2023-08-24 11:05:26 ET
Summary
- Tyson Foods' stock is down 50% from its all-time high, but has rebounded 6% in the last few months. However, challenges persist.
- The company faces volatility due to commodity price sensitivity, labor-intensive operations, and thin margins.
- Tyson is taking action to improve efficiency, innovate, and manage challenges, offering potential for 30% upside in two years.
Introduction
On June 18, I wrote an article titled Tyson Foods Yields 4% - Value Trap Or Opportunity? In that article, I assessed the risk/reward after the company's stock price had dropped 50% from its all-time high.
Now, it's time for an update, as shares of this Arkansas meat processor are up 6% since then, beating the 1.1% return for the S&P 500.
While Tyson Foods ( TSN ) isn't out of the woods yet, the company is making progress. It's closing plants and reducing costs. It's also seeing improving financials, allowing the company to stick to its full-year outlook.
In this article, I'll give you the details as I explain why I believe that Tyson is bottoming and how I would deal with this stock from a dividend (growth) point of view.
This Could Be A Bottom
With a market cap of $19 billion, Tyson Foods is one of the largest consumer staples in the United States. However, one thing sets it apart from this sector, which is known for its anti-cyclical and low-volatility characteristics: its volatile business model and stock price.
Since 1998 (the initiation of the consumer staples ETF ( XLP )), TSN shares have returned 260%, including dividends. The XLP ETF has returned 381%.
What's interesting is that on various occasions, TSN has crushed the XLP ETF.
Since 2017, TSN shares showed three rallies between 40% and 130%.
Unfortunately, each of these rallies was followed by a steep decline.
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.
Looking at the chart below, we see that Tyson Foods has much lower margins compared to companies like PepsiCo ( PEP ) and Procter & Gamble ( PG ). These companies are also consumer staples. However, they come with stronger pricing power and different input costs. Hormel Foods ( HRL ), which is a peer of TSN, also has somewhat subdued margins - yet higher than Tyson.
Buying low-margin businesses isn't always a bad thing. It's just important to keep in mind what's driving margins.
When done correctly, low-margin businesses can make terrific investments when the timing is right.
Right now, we could see the third bottom since 2016 - once again, close to $50 per share.
So far, so good.
Now, we need to find out if the fundamentals align with my thesis that this could be another distressed buying opportunity.
Tyson Sees Improvements
Of all recent challenges, this might be the toughest environment for Tyson.
As reported by the Wall Street Journal earlier this month, Tyson's chicken business has faced multiple issues over the years, including challenges related to chick hatching, staffing, falling chicken prices, and rising costs.
Wall Street Journal
As a result, the company has been implementing various strategies, such as layoffs, plant closures, and operational changes, in order to mitigate these challenges.
The struggles faced by Tyson aren't unique, as they reflect broader challenges in the meat industry, including supply chain issues and fluctuating consumer demand.
Hence, Tyson has not ruled out the possibility of further actions, including more plant closures, across all of its business units to address these challenges.
While I believe that these actions are bad for the consumer, as producers are choosing margins over volume, it could be a smart move for TSN and its shareholders.
Looking at the chart below, producer prices of meats have risen by 40% two times since the pandemic, which has caused meat prices to skyrocket compared to pre-pandemic levels.
Federal Reserve Bank of St. Louis
In its 3Q23 earnings call, the company reiterated its commitment to achieving sustainable top-line growth and margin improvement.
In order to achieve this, Tyson is executing a multi-point plan for efficiency and modernization, focusing on cost structure across the business.
According to the company, the leadership team's actions have already yielded positive results, with sequential improvements seen in Q3.
Starting with the Chicken segment, despite challenging market conditions and lower commodity prices compared to the previous year, the adjusted operating income improved by over $100 million in 3Q23. This increase primarily resulted from internal actions taken, such as plant closures, conversions, and SKU rationalization. In other words, margins over volume.
Furthermore, despite similar challenges in the beef industry, Tyson performed better than anticipated due to a disciplined approach to the supply/demand balance and leveraging seasonal increases in cutout values.
Tyson Foods
However, the industry is expected to face ongoing headwinds with cattle herd liquidation, higher cattle costs, and export market difficulties.
Having said that, I want to note that one major headwind is easing: drought.
Roughly 34% of cattle areas in the United States are experiencing drought. That number is down from 42% in mid-June. Extreme drought is down to 5%.
USDA
Furthermore, improved weather conditions have caused corn prices to drop. Corn is a major feedstock for pork and beef production, which should result in easing cattle prices in the next few quarters. This could provide a much-needed tailwind for Tyson.
The chart below compares corn (blue) to cattle (black) futures.
TradingView (CBOT Corn, CME Cattle)
While year-on-year Beef results were poor, sequentially, the segment demonstrated improved operating profits driven by disciplined yield, procurement benefits, and seasonal cutout improvements.
If the aforementioned tailwinds last, we could see better-than-expected results in the next two (likely more) quarters.
Having said that, the Pork segment also continues to be under pressure, facing challenges in internal live production and externally sourced hog supply, compounded by increased feed costs and reduced production margins.
Tyson Foods
The segment also experienced setbacks from a processing facility fire in the third quarter.
However, I believe that input costs may be easing due to a drop in key commodity prices - at least for the next few quarters.
Having said that, the Prepared Foods segment was highlighted as a key growth pillar, as it performed well in the third quarter.
Retail core business lines demonstrated robust volume growth, gaining both pound and dollar share.
The company maintains market share leadership in most retail categories, and Tyson, Jimmy Dean, Hillshire Farms, and Ballpark are consumer-favorite brands.
Tyson Foods
Tyson continues to invest in advertising and merchandising to support these brands while focusing on innovation.
In the case of Tyson, innovation stands for new products that (hopefully) go well with customer demand. So far, this is a success, as the company rolled out new chicken sandwiches and handheld breakfast items.
Essentially, the company wants to be more trendy. So far, this is working out quite well. It also adds a bit more pricing power when customers find new products they like.
Guidance & Shareholder Returns
Despite the aforementioned challenges, the company maintained its total sales guidance range of $53 to $54 billion for fiscal 2023, expecting sales growth to be nearly flat for the year.
Tyson Foods
- Beef segment margins are projected to be at the higher end of the -1% to 1% range.
- Pork segment margins are anticipated to be between -2% and -4%, closer to the higher end of the range.
- Chicken segment margins are expected to fall between -1% and 1%, with the lower end being more likely due to net derivative losses.
- Prepared Foods segment is likely to maintain strong margins between 8% and 10%.
CapEx expectations were revised down to approximately $2.1 billion as the company intends to moderate its spending pace.
Year-to-date, the company has invested $1.6 billion in its business. The net leverage ratio was 3.2x. The company's target is a sub-2.0x leverage ratio.
Our balance sheet management approach remains unchanged, as we are committed to building financial strength, maintaining our investment grade credit rating and targeting net leverage of at or below 2x net debt to EBITDA for the long term. - TSN 3Q23 earnings call
Using the current trajectory, the company is likely to reach its leverage target in 2026.
The company reduced YTD buyback to $343 million, which is down from $693 million in the prior-year period.
Dividend payments were $503 million, up from $491 million.
- The current dividend yield is 3.6%.
- The payout ratio is just 18%.
- The five-year average annual dividend growth rate is 11.1%.
- In November 2022, the company hiked its dividend by 4%.
I expect dividend growth to remain subdued until the company sees meaningful improvements in its margins.
Valuation
Having said all of this, the company is expected to see a strong rebound after this year. Both 2024 and 2025 are expected to see significant EBITDA growth after the abysmal year 2023 is shaping up to be.
Leo Nelissen (Based on analyst estimates)
Based on this EBITDA trajectory, the company is trading at 7.5x 2025E EBITDA, which would indicate a roughly 21% upside if I apply a 9x multiple.
Leo Nelissen (Based on analyst estimates)
The company's longer-term EBITDA multiple is 9x EBITDA, with outliers depending on the macro environment: a lower-rate environment tends to boost the valuation.
Based on these numbers, I stick to what I wrote in my prior article:
While I do believe that TSN will rebound in the years ahead, I do not expect a steep rebound, as its recovery will be slow. I also expect headwinds to remain persistent, as inflation headwinds are currently proven to be sticky - especially in agriculture, where feed costs are rising again.
So, to answer this question, I do not think that TSN is a value trap. It's a good company with a bright future. I believe that TSN's stock price will do well over time. This includes long-term dividend hikes and buybacks.
However, it's not a no-brainer. The recovery will likely be slow. Dividend growth won't likely pick up until 2025, and shares will likely remain volatile.
All things considered, I do like the risk/reward at these levels. A lot of weakness has been priced in.
While the valuation doesn't make TSN a screaming buy, I believe that we're more likely to encounter additional tailwinds than headwinds, especially with agriculture input costs having come down.
Hence, I remain a Buy rating and believe that we could see about 30% upside over the next two years. The upside could be substantially higher if tailwinds start to materialize faster than expected.
Also, I need to reiterate what I said in my prior article with regard to elevated volatility and the reason why I do not own TSN.
If you're interested in TSN shares, be aware that they need to be approached with a long-term view. While I will give the stock a bullish rating due to the favorable long-term outlook, I won't be a buyer, as I have significant agriculture exposure through some railroads, machinery stocks, fertilizer producers, and energy (it's a highly correlated industry).
Takeaway
While challenges persist, recent improvements are evident.
Tyson's focus on efficiency, cost reduction, and innovative product offerings position it for growth.
Though historical volatility is a concern, its current valuation offers a potential upside.
I maintain a Buy rating due to a positive long-term outlook.
While I won't be investing due to my existing agriculture exposure, for those considering Tyson, a patient, long-term approach is crucial.
The recovery might be gradual, but the potential for substantial gains exists, especially if unexpected tailwinds accelerate progress.
In essence, Tyson Foods appears to be on track for a promising future, presenting a compelling opportunity for investors willing to deal with volatility for potential future rewards.
For further details see:
Tyson Foods: This Looks Like A Bottom