2023-06-18 03:46:31 ET
Summary
- Tyson Foods faces challenges due to lower product prices and high input inflation, resulting in squeezed margins.
- The company maintains a positive long-term outlook, with healthy financials and an attractive valuation.
- Investors should be aware of the persistent headwinds and slow recovery expected in the near term, requiring a patient and long-term perspective.
Introduction
Tyson Foods ( TSN ) is in trouble. Shares of the meat producer are down 50% from their all-time high and down 19% year-to-date. Furthermore, shares aren't yet in recovery mode, as they are up less than 7% from their 52-week lows.
FINVIZ
Thanks to this decline, the company yields close to 4%. The problem is that this decline is driven by significant fundamental headwinds, as the company is struggling from both lower prices for its products and high input inflation, squeezing margins.
The good news is that the company is sticking to a good long-term outlook. Its financials remain healthy, and its valuation is attractive.
Hence, in this article, we'll assess the risk/reward of Tyson shares at one of the lowest levels of the past ten years.
So, let's get to it!
What's Tyson?
With a market cap of $18 billion, Tyson Foods is one of the biggest players in the farm products industry. Headquartered in Springdale, Arkansas, the company employs more than 140,000 people.
It has major operations in chicken, beef, and pork segments. For example, Tyson Foods operates a fully vertically-integrated chicken production process. This integration includes breeding stock, contract farmers, feed production, processing and further processing, marketing, and transportation of chicken and related specialty products.
Furthermore, Tyson Foods processes live-fed cattle and hogs, converting them into dressed beef and pork carcasses, primal and sub-primal meat cuts, case-ready products, and fully-cooked meats. The company also generates value from specialty products like hides and a variety of meats, which are sold to other processors and buyers. In other words, that's essentially turning by-products into revenue.
The bottom line is straightforward. Tyson Foods produces a wide range of fresh, value-added, frozen, and refrigerated food products. These products are marketed primarily to grocery retailers, wholesalers, and meat distributors. Its largest customer is Walmart ( WMT ), which accounted for 18% of its 2022 sales.
The company produces roughly a fifth of all chicken, beef, and pork in the United States, which goes to show the massive footprint of this business.
With all of this said, it's important to keep in mind how important supply risks are. Not only is veterinarian health a major risk (like the avian flu or swine flu), but inflation is also a major issue. After all, raising animals comes with a wide variety of costs, including feed costs.
That's why Tyson is currently struggling. Well, it's one of the reasons.
What's Going On At Tyson?
S&P 500-listed Tyson shares peaked roughly 12 months ago. However, it took until the second fiscal quarter of 2023 for headlines like the one below to pop up:
As reported by Seeking Alpha , in 2Q23, the company generated $13.1 billion in revenue, which missed estimates by $490 million. Adjusted EPS came in at a loss of $0.04, which was $0.84 below estimates.
After these results, shares fell by more than 16%. The Wall Street Journal reported that the company's three commodity meat divisions are encountering supply and demand imbalances that are negatively impacting the broader industry. Factors such as declining chicken prices, cattle shortages, and weak consumer demand for pork have contributed to the challenges faced by the meat company.
Last quarter, we said that we expected Q2 to be tougher than Q1, and this quarter was definitely a tough one. - Donnie King , TSN President, CEO
These problems aren't new. They are just getting worse.
The company has been dealing with increased expenses for animal feed and plant worker wages, which have pressured profits over the past year. This is an issue in general, but especially in the low-margin food business, which depends on labor (>140,000 employees) and low-margin suppliers dealing with their own issues (farmers).
Additionally, the company is encountering lower earnings in its chicken and beef divisions, two of its largest sales segments. The beef unit, responsible for nearly 40% of Tyson's annual sales last year (as shown in the first table of this article), has faced pressure on profit margins as ranchers reduce the size of their herds due to years of drought. According to the latest data, roughly 42% of cattle inventory is in an area experiencing drought. That's a huge issue.
USDA
These developments have driven up livestock prices, which affects meatpackers like Tyson. The chart below shows live cattle futures. Prices have reached a new all-time high in the most recent trading week.
Moreover, Tyson's beef unit experienced lower sales compared to the previous year, as price-conscious consumers prefer cheaper cuts of beef due to inflation concerns.
The slide below shows what this did to 2Q23 beef results. Volumes were down, prices were down, and margins took a severe beating.
Tyson Foods (Author Annotations)
In other words, it's the perfect storm. Tyson is dealing with high inflation impacting its business while customers are also dealing with high inflation, causing them to reduce purchases of some expensive meat products.
Furthermore:
- The Chicken segment saw an increase in sales due to internal production growth and benefits from prior period pricing actions. However, market conditions and near-term impacts of strategic decisions resulted in an operating loss of $166 million for the second quarter. Other headwinds included export impacts and higher feed ingredient costs.
- The Prepared Foods segment's total sales revenue grew, mainly driven by pricing gains. While there was a slight decline in volume due to softness in food service volumes (as seen in the overview below), the strong performance of retail brands offset this decline. The segment's operating income decreased slightly due to increased raw material costs and brand-building investments. Overall, margins remained relatively stable.
With all of this in mind, where's the shareholder value?
Value Trap Or Opportunity?
Based on the poor performance in the first two quarters and a moderating outlook for revenue growth, the company has lowered its total company sales guidance to the new range of $53 to $54 billion (flat to 1% growth) for the year.
- The margin guidance for the Beef segment is expected to be between a loss of 1% and a gain of 1%.
- The Pork segment's margin guidance is between a loss of 2% and a breakeven.
- In the Chicken segment, full-year margins are expected to be between a loss of 1% and a gain of 1%. The Prepared Foods segment is maintaining its margin guidance at 8% to 10%.
Overall, it needs to be said that guidance adjustments were ugly. Needless to say, the market was quick to react, as shares fell by more than 16% after the earnings call.
Tyson Foods (Author Annotations)
With that in mind, Tyson's dividend yield is now at 3.8%, which is one of the highest dividend yields in its history.
The company, which has a history of 11 consecutive annual dividend hikes, has hiked its dividend by 11.1% per year over the past five years - on average.
Over the past three years, dividend growth has slowed to 5%, which makes sense, as the industry has been through a lot since the start of the pandemic.
Currently, the payout ratio is 50%, which massively reduces the risk of a dividend cut.
With that in mind, the company's capital allocation strategy is straightforward, as it focuses on building financial strength, investing in the business, and returning cash to shareholders.
- The approach to capital expenditures ("CapEx") prioritizes maintenance needs and growth and profit optimization. The total CapEx for the year is expected to be around $2.3 billion.
- The company has returned cash to shareholders through dividends and share repurchases and remains committed to supporting the dividend.
- The company ended the quarter with $2.2 billion of liquidity and net leverage of 2.4x EBITDA. A new term loan agreement for $1.75 billion has been entered into to enhance liquidity and support a strategic focus on branded retail growth.
In other words, the company maintains a healthy balance sheet with a BBB rating and a solid leverage ratio, remains committed to the dividend and buybacks, and has financial resources to invest in areas that are likely to provide long-term growth.
Looking at analyst estimates below, we see that the company is expected to generate negative free cash flow this year. This is caused by the aforementioned temporary increase in CapEx to $2.3 billion. Next year, CapEx is expected to fall to $1.7 billion again, with a further decline to $1.5 billion in 2025.
Hence, while 2023 isn't a good year for its financials, the company is working its way to $1.5 billion in expected free cash flow in 2025. That would indicate an 8.3% free cash flow yield, which can (read: likely will) be used to reduce debt, buy back shares, and boost its dividend.
However, due to poor free cash flow estimates for both 2023 and 2024, I do not believe that the company will hike the dividend by more than 5% until the end of 2024 or early 2025.
In the future, dividend growth will likely accelerate again.
These issues are also reflected in its valuation. Despite its steep stock price decline, the company is trading at 11.5x NTM EBITDA. This is the result of its longer-term recovery. EBITDA is expected to rise to $3.2 billion in 2024, which would still be well below the average of $5.5 billion for both 2021 and 2022. In 2020, it was $4.3 billion.
Adding to that, due to high volatility, the stock is now up just 135% over the past ten years (including dividends). It has now underperformed its consumer staple peers and the market.
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.
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).
I'm also not a fan of its volatile business, which is impacted by so many factors. As I do have plenty of volatile stocks already, I have to be careful, even if I believe that a stock is (long-term) undervalued.
Takeaway
Tyson Foods is currently facing significant challenges due to lower prices for its products and high input inflation, resulting in squeezed margins. However, despite these difficulties, the company maintains a positive long-term outlook, with healthy financials and an attractive valuation. While the recent decline in share price presents an opportunity, investors should be aware of the persistent headwinds and slow recovery expected in the near term.
Considering the company's dividend yield of 3.8% and its commitment to returning cash to shareholders, it remains an attractive investment option.
However, the poor performance in recent quarters, lower guidance, and negative free cash flow estimates for the next couple of years suggest a cautious approach.
While Tyson Foods shows promise for the long term, it requires a patient and long-term perspective, taking into account its volatility and correlation to the agriculture industry.
For further details see:
Tyson Foods Yields 4% - Value Trap Or Opportunity?