Tyson Does Well This Time, But The Value Is Not Compelling

By Stephen D. Simpson, CFA | November 20, 2012 AAA

I'm not generally in favor of trying to make money by actively investing, but I can't deny that there are certain stocks that seem to lend themselves to it. Huge protein company Tyson (NYSE:TSN) is a good example. I've run hot and cold on these shares largely on the basis of investor enthusiasm, and going positive/negative on the basis of where the shares trade relative to book value has been working for at least a little while now. While Tyson's outperformance this quarter and tough ongoing conditions in the protein space could offer some reasons for optimism for longer-term investors, I still believe Tyson is a stock better traded than approached with a buy-and-hold attitude.

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A Surprisingly Strong End to the Fiscal Year
Tyson surprised the Street with a strong fiscal Q4 report that included a clean beat of roughly 25% relative to sell-side expectations. Perhaps even more encouraging are the signs that Tyson can produce a certain degree of consistency in what has long been a volatile industry with difficult-to-control inputs.

Revenue was down 6% for the quarter, and that was lower than expected, but by less than 2% (relative to the average of sell-side estimates). Revenue was led by strong chicken results, where a greater than 3% volume decrease and better than 9% price increase drove almost 6% growth. Pork and beef were roughly equally disappointing (relative to expectations), as pork revenue declined 8% and beef declined 2%. Prepared foods was down 3%.

Margins were surprisingly strong, though. Gross margin improved by about 50%, despite ongoing cost input pressures. Operating income more than doubled on an adjusted basis. A positive surprise in beef (flat margins, a 1% year-on-year decline in op income) offset a disappointment in pork (margins down about 270 basis points (BPs) and income down 40%), while chicken posted a big beat (margins up more than 700bp, reversing a year-ago loss. Prepared foods saw a 140bp margin improvement and 40% income growth.

SEE: A Look At Corporate Profit Margins

Will Bad News Be Good?
In the weird world of investing, bad news can sometimes be good news for companies, or at least less-bad news. It's likely that operating conditions next year are going to be difficult. Between the drought, consumer confidence and other issues, management at Tyson said next year will be just as challenging, if not more so, than this year.

Nevertheless, that doesn't mean the same things to Tyson, Smithfield (NYSE:SFD), Seaboard (AMEX:SEB) and Pilgrim's Pride (NYSE:PPC) as it does to smaller farmers. While paying $600 million more for grain is a problem for Tyson, higher grain costs may well prove crippling for smaller operators. That is likely to push up prices and lend even more significance to the operating efficiencies of these larger operators.

Now, it's not all smooth sailing. Higher protein prices are eventually going to result in less protein going into shoppers' carts at Costco (Nasdaq:COST) and Wal-Mart (NYSE:WMT). Moreover, higher global prices could be more of a boon for non-U.S. producers with lowering operating costs. That said, these large agribusiness giants just don't seem to suffer as much in the bad times as commonly believed.

SEE: A Primer For Investing In Agriculture

The Bottom Line
I still happen to favor the overseas protein producers more than the U.S. companies, and I likewise still see more attractive opportunities in areas like seed traits. Overall, while I think Tyson has done a laudable job in recent years of making its performance more consistent, I still just don't like it much as a long-term holding. I tend to like Tyson when it is at, or below, book value.

With trailing book value now in the mid-$16s, the stock is priced at about a 10% premium. That's not terrible, particularly if you believe that Tyson can outperform again in the next quarter, but I've seen too many difficulties here to go against a discounted cash flow (DCF) analysis that suggests the shares are overpriced on that metric. Consequently, I'd wait for another pullback in the shares before thinking about reloading a long trade.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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