2023-08-24 12:42:21 ET
Summary
- TSN's FY23 has been turbulent due to rising input costs, falling meat prices, subsequently resulting in significant margin pressure.
- The company's financials have deteriorated, with a significant decrease in total sales and an 86% plunge in EPS over the past nine months.
- Lack of growth drivers, particularly in the US market, limits its potential for expansion, and its international investments have not yielded positive results.
- With no foreseeable relief in the coming 6-12 months, I anticipate the ongoing pressures to persist, compounded by a high valuation, leading to lackluster performance.
Investment Thesis
Tyson Foods ( TSN ), a prominent player in the global food industry, stands as one of the largest processors and marketers of meat and poultry products. With a rich history spanning several decades, Tyson Foods has solidified its position as a leading provider of protein-based foods to customers across the world. Known for its iconic brands like Tyson, Jimmy Dean, Hillshire Farm, and Ball Park, the company boasts a diverse portfolio that caters to both retail and foodservice sectors.
Tyson Food Brands (TSN IR)
Even with its impressive history and wide range of products, Tyson Foods faced a tough beginning in FY23, performing significantly worse than its competitors over the past year. The company is in a tight spot since it's deeply affected by changes in commodity markets through feed costs, and at the same time, it's dealing with dropping meat prices. The pressure from these markets, along with unimpressive growth, has hit the company hard, causing its profit margins to shrink considerably. Without any noticeable relief or a clear strategy beyond just cutting costs internally , I foresee Tyson Foods continuing to struggle compared to its peers, which will likely lead to disappointing returns for investors in the short and medium term.
Deteriorating Financials
It's widely recognized that 2023 has posed considerable challenges for numerous companies operating on narrow profit margins, particularly those heavily reliant on commodities as their primary inputs. Among these, Tyson stands out as one of the most adversely affected. In the Q3 FY23, the company's financial report revealed a 2.6% YoY decrease in total sales, accompanied by a mere $68 million in Operating Profit over the last nine months. This decline can be largely attributed to difficulties faced in the beef and chicken segments due to the plummeting prices of these crucial commodities.
EPS over the past nine months amounted to just $0.97 , marking an alarming 86% plunge from the preceding year, during which the company had achieved an EPS of $7.10.
Unfortunately, the situation is anticipated to deteriorate further. Historically, Tyson has demonstrated vulnerability to volatile margins, given its susceptibility to commodity price fluctuations at the onset of its supply chain, involving commodities such as cereals and corn used for livestock feed. This susceptibility also extends to the other end of the supply chain, where meat is traded as a commodity, and this year's market conditions have been particularly harsh. Notably, Tyson heavily relies on beef, which constitutes 36% of its total revenue in FY23, but its prices have contracted by 20% YoY. Likewise, the poultry segment, contributing 32.6% to revenue, has seen a 21% drop in prices, and the pork segment, accounting for 10% of revenue, has experienced a nearly 13% price reduction.
According to their projections , the company doesn't foresee significant relief in the near future, as persistently low margins and ongoing price pressures are expected. By the year's end, the AOI margin outlook for the beef and poultry segments is projected to range from -1% to 1%, while the pork segment is estimated to see a range of -4% to -2%. Given these circumstances, and with no effective hedging strategy on the horizon, it's unlikely that substantial margin recovery will occur within the next 6-12 months. This leaves the company susceptible to continued pressure and pain.
In essence, Tyson is excessively exposed to the fluctuations of the commodity market. While commodity bull markets can trigger margin expansions, they are often succeeded by significant contractions during bearish periods, such as the one today. Looking back over the past decade, Tyson's highest operating margin reached 9.4% in 2022, during the commodity bull market. Unfortunately, 2023 stands as the worst year the company has experienced in over a decade, with a meager YTD operating margin of just 0.2%. In my opinion, this trend is set to continue.
Lack of Growth Drivers
Tyson faces an additional challenge in terms of its growth trajectory. While the company achieved an average YoY growth rate of 5.2% over the past decade, this rate actually falls below the projected industry forecast. The industry is expected to grow at a CAGR of 6.35% over the next 10 years. In my view, the reason behind this stagnant growth is quite straightforward. The majority of Tyson's revenue originates from the US market, where the company already holds a prominent position as a market leader with a substantial market share. This situation inherently limits growth potential, particularly beyond any expansion facilitated by M&A activity.
Simultaneously, Tyson has announced the closure of four chicken plants in the US in an effort to enhance utilization rates due to their excess capacity. While this cost-cutting measure is likely to result in increased efficiency, it also signifies a retreat from pursuing any growth opportunities within the country.
Tyson is fully aware of this challenge, recognizing that the era of finding growth primarily within the US has concluded. As a result, the company is actively seeking alternative avenues for investment and expansion abroad, with a particular focus on Asia and Europe where its presence is currently limited. In 2019, Tyson made a strategic move by acquiring operations in Europe and Asia from BRF S.A. This approach holds merit, especially given the abundance of emerging economies, particularly in the Asian region, where enhanced economic conditions often correlate with an upswing in meat consumption.
However, this segment hasn't yielded strong results for Tyson, as evidenced by a reported loss of $238 million over the past nine months. Simultaneously, during the third quarter, Tyson undertook a goodwill impairment of $210 million in its chicken business and an additional $238 million in its international business. In the case of the international business, this impairment could signify either an initial overvaluation of acquired assets or a decline in the overall value of the business. It's possible that further impairments might occur unless the company initiates improvements to its fundamental business model.
Furthermore, Tyson is contemplating the sale of its Chinese business , which generates approximately $1.1 billion in annual sales. This move would impact the company's top-line performance and growth objectives, particularly considering the withdrawal of its presence from the largest market in Asia. From my perspective, this decision seems contradictory to the management's earlier expansion plans and rhetoric.
Changing Customer Preferences
Another highly debated subject , particularly on Seeking Alpha, revolves around the alternative protein sector, which holds the potential to significantly disrupt traditional meat companies. Although I am inclined to agree that plant-based alternatives will witness increased popularity in the years ahead, I contend that this trend shouldn't be viewed as an immediate risk or a catalyst for companies currently investing in this industry. It's worth noting that as of 2022, the plant-based market constituted merely 1.4% of the overall meat market in the US.
However, it's important to recognize the multitude of innovative companies within this sector, and Tyson Foods is certainly among them. Initially, the company held a 6.5% ownership stake in Beyond Meat , a prominent plant-based meat producer. However, in 2019, they divested this ownership and opted to forge ahead by creating their own 100% plant-based product line, an initiative undertaken under their Jimmy Dean brand .
Valuation
When it comes to valuation, the outlook is far from optimistic; in fact, it's quite the opposite. Despite a notable 14.10% decline in the stock price on a YTD basis, the company's trading levels remain elevated. Considering the lackluster financial performance over the past 9 months, the company's Forward PE ratio has surged to 46.32x. This surge indicates a significant premium compared to its industry peers. For instance, Pilgrim’s Pride ( PPC ) is trading at 22.13x, Kellogg ( K ) at 14.10x, and Hormel Foods ( HRL ) at 20.44x. This premium over competitors now represents a premium of over 100%. This leads me to perceive this as a rather concerning indicator, potentially foreshadowing underperformance in the upcoming months.
The situation doesn't improve when considering the Forward PE Ratio for FY25, which is two years ahead. According to its projected financials, the company is still expected to trade within a range significantly higher than its historical PE ratio and well above its competitors. This scenario could potentially result in negative returns for its shareholders.
Conclusion
It comes as no surprise to acknowledge that 2023 has posed significant challenges for companies whose input expenses are susceptible to the fluctuations of commodity markets. Coupled with the heightened inflation rate and the implementation of monetary tightening measures, there has been a reduction in people's disposable income, leading to a decline in sales growth and of profit margins. My optimism regarding substantial improvements in the commodity markets over the next 6-12 months is limited, and I anticipate that the persistent cost pressures will further erode the profitability of Tyson Foods.
With the company's financials showing deterioration, coupled with elevated input costs and uninspiring growth prospects in the foreseeable future, all while its valuation is exceeding historical norms and those of its peers, my expectation is that the company will deliver disappointing returns to its shareholders in the upcoming months. With that, I am assigning a STRONG SELL rating to the stock.
For further details see:
Tyson Foods: Why It Might Be Time To Sell Your Shares