Tyson Foods Continues To Leverage Strong Margins In Proteins

By Stephen D. Simpson, CFA | August 07, 2013 AAA

As many packaged food companies start to stumble and sputter, Tyson Foods (NYSE:TSN) appears to be picking up steam. With generally solid volume and pricing trends across the business and lower feed costs boosting margins, Tyson is starting to draw the “it's different this time” bullish arguments. It's hard to argue with a stock that has nearly doubled over the past year, and management's guidance sounds pretty solid, but investors buying today need to hope for strong grain harvests and restrained competition going forward.

Chicken Takes Flight In Fiscal Q3
Tyson saw a very favorable combination of circumstances in the fiscal third quarter, and that led to beats versus estimates pretty much across the board. In particular, Tyson has found itself in the enviable position of being able to grow volume and boost pricing while simultaneously benefiting from declining production costs.

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Revenue rose 5% this quarter, with underlying revenue growth closer to 6%, as volume improved more than 2% and average prices rose by nearly 4%. Poultry was the biggest grower and the second-biggest contributor as sales rose nearly 9% and strong volume and pricing. Beef was up nearly 7% and also saw solid volume and pricing. Prepared food growth was a little better than 4%, while pork revenue declined 1% and a nearly 5% decline in volume.

Gross margin improved by a full point, which is a big deal for a company with single-digit gross margin. That flowed into a significant jump in operating income (up almost 23% as reported), with poultry profits up 44% and beef profits up 61%, while pork declined 3% and prepared foods fell nearly by half.

Can It Get Even Better? Management Seems To Think So
Tyson finds itself in a very good position with respect to its industries. Past turbulence in the poultry market (particularly higher grain prices) led many smaller producers to cut back their flocks, leaving Tyson in position to offer more volume and exploit higher prices (and reap better operating efficiencies).

What's more, management estimates that feed costs could decline by as much $500 million on a year-over-year basis for fiscal 2014, while year-to-date egg set growth has been running around 2%. This raises the prospect that companies like Tyson, Sanderson Farms (Nasdaq:SAFM), and Pilgrim's Pride (NYSE:PPC) could reap some abnormally high profit margins before supplies increase and push pricing back down.

Looking at the other proteins, the outlook is a little more mixed. Beef margins were higher than expected this quarter, but management is worried that lower supplies to its plants could pressure margins later in the year. On the other hand, they also expect pork margins to come within the normalized range of 6% to 8%, which would be better than this quarter's 5% (with nine-month margin of 6.6%).

Still A Global Story, And Size Counts
As seen with the proposed acquisition of Smithfield (NYSE:SFD) by a Chinese company, protein is an increasingly global business. As one of the largest protein company in the world, scale is a strong competitive edge for Tyson. Simply put, Tyson can afford to run its business for the long term, avoiding the big swings in flock/herd size that smaller producers have to take in response to input costs (like feed) and market prices.

That said, Brazilian rival JBS (which owns Swift in the U.S.) is hardly standing still – having become the largest beef processor in the world and, with the acquisition of Marfrig's poultry business, the largest poultry producer as well. What's more, JBS has posted higher margins than Tyson and Brazilian protein is increasingly welcome in markets like Japan, Mexico, and China.

The Bottom Line
I've definitely underestimated the margin leverage that Tyson was going to see in this up-cycle, as well as Wall Street's willingness to forget the past (and mostly likely future) cyclicality of the business. With these earnings, I expect another round of higher estimates and price targets and I suspect these shares can stay strong so long as the U.S. grain harvest forecast stays strong and the poultry flock forecasts stay low. I'm not going to be chasing these shares at this price, but Tyson shareholders may as well enjoy the ride for now.

Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.

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