PDF Tyson Foods, Inc. - Tippie College of Business

Krause Fund Research | Spring 2016 Consumer Staples

Recommendation: BUY

Tyson Foods, Inc.

Analysts

Colin Rogers colin-rogers@uiowa.edu

Brandon Schreiner brandon-schreiner@uiowa.edu

April 19, 2016

Current Price: $65.79 Target Price: $77.66

Company Overview

Tyson Foods is one the largest meat processing and prepared foods companies in the world. Tyson Foods, currently headquartered in Springdale Arkansas, employs about 113,000 people and contracts more than 11,000 family farms. [24] The company began as a small chicken and feed operation and has expanded into different segment such as beef, pork and various prepared foods. In addition, they operate along with subsidiaries such as Jimmy Dean, Hillshire farms, Sara lee, Ball Park, Wright, Aidells, and State Fair. Tyson Foods predominately operates in the United States, but has operations in China and India. After the acquisition of Hillshire farms, Tyson Foods has repositioned themselves in the prepared food segments whereas previously were predominated by protein- added meats.

Stock Performance Highlights

52-Week High 52-Week Low Beta

$68.84 $37.24

0.92

Share Highlights

Market Capitalization Shares Outstanding Book Value per share Basic Earnings per Share P/E Ratio Dividend Yield

$25.63B 288.79M

$24.72 $3.37 15.05 .92%

MARGINS POISED FOR GROWTH U.S CATTLE HERD STABILITY

? The US cattle herd has made a correction in favor of Tyson Foods. We expect the rebuilt herd will reduce the volatility in market prices realized in earlier periods.

? Grain and feed cost are trending near eight year lows. This should reduce input costs for all of Tyson's company segments.

? Tyson currently operates four different protein markets. This provides a competitive advantage as fluctuations in consumer preferences can shift among segments in which they operate. As a result, a decrease in sales in one segment can result in an increase in sales in another.

? High start-up costs and robust customer relationships discourage new entrants in the market. The sector as whole has a medium concentration of ownership which provides opportunity to expand ownership, as a result, Tyson Foods can increase their purchasing power.

? Tyson Food's has outperformed the consumer staples segment as a whole by over 20%. [35]

Company Performance Highlights

ROA ROE ROIC Sales

5.30% 12.57%

9.81% $41,373B

Financial Ratios

Current Ratio Debt-To-Equity

1.52 69.29%

Source: Yahoo! Finance

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Executive Summary

We believe that Tyson Foods, Inc. is a stable investment in terms of company growth and future outlook. To elaborate further, the company has shown strong operating margins in early beginnings of fiscal year 2016. The synergies from recent acquisitions, mainly Hillshire Farms?, pose a positive outlook for future earnings. Operating conditions are strong and we predict them to continue strengthening going forward. Therefore, we issuing a `hold' rating on Tyson Foods in the consumer staples segment.

We believe that the recent capital market volatility is a result of global economic uncertainty of the strength of the interest rate proposals made by the Federal Reserve. If the Federal Funds rate remains constant at a level of 0.50% in the short-term of six months, we believe that it will not drastically effect consumer spending. As a result, real GDP will be an annualized number of 2.10% in Q2 of Fiscal Year 2016. We expect this decrease is due to the weakening number of net Exports from the strengthening dollar.[2] In the long run of three years we expect GDP to increase 2.60% year-over-year because of recent strong employment numbers and a prediction of a return to stable capital markets.

Economic Outlook

We believe that there are four primary macroeconomic measures that have a notable effect on the food products industry and Tyson Foods. These measures include: Real GDP, Inflation, Employment Situation, and Consumer Confidence.

Gross Domestic Product (GDP)

The growth of the overall U.S economy is strongly linked with the growth of real GDP. Given that the purchases of non-durable goods makes up 15% of total GDP, this indicator is an effective measurement to consider when evaluating Tyson Foods.[2] Any growth of real GDP between economists consensus range for quarterly or yearly growth, is considered to be a sign for a healthy economy. Therefore, when real GDP is realized above consensus, it is generally a positive indicator for the food products sector growth. An overall increase of GDP is important for Tyson Foods because it can indicate that consumers will be more likely to purchase Tyson's new product mixes generated from the acquisition of Hillshire Farms in 2014.

Unemployment

Similar to GDP, low levels of unemployment contribute to increased sales in the food products industry. As more people are employed in the labor force, their income increases, which in return, enables consumers to spend more on brand protein based products offered by companies like Tyson Foods. On the other hand, when the labor force remains at a steady level while the number of unemployed persons increase, consumers tend to purchase more inferior goods to save money, which are typically off brand products

Unemployment remains low as of Q1 Fiscal Year 2016 at 5.0%, which is at consensus estimates. This number is increasingly effective when paired with the drastic increase of nonfarm payrolls of 215,000, which also fall within the consensus estimates. This suggests that the number of people working match the output of jobs made which suggests the economy is nearing a steady state. As seen below, unemployment has been straddling 5.0% since May of 2015.

Real GDP increased 2.4% in 2015, the same rate as in 2014. The most recent data shows Q4 of 2015 Real GDP growth at 1.4% annualized, which is above economist consensus of 1.3%.[1] While these figures show a relatively stable but negative trend in economic growth, consumer spending has been an underlying strength of total real GDP. We believe that real GDP growth beating economist estimates in Q4 contradicts the recent volatility in the capital markets. This suggests that personal consumption of 2.4% of real GDP which was .4% above estimates, shall remain strong. As a result, we expect the food products industry to perform well.[1]

Source: Bloomberg Data

Although the employment situation seems stable, the average hourly earnings decreased 0.1% from January to February and the year-over-year average is down 0.3% at 2.2%.[3] The most recent data it has increased 0.3% but has had no effect on the year-overyear percentage growth.[3] Theoretically, this means that consumers are going to be less likely to purchase name brand food items because their income has decreased overall; but because this number is fairly volatile it suggests that a one month of negative numbers should not affect consumer spending significantly.

Source: Bloomberg Data

We believe that in the six-month short run, unemployment will decrease to 4.8% because of the strong job creation numbers in

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Q1. Overall in the next three years we also believe unemployment to remain constant at 4.8% because we forecasted forward looking GDP numbers to increase.

Inflation

Inflation is best measured through the monthly changes in the Consumer Price Index (CPI) and the Producer Price Index (PPI). The CPI and the PPI are calculated in a similar way but the CPI is an average price level of a fixed basket of goods for consumers while the PPI is an average price level received by domestic producers of goods and services.[4] In the most recent data released for Q1 fiscal year 2016, CPI increased 0.1% month-overmonth.[5] Overall, this increase is disappointing for Tyson because as prices rise consumers will presumably hold off for future prices to decrease. When each component of CPI is analyzed, food prices pull this number down 0.2%, followed by apparel and gas utilities. This means that Tyson's consumers are already paying low prices for food and prices are not driving consumers to off brand food items at the supermarket.[4]

In the next six months we expect that there will be an increase of 0.3% inflation due to the rising oil prices and the oil oversupply to diminish. This prediction will also effect long run inflation because we predict oil prices to reach a steady state around $50.00 per barrel which will increase the price the producer pays for crude oil then conversely effected what consumers pay.

Consumer Confidence

Consumer confidence and consumer sentiment are directly correlated to consumer expenditures. The difference between the two numbers of consumer sentiment and consumer confidence is the sample size of consumers polled, which is why consumer confidence is more statistically sound to follow. This being said, the direct correlation of consumer confidence to their expenditures can be shown in the graph below.

Source: FactSet

Source: Bureau of Labor Statistics

Amidst the low CPI food prices numbers, we expect to see producer input prices to decrease, as most recent data for PPI in Q1 fiscal year 2016, shows a 0.1% decrease month-over-month.[7] This number boasts well for Tyson especially because the most recent number was brought down by food prices decreasing 0.9% month-over-month.[7] This suggests that food prices currently are deflationary and Tyson will spend less money on input prices overall which will combat the low prices that consumers are spending at the supermarket.

With recent capital market volatility and interest rate uncertainty, consumer confidence has followed suit in Q1 fiscal year 2016. Consumer confidence levels were 98.1, 94.0, and 96.2 for January, February, and March respectively.[9] Furthermore consumers claiming business conditions were "good" fell 0.6% while consumers feeling "bad" also fell 0.2% which suggests that consumers feel the economy is balanced.[9] This implies that consumers as a whole do not feel a need to save money at the supermarket by buying off-brand items which is a good indicator for Tyson growth. We believe that within the next six months consumer confidence will mimic our forecasted GDP growth and reach 97.0. Thus after forecasting a larger GDP growth rate relative to the short term, we believe that in the next three years consumer confidence will reach 99.0. This is mainly due to positive outlooks of inflation and unemployment remaining stable.

Capital Markets Outlook

Source: Bureau of Labor Statisitcs

The consumer staples sector, and more specifically and the meat industry, is defensive by nature. This can be deciphered by a relatively low industry beta which currently is 0.6.[22] Though we have recently seen one of the worst capital market performances for the beginning of a year, it has stabilized and posted gains towards the end of March. With that being said, the Consumer Staples ETF (RHS) that mimics the companies in the S&P 500, posted higher six month gains of 7.44% despite market uncertainty shown in the graph below.[23]

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competitiveness abroad. Revenue growth for this industry is expected to be held back as grain costs remain low and overall supply of livestock remains stable, which ultimately keeps sales price sluggish. [16]

Source: Yahoo! Finance

We expect these gains to grow further past the S&P 500 Index because of our outlook on low commodity prices that will lower the input prices for companies like Tyson Foods. This positions Tyson to have lower gross margins and thus increase their net income. As this is a naturally defensive industry, we do not expect the industry to post major gains in the short run.

Industry Analysis

Brief Consumer Staples Breakdown

As previously stated, the consumer staples sector is defensive by nature and this is because companies in this sector sell items that are non-cyclical, which means that the performance of the companies is less affected from the "ups and downs" of the business cycle unlike many other sectors. The consumer staples market consists of food, drugs, beverages, household products and personal products. [12] More specifically, the food product segment consists of the agricultural products and packaged foods which includes protein based goods.[12] Consumer staples as a whole currently makes up for about 10.50% of the S&P500 as of April, 2016.[13]

Industry Description

The few aspects that make up the food products industry are the following; farming, packaging, distribution and marketing. While the core product is derived from the farming aspect, only 17% of what consumers spend at the store goes to the farmer. [14] The remaining expenditure accounts for other aspects such as distribution, packaging and marketing. Tyson acts both as a producer of chicken and a processor of beef and pork. While this helps mitigate their commodity risk, it does not eliminate it as fluctuations in grain prices directly effects the prices they pay for their processing segments for beef and pork.

Industry Gross Margins

In recent industry developments, we have seen increasing trends for food companies to remove unprofitable sectors of the business and in return, exert more focus on core product lines. We have seen similar trends from Tyson who sold their unprofitable chicken operations in Brazil and Mexico. As a result, they can employ more emphasis on new core product lines from the Hillshire Farms acquisition.

When grain prices were high in 2013, gross margins were squeezed. Companies in this industry found those costs difficult to pass on to the end consumer in the form of high sales prices, without damaging market share.[14] However, recent market conditions has improved margins. This is a result of favorable market conditions for purchasing inputs, as well as initiatives to cut unprofitable product lines. Tyson announced in its most recent earnings report a total company operating margin of 8.5%.[18] In comparison, over the previous six years, average operating margin was 4.38%, with no margin exceeding 5.5%.[19] Moving forward, we predict improving margins is highly probably because of more efficient operations, stable livestock supply and low commodity prices.

Markets & Competition:

The industry of meat, beef and poultry processing has a medium concentration of ownership.[17] The four largest companies within the industry account for 37.7% of the domestic market.[17] Many major companies that compete for market share produce more than one type of protein.[17] Companies benefit from processing multiple protein based foods because when consumer preferences change, the shift from one protein to the other makes total sales volume less volatile. We included the four biggest meat processing companies' that best fit the market share comparison. The other section includes companies that hold less than 5%.

Industry Revenues

The food products industry realized a compound annual growth rate of 0.7% over the three years previous to quarter three of 2015.[16] In comparison, this slightly underperformed the consumer staples sector as a whole by 1.0%.[16] The slower growth is a result of an increasingly difficult U.S export market. This industry is ultimately in the business of feeding the world. Therefore, the strong U.S dollar and overall unstable global economic conditions has decreased U.S company's

Source: D'Costa

This industry has a medium concentration of ownership, thus we believe it is in a position for potential mergers and acquisitions. As U.S export markets continues to decline, and sales price

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decreases, we believe acquisitions are a realistic option to improve top line growth in this low interest rate environment. Acquisitions create an opportunity to increase sales for new product lines, while subsequently gaining synergies such as lower overhead and supply chain efficiencies.[14] We have found a multitude of trends that show signs of increasing value of M&A. In 2015, the merger and acquisition deal value was greater than the value of the two previous year's combined.[14] In addition, the core value of acquisitions has increased as companies compete to add to their core product lines. In 2015, the average transaction multiple for this industry was 2.7x revenue.[14] In comparison, that multiple has only breached over 2x revenue in three of the previous 11 years.[14]

Competitive Forces (Porter's 5-Forces)

Industry Competition This industry has moderate company concentration. However, acquisitions by larger industry operators have increased concentration over the past five years.[10]

Threat of Substitutes Beef, chicken, and pork can be substituted for one another, making it advantageous for a company to operate in each of these markets. For example, if beef prices rise, consumers might buy more chicken. If a company sells chicken in addition to beef, they will be less affected than a company who sells only beef. Seafood and eggs are protein substitutes that have the possibility to impact the profitability of the meat, beef and poultry industry. However, neither of these are considered to be suitable substitutes to chicken, beef and pork, and aren't currently priced low enough to have significant impact.

Buyer Power We believe buyer power in this industry is moderate to high. Supermarkets, warehouse clubs and food distributors have consolidated in recent years which has increased buyer power. We expect consolidation to continue throughout the United States and other major markets.[11] This consolidation increases buyers bargaining power for pricing and promotional programs.

Supplier Power We believe supplier power for this industry is moderate to low. The four largest companies in the industry account for roughly one-third of the domestic market.[10] In addition, there are more suppliers than buyers in this industry.

Threat of New Entrants Barriers to entry in this industry are medium and are steady.[10] Regulation poses the major entry barrier into the meat, beef and poultry processing industry.[10] Established contracts allow industry participants to develop long-term sales relationships with customers, making it difficult for new entrants to find sufficiently large customer bases.[10] In addition, high industry start-up costs make entry difficult.

millennials, who have an increased interest in natural food options.[14] The aging population has a direct effect on consumer preferences. This population segment of ages 65 and older is projected to increase from 46 million in 2014, to 88 million by 2050.[14] Increased preferences for healthy food options provides opportunities for food producers. Tyson announced in 2015 their plan to eliminate their use of human antibiotics in U.S broiler chicken flocks by the end of fiscal 2017.[20] In addition, Tyson is working with their independent contractors on efforts to reduce the use of human antibiotics on cattle, hog and turkey farms.[20] This transition, while a year and half away, shows adaptation in the industry to capture the changing consumer preferences.

Demographics

The package food segment of this industry is competing for market share. The packaged food industry historically has produced better margins than those of other protein segments. Tyson Foods acquisition with Hillshire Farms increases their ability to compete for that market share. For example, the country's largest minority group, Hispanics, on average spend 14% more on consumer packaged goods when compared to the total market. [14] As the Hispanic population grows in the United States, companies who are best positioned to serve their preferences will hold a greater advantage when competing for market share.

Asian Market

We predict that international markets are a possible opportunity for growth. While this is a more long-term outlook, it is especially true for China. China's import activity is expected to increase with improvements in wealth, urbanization and population growth. China imports over 20% of its beef requirements, which represents about 15% of total trade in beef.[21] The majority of China's beef imports are from Australia. However, as their middle class income increases and taste for beef matures, the U.S market can be at a strong position to capture more of the market share since they are the premier standard for beef.[21]

Catalysts for Growth/Change

Many companies are realizing decreases in revenues as they cut out unprofitable segments and major crop prices trend near eight year lows. Manufacturers are having to cut operation costs, discontinue lagging product lines and focus on core products to increase their profit margins.[14] The food sector's growth is greatly affected by the foreign currency exchange rate for international markets. Due to the strength of the U.S dollar, the sector's growth rate has been sluggish. Companies within the industry need to improve their ability to adjust operations in a less favorable exchange rate environment. As a result these companies can better combat the effects of exchange rates and operating margins in foreign markets.[14] As consumer demand increases for healthy food options, we predict that growth for companies who capitalize on these consumer preferences will experience greater growth than that of the food sector average.[14]

Consumer Preferences

Consumer preferences for the food industry are changing. One changing demographic observed is the growing population of

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