fiscal 2020 as compared to the same period in fiscal 2019. For the remainder of fiscal 2020, we believe increased retail sales will reduce the impact of lower foodservice demand.
All things considered, while near-term results will likely be challenged by the current operating environment at plants and foodservice demand, fundamentals for protein demand and sales were pretty solid heading into the COVID-19 crisis. While there will be some short-term added operational costs to ensure sanitation of plants, worker safety, packaging safety, and more, we expect this tough situation to improve as the crisis subsides in late 2020. As such, we think, from an investment standpoint, $50 a share is an attractive buy point for this stock.
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This article was written by
Quad 7 Capital is a team of 12 with a wide range of experience sharing investment opportunities for nearly 7 years. Quad 7 Capital as a whole has expertise in business, policy, economics, mathematics, game theory, and the sciences. They share both long and short trades and invest personally in the stocks they discuss within their investing group. They lead the investing group Bad Beat Investing include: daily market commentary and market briefing, 1-2 trade ideas per week, 5 chat rooms for a range of sectors, volatility screeners, unusual options activity alerts, and economic calendars. Analyst’s Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Analyst’s Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.