No Reason to Be Chicken-Hearted

Feature | SATURDAY, SEPTEMBER 17, 2011

By NEIL A. MARTIN

Tyson shares have been plucked recently, on the continuing woes of the poultry business. But the pummeling has set the stage for a comeback in 2012.

Donnie Smith, the peripatetic CEO of Tyson Foods, America's top poultry and beef producer, likes to nose around his company's research complex, called Discovery Center, to see what's cooking.

The center, at Tyson's headquarters in Springdale, Ark., boasts 19 research kitchens and draws chefs and customers from around the world. The aim, says the 51-year-old Smith, is "to collaborate with customers to create new foods and bring them to market more quickly."

These days, Tyson could use new ideas, as the chicken business labors against a backdrop of high feed prices, overproduction, mediocre demand and soft pricing. This has weighed on the company's shares (ticker: TSN), which recently were around 17.50 after trading at about 20 in the spring. But for long-term investors, the decline presents an opportunity because there's more to Tyson than chicken. For one thing, its beef and pork businesses remain strong. In fact, the company is on track to deliver the second-highest earnings per share in its history in fiscal 2011, which ends on Sept. 30. And when the chicken cycle turns—and bulls think it will in 2012—Tyson is likely to emerge as an even stronger competitor in a poultry industry winnowed by the economic downturn. Fans of the stock argue that it could rise by at least 20% over the next 12 months.

Capitalizing on opportunities and finding new ways to do things is very much a part of Tyson's culture. The company was born in 1936, when founder John W. Tyson discovered that it was twice as profitable to sell chickens in Chicago as in his home state of Arkansas. He bought some trucks and began regular runs to the Windy City.

Over the decades, under Don and his son, John, now Tyson's chairman, the company has become the world's second-largest food-production outfit, behind Archer Daniels Midland. It's the No. 1 processor and marketer of chicken and beef in the U.S., with 22% of each market, and No. 2 in pork, with 17%. Chicken accounts for about a third of its revenue; beef, 41%, and pork, 13%. The rest comes from its prepared-foods division, which sells things like soups, sauces, stews, tortillas and pizza toppings.

In 2010, in an effort to lessen its dependence on food, Tyson established a joint venture, Dynamic Fuels, with synthetic-fuel maker Syntroleum. It uses grease and fats to make renewable diesel and jet fuel. Last June, KLM Royal Dutch Airlines became the first airline to operate a commercial flight on "biokerosene" from Dynamic.

Under Smith, who holds a degree in animal science from the University of Tennessee, Tyson has ramped up its global ambitions and now operates in Mexico, India, Brazil and China. Its goal is to eventually be as big in chicken, pork and beef abroad as it is in the U.S.

But first, it must work its way through the domestic poultry market's current malaise. And although the overall picture still isn't bright, there are some slivers of light.

FOR ONE THING, FEWER EGGS are being produced, which means fewer birds will be hatched. "The industry has seen 17 consecutive weeks of declining egg [shipments], and it looks like these cutbacks are finally resulting in declining production levels," says Jeffrey Farmer, an analyst with Jefferies in New York City. While chicken production was up 5% in June, it was flat in July and was down more than 3% in August. No decline that large had been seen since October 2009, he notes, adding that this has helped push chicken prices up 12% over the past five weeks.

Farmer also says that, while the industry's gross margins slid to 20 cents a pound in February—a 10-year low—they averaged 24 cents to 26 cents a pound for most of the past three months and recently hit 28 cents. Farmer rates Tyson a Buy, with a 12-month target price of $20.

Another positive: Excess production should put downward pressure on the price of corn, the main cost input for poultry producers. Over the past five years, the price of corn has fluctuated between $3.50 and $8; it's recently been around $7.00. But the high price of corn has encouraged heavy planting in Latin America and the U.S. Some analysts say that this could result in a glut of 1.5 billion to two billion bushels, putting downward pressure on corn next year. Predicts Shawn Hackett, a commodities authority and president of Hackett Financial Advisors in Boynton Beach, Fla., "By the back half of 2012, corn futures should be in the $4-to-$5 range. You could see feed prices dropping 20% to 30% from where they were, while poultry prices could go up 50% easily, if not more, which will result in dramatic profitability for producers," which could last for two or three years.

That's why he asserts that Tyson's stock—which hasn't been trading much above book value lately—could easily double over 12 to 18 months.

Tyson certainly hopes that Hackett is a seer. Hammered by the unfavorable supply-demand ratio in its chicken business, the company, whose fiscal year ends Sept. 30, lost $215 million, or $1.44 a share, on $26.7 billion in sales in fiscal 2009. It bounced back in fiscal 2010, aided by an effort to make its operations more efficient; the company says it squeezed out $600 million in costs at its chicken unit alone in 2010, and it will have eliminated another $200 million by the end of this year.

This helped Tyson earn $1.56 billion, or a record $2.06 a share, on $28 billion in revenue. The Wall Street consensus is that the meat processor will report earnings of $1.95 a share for this fiscal year, on sales of $32 billion. For 2012, the consensus forecast calls for $1.98 a share on $34 billion in sales.

Most of that is being driven by Tyson's beef and pork businesses, which differentiate it from rivals like Sanderson Farms (SAFM), a pure-play chicken producer that Barron's covered last month ("This Stock Could Really Lay an Egg," Aug. 22). In a third-quarter conference call, Chief Operating Officer Jim Lochner noted that Tyson's pork segment continued to perform very well, with an 8.8% return on sales and operating income of $124 million during the period. U.S. pork exports this past May were nearly 13% higher than a year ago, and Tyson is accounting for more of them. The beef operation also did well and continues to grow, with a 4% return on sales and an operating income of $140 million for the quarter. U.S. beef exports in May were 15% higher year-over-year. "As with pork, our share of the growing beef export market has increased," Lochner said.

The company didn't disclose its specific share of beef or pork exports.

Although still under pressure, Tyson's chicken segment had a 1% return on sales, with $28 million in operating income. Although these numbers certainly are nothing to boast about, Lochner says he is "pleased our chicken business remained profitable in such a difficult operating environment."

Underpinning Tyson's longer-term outlook is a solid balance sheet, with $1 billion in cash, and $1.5 billion in net debt. This gives it the wherewhithal to carry out its plan to repurchase 22.5 million shares by an unspecified date. In the third quarter, it bought back some 4.4 million shares for about $80 million. Tyson pays a modest dividend of 16 cents a share, producing a yield of less than 1%.

In an interview at Tyson's headquarters, CEO Smith said, "The efficiency improvements we'vemade over the past several years have made our operations very competitive…And looking ahead, there seems to be improvement in market fundamentals, although the next few months will remain very challenging."

Patient investors who can look beyond the rough patch should be rewarded. Based on its prospects, there's no need to be chicken-hearted about betting on Tyson.