Tyson Almost Ready To Serve

By Stephen D. Simpson, CFA | August 11, 2011 AAA

For the most part, the average investor should approach Tyson Foods (NYSE:TSN) with skepticism. It is the top player in America in its respective markets, but that has never translated into a sustained attractive margin structure or free cash flow record. On the other hand, savvy investors don't turn away from profit-making opportunities, and Tyson's stock may be very close to a point where there is real money to be made.

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Familiar Themes Dominate the Third Quarter
Investors who have been following agribusiness are not going to see too many surprises in Tyson's fiscal third quarter results. Revenue was not too bad, as Tyson reported 11% sales growth on a combination of better-than 12% higher pricing and slightly worse than a 1% decline in volume. Sales growth was fairly balanced - all of the major categories had significant sales growth, with beef leading the way at 13.5% price increase. The relatively small prepared food business was the laggard at 9% growth.

Unfortunately for shareholders, the margin picture is not nearly so healthy. The company is certainly passing on some of its higher costs to consumers, but clearly not all of them. Operating income dropped by nearly one third, and the operating margin was nearly cut in half this quarter. Margins held up decently in the pork and beef businesses, but the chicken business continues to be problematic and was barely profitable this quarter.

Can Tyson Push Harder?
It would not seem that Tyson can go much further on passing along price increases. As packaged food producers like General Mills (NYSE:GIS) have recently seen, there is only so far a company can go with higher prices before it starts losing volume and market share. Now, Tyson has it a little better than most, as retailers like Wal-Mart (NYSE:WMT) don't like to carry too many different meat brands, but the fact remains that the consumer wallet is already under strain.

It is also worth noting the more than 2% volume decline in prepared foods that Tyson reported this quarter. Quick service restaurants like McDonald's (NYSE:MCD) are doing okay, but results from distribution giant Sysco (NYSE:SYY) show pretty clearly that the sector as a whole is far from healthy.

Packaged Foods Look a Little Healthier
There is little that Tyson can do about it now, but the company may want to take a page from Sara Lee (NYSE:SLE) and Hormel (NYSE:HRL) when thinking about its future. More specifically, Tyson should consider adding more prepared and processed meat products to its stable. In times like these, packaged foods (and packaged food companies) tend to hold on better, and the expansion of this business could offer some counter-cyclical buffering to Tyson.

Getting Ready To Go Green
Tyson is hovering around book value these days, and that has traditionally been a good place to buy agribusiness companies like Archer Daniels Midland (NYSE:ADM), Tyson and its protein rivals like Pilgrims Pride (NYSE:PPC) and Smithfield (NYSE:SFD). That said, Tyson's stock has generally not performed so well when estimates have been heading lower, as they have been recently.

The Bottom Line
Investors should probably think about this name like a flashing yellow light. It may be safe to enter the intersection (by virtue of that low price-to-book ratio), but a more cautious investor may want to wait for the green light (price to book of 1.0 or below, and stable earnings estimates) before hitting the gas. (This very useful volatility index of the CBOE tells investors about the mood of the stock market. Check out Getting a VIX on Market Direction.)

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