Tyson Foods: Almost Fully Priced But Decent Income Potential (NYSE:TSN)

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Summary

Tyson Foods (TSN) has had a great start to 2021, but remains below its 2020 pre-COVID highs.
The valuation is reasonable but expected growth is modest.
The Wall Street consensus is bullish but the price is close to the 12-month price target.
The market-implied outlook (derived from options prices) is neutral.
My overall rating is neutral but covered calls look somewhat attractive.

Tyson Foods (NYSE:TSN) is expanding into fully non-meat protein sources. Non-meat protein consumption is growing rapidly and TSN knows it cannot afford to get left behind. Aside from the direct impacts of maintaining market share for protein consumption, there is a secondary effect that should benefit TSN. Just as utilities have learned that building out renewable portfolios drives up their P/Es (because renewable energy companies trade at higher P/E’s than traditional utilities), TSN’s shift will probably increase the supportable price multiple. Rather than being compared to its own historical valuation levels, investors will start to think about TSN as being more similar to companies like Beyond Meat (BYND).

Tyson Foods stock has been rallying in the past several months, outpacing both the Farm Products sector and the broader U.S. equity market. For a stock that tends to have low volatility, the 20.6% gain over the path three months is notable.

Trailing total returns for TSN vs. Farm Products sector and total U.S. stock market (Source: Morningstar)

The recent gains for TSN have not returned the stock to its pre-COVID 2020 highs, however. TSN closed at $93.46 on Jan 13, 2020. The current price of $77.80 is 16.8% below that January 2020 close. The share price is also below its peak from late 2017. The annualized 5-year total return for TSN is 5.05% per year, lagging its sector and providing less than ⅓ of the return of the equity market as a whole.

Price history and basic statistics for TSN (Source: Seeking Alpha)

While the forward dividend yield of 2.27% is not terribly high, the 5-year annualized growth rate for the dividend is 28% with a 30.5% payout ratio. The consensus 3-5 year EPS growth rate is 9.19% per year. With the current 13.45 forward P/E, the valuation and dividend stream are reasonable.

Rather than generate one more bottom-up analysis of TSN, I base my opinion on two forms of consensus outlooks for the stock. The first is the consensus of Wall Street analysts who follow the stock. Along with the consensus rating and 12-month price target, the dispersion of the individual opinions about the consensus provides insight into the level of agreement. The second form of consensus view is the market-implied outlook derived from options prices. Market-implied outlooks provide the options market’s consensus view of the probabilities of the range of possible future returns. There is considerable research on the degree to which options prices have predictive value. For those who are unfamiliar, I have written an overview post that provides examples and links to the finance literature on market-implied outlooks and the use of options prices as predictive. I have also written analysis on a range of stocks using this approach.

Wall Street Consensus Outlook

E*TRADE builds its consensus outlook using only ranked analysts who have issued a rating and price target over the past 90 days. Currently, there are only two analysts in this consensus. The consensus 12-month price target is $83 (6% above the current price) and the consensus rating is bullish. Having only two analysts in the consensus does not motivate much confidence.

Wall Street analyst consensus rating and 12-month price target for TSN (Source: E*TRADE)

Seeking Alpha’s Wall Street consensus combines the views of 15 analysts who have issued ratings and price targets for TSN over the past 90 days. The consensus rating is bullish and the consensus price target is $80.69, just 3.2% above the current price. None of the 15 analysts give TSN a rating below neutral.

Wall Street analyst consensus rating and price target for TSN (Source: Seeking Alpha)

While the consensus rating for TSN is bullish, the substantial price gains over the past several months mean that the stock looks almost fully priced relative to the 12-month price targets.

Market-Implied Outlook

Prices of options reflect the market’s consensus estimates of the probability that the price of a stock will go above (call option) or fall below (put option) a specific level (the strike) over a specific period of time (until the option expires). By analyzing calls and puts at a range of strikes but the same expiration date, it is possible to calculate the probabilities of all possible return outcomes (between now and the expiration date) that will reconcile the market prices of the options. The probability distribution of returns is referred to as the market-implied outlook.

For this post, I have analyzed call and put options expiring on January 21, 2022. I have chosen this date because it is the closest option expiration date to the end of 2021. The market-implied outlook is for the period from now until that date, the next 8.6 months. The market-implied outlook is typically presented as a standard probability distribution of returns, with probability on the vertical axis and price return for the period (8.6 months) on the horizontal axis (going from most negative on the far left to most positive on the far right).

Market-implied price return probabilities for TSN for the period from now until January 21, 2022 (Source: author’s calculations using options quotes from E*TRADE)

The market-implied price return outlook for the next 8.6 months is highly symmetric from left to right, which means that the probabilities of positive and negative returns of the same magnitude are very similar. This is consistent with a neutral view from the options market. Stocks which pay dividends are expected to have a slightly negative tilt to the market-implied outlook because the dividend payments reduce the potential upside but do not mitigate downside. Further, it is hypothesized that a truly neutral market-implied outlook will always have a bit of a negative tilt (higher probabilities of negative returns than same-magnitude positive returns) because investors tend to be risk averse and thus would tend to be willing to pay more than fair value for downside protection. The peak probability corresponds to a price return of -1.75% and median price return for the 8.6 month period is -1.4%. The dividend yield of 2.27% brings the total returns corresponding to the peak probability and the median almost perfectly to zero.

The annualized volatility derived from the market-implied outlook is 26%, fairly low for an individual stock.

To make it easier to see the relative probabilities of positive and negative returns of the same magnitude, I typically chart the market-implied outlook with the negative return side of the distribution rotated about the vertical axis (see below). The Negative Return (red dashed line) shows the probabilities of the negative of the return on the horizontal axis. The probabilities of positive and negative returns of the same magnitude are very close to one another, albeit with a slightly elevated probability of negative returns that is consistent with the dividend payment.

Market-implied price return probabilities for TSN for the period from now until January 21, 2022 The negative return side of the distribution has been rotated about the vertical axis (Source: author’s calculations using options quotes from E*TRADE)

Selling covered calls against TSN looks quite attractive, especially given the neutral market-implied outlook. This morning, I bought shares of TSN at $78.25 and sold the January 21, 2022 $85 (strike) call options for $3.39. This net position gives me 4.3% in option premium income over the next 8.59 months in addition to the dividend yield (2.27 annualized). In addition, this position retains 8.6% in potential price appreciation before the options go into the money. The market-implied outlook estimates a 70% probability that the option will expire out-of-the-money (e.g. a 70% probability that the TSN’s price at expiration will be less than $85). If the stock rises above $85, my return will be the sum of the 8.6% price appreciation and the 4.3% option premium income, in addition to the dividend payments.

Summary

Over the past 5 years, Tyson Foods (TSN) has delivered a total return of 5.05% per year. The 3-year period is a bit better. The slow price appreciation shows that the market has been expecting low earnings growth and that the company has, indeed, grown slowly. The new initiatives in plant-based protein are interesting and the consensus outlook for EPS growth over the next 3-5 years is a reasonably attractive 9.2% per year. While the Wall Street analyst coverage is fairly sparse (which reduces the confidence in the consensus), the consensus rating is bullish and the 12-month price target is 3%-6% above the current price. In addition to the 2.27% dividend, the expected total return is 5.3%-8.3%. This is quite low for a stock with expected volatility of 26%. The market-implied outlook is neutral, with the peak-probability price return of -1.75%. My final rating on TSN, given the reasonable fundamentals and considering both the analyst consensus and the market-implied outlook is neutral. Selling covered calls provides a way to generate a decent income stream for those inclined to hold TSN.

This article was written by

Geoff Considine

5.77K Followers

Geoff has worked in quantitative finance for more than twenty years. Before entering finance, Geoff was a research scientist for NASA. Geoff holds a PhD in Atmospheric Science from the University of Colorado - Boulder and a BS in Physics from Georgia Tech. Neither Geoff Considine nor Quantext (Geoff's company) are investment advisors. Nothing in any commentary here on Seeking Alpha or elsewhere shall be regarded as advice.

Analyst’s Disclosure: I am/we are long TSN. 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.

I have sold covered calls as described in the post

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