2023-12-04 11:00:00 ET
Summary
- Tyson Foods, a struggling company in the food processing industry, may offer investors an opportunity for prolonged elevated returns.
- The company's recent financials show sequential improvements, with some segments experiencing volume growth and profit improvement.
- Tyson aims to capitalize on improved market conditions and lower grain costs in the upcoming fiscal year, and plans to sustain its success by aligning with key customers and leveraging its strong portfolio.
Introduction
Whenever I research companies, I like to compare them to sector peers and try to figure out what kind of stock we're dealing with.
For example, on November 11, I wrote an article covering one of the nation's biggest consumer staple stocks, Kraft Heinz ( KHC ). In that article, I mentioned that I monitor two groups in its sector (emphasis added):
I'm watching two groups of stocks in this sector. Companies with strong pricing power and consistent long-term outperformance and players that are struggling more with elevated inflation .
To give you an example, PepsiCo ( PEP ) is a company I would put in the first category. The Kraft Heinz Company is in the second category.
One of the most fascinating companies in the second group of struggling companies with hidden value is Tyson Foods ( TSN ) , a giant in the meat processing industry.
This year, I have written two articles on the company. The first bullish one was written close to current prices. The other call is a bit underwater.
To be honest, I wanted to go with a similar title again, as I still believe that Tyson is in a bottoming process.
However, I went with a focus on its yield and its total return potential, as I believe that Tyson may be in a good spot to offer investors an opportunity at prolonged elevated returns, as it looks like it's seeing stronger tailwinds and suffering less from inflation and related issues, making the current risk/reward very attractive.
With that said, let's dive into the details
Hope From Sequential Improvements
Although Tyson operates in the consumer defensive sector, it hasn't been a very defensive investment for investors.
After peaking in early 2022, the stock has sold off close to 50%. This is one of the worst sell-offs in its recent history. In general, TSN is more volatile than some of the blue-chip stocks you may hold in your portfolio - like PepsiCo.
Although the company sells products that are anti-cyclical, it is accompanied by a number of risks.
This is what I wrote in my prior article :
The problem is that TSN is operating very high up the food supply chain, which means it is prone to commodity prices. This includes feed costs and prices for the animals it turns into food.
On top of that, it's a company with more than 140 thousand employees, which makes it highly labor-intensive.
In general, margins are slim and prone to disruption as prices rise or revenue declines.
The company's recently released 4Q23 numbers confirm some of these trends.
For example, total company sales were down 2.9% year-over-year, attributed to lower prices in the Pork and Chicken segments.
Adjusted operating income fell from $823 million in 4Q22 to less than $240 million in 4Q23, driven by severe price/mix and cost issues. Earnings per share fell to $0.37. That's down from $1.63 in the prior-year quarter.
Despite the substantial year-over-year profit decrease in Q4, adjusted EPS more than doubled compared to the third quarter.
Prepared Foods showed resilience with slightly lower revenue, offset by volume growth, resulting in the second-highest Q4 adjusted operating income in the past five years.
The Chicken segment experienced a 10% sales decline, but modest volume growth and sequential profit improvement were notable, resulting in a significant quarter-over-quarter operating income improvement.
The company believes that its actions, including the closure of older, less efficient plants, demonstrate a commitment to operational excellence and capacity utilization improvement.
Tyson aims to capitalize on improved market conditions and lower grain costs in the upcoming fiscal year.
Beef saw modest revenue growth, but compressed spreads led to a decline in operating profit.
In this segment, the company feels the pressure from limited cattle supply but benefits from operational discipline and preparedness for various outcomes in the cattle cycle.
The Pork segment faced a 7% revenue decline but showed improved operating income, both year-over-year and sequentially.
Furthermore, despite challenges, Tyson's brands outpaced competitors, gaining market share and achieving volume growth.
According to Tyson, its commitment to meeting customer needs is evident in its top-10 position in Kantar PoweRankings.
Tyson plans to sustain and build on this success by aligning with key customers, focusing on food service momentum, and leveraging its strong portfolio.
Now, the question is: does this last?
What's Next?
Looking ahead, Tyson's future strategies include sustaining and building on the strength of Prepared Foods, aligning with the right suppliers and customers in Beef, and driving operational improvements in Pork.
During its 4Q23 earnings call, the company emphasized ongoing productivity initiatives, focusing on scalable enterprise-wide solutions in procurement, logistics, and digitalization.
To add some numbers to its 2024 outlook, the Prepared Foods segment is expected to contribute an adjusted operating income in the range of $800 million to $1 billion, driven by volume growth and productivity initiatives.
The Chicken segment anticipates generating between $400 million and $700 million of adjusted operating income, reflecting operational improvements and lower input costs.
The Beef segment faces uncertainty, with a guidance of a loss of $400 million to break even due to factors like heifer retention.
However, the Pork segment is expected to improve, with adjusted operating income reaching roughly breakeven.
The total company-adjusted operating income for fiscal 2024 is expected to be between $1.0 billion and $1.5 billion.
This is good news for shareholders, as there's finally light at the end of the tunnel.
High Expected Shareholder Returns
On top of business improvements and a decent outlook, the company has focused on financial strength, ending the fiscal year with $3 billion of liquidity and net leverage just over 4x (EBITDA).
It has an investment-grade BBB credit rating.
Going forward, capital allocation priorities include maintaining this investment-grade credit rating and returning to net leverage at or below 2x net debt to EBITDA.
Analysts expect the company to lower the net debt ratio to 2.3x by FY2026.
As the chart above shows, the biggest factor is increasing EBITDA to reduce the net leverage ratio.
In fiscal 2023, $670 million was returned to shareholders via dividends, and $354 million was spent on share repurchases. Capital expenditures for the year were between $1.0 billion and $1.5 billion, with a focus on maintaining tight controls in line with profitability and cash flow.
The current yield is 4.1%, which is based on a $0.49 per share per quarter dividend.
During the summer, the company hiked this dividend by a penny.
The five-year dividend CAGR is 8.6%.
Currently, the payout ratio is above 100%, which does not bode well for its dividend.
However, the company is quickly expected to see rebounding earnings, which is good news for its dividend and its valuation.
Using the data in the chart below:
- TSN is expected to grow its EPS by 44% this year after last year's 85% decline. Again, bear in mind we're talking fiscal years, not calendar years.
- FY2025 is expected to see 75% EPS growth, followed by 29% expected EPS growth in FY2026. In other words, the company is expected to start a lasting earnings recovery, which means Wall Street agrees with the company's positive outlook and business improvement plans.
- TSN shares currently trade at a blended P/E ratio of 33.5x. This is well above the long-term normalized P/E ratio of 15.9x.
- However, because of high expected EPS growth, the company is expected to return more than 17% per year (including its dividend) over the next three years if it returns to 15.9x earnings. Needless to say, this is based on the expected earnings trajectory.
While this is obviously a theoretical performance and in no way a guarantee of elevated results.
Nonetheless, I believe the company is in a good spot to significantly grow its earnings in the years ahead, which is likely to provide elevated returns.
It will also likely result in a sub-60% dividend payout ratio in the 2025 fiscal year.
Furthermore, despite its current downtrend, TSN shares have returned more than 14% since the Great Financial Crisis.
I expect returns of the next few years to be similar, backed by the company's earnings recovery and a return to its normalized valuation.
Mayor risks include lasting consumer weakness, which could keep a lid on food demand growth, agriculture inflation pressuring margins, or a general failure of the company to grow its brands and margins.
While I'm in the camp of people who expect inflation to remain elevated on a prolonged basis, I believe this is incorporated in the company's growth outlook.
Takeaway
Despite recent setbacks, sequential improvements and strategic initiatives signal a potential turnaround for Tyson.
The company's commitment to operational improvements, cost management, and market alignment positions it for a lasting earnings recovery.
Shareholders can anticipate elevated returns, supported by a solid financial foundation, a growing dividend, and optimistic earnings projections.
While risks linger, Tyson's proactive approach and positive outlook make it a compelling opportunity for long-term investors.
For further details see:
Tyson Foods: 4% Yield And A Path To >14% Annual Returns