Tyson Foods, Inc., (TSN) operates as a food company worldwide through four segments, Chicken, Beef, Pork, and Prepared Foods. The company grows and processes chickens into fresh, frozen, and value-added chicken products such as chicken nuggets, strips, wings, etc. It also supplies poultry breeding stock to the farmers who grow the chickens. It processes live fed cattle and hogs and fabricates into meat cuts and fully cooked meats like pepperoni. In addition, the company sells allied products, such as hide.
Tyson Foods, Inc. has a multitude of food brands. It offers its products under the Tyson, Jimmy Dean, Hillshire Farm, Ball Park, Van’s, Sara Lee, Chef Pierre, Wright, Aidells, State Fair, Gallo Salame, and Golden Island brands. The company sells its products through its in-house sales staff to grocery retailers, grocery wholesalers, meat distributors, warehouse club stores, military commissaries, industrial food processing companies, chain restaurants, restaurant food distributors, live markets, international export companies, and domestic distributors. They use independent brokers and trading companies at the margin as well. TSN has been a part of the US economy since 1935. In the last 12 months, the company generated profits of 1.9 billion ($6.92/share) on $36.7 billion in revenue.
The food business is the ultimate staple. People need to eat no matter what the condition of the economy. What changes is that in good times, people eat more organic and other high-quality foods. When times are tough, people look for value. This steady performance is reflected in TSN’s financial and share price performance. The share price has been rising in a trend channel since the financial crisis. Within that channel, price action has shown strength as well. The share price dipped in Q4-2016 finding buyers in the $55 price range. This selloff allowed investors to “buy the dip.” The share price formed a base and we think that from a technical perspective, it will move higher from here.
Valuation is supportive of the bullish case. The shares are priced at a PE of 13 based on trailing earnings. Analysts do not expect earnings growth in 2017, so the PE on a forward-looking basis is 13 as well. The company will be reporting earnings on or about May 8-12 and we do not expect any surprises. In addition, EV/EBITDA is a modest 8 suggesting investors are capturing cash flow on the cheap. The company generates about $2.5 billion in cash from operations. It uses about $700 to $800 million on CapEx to improve production efficiency and expand manufacturing capacity. They use the remaining cash to repurchase shares and pay down debt. (The company maintains a conservative balance sheet. The company has $5.3 billion in debt against a market cap of $24 billion.)
One of the things we find intriguing is that the company generates steady returns no matter what the cost of chicken, beef, and port. This should be the case because a big part of their business has to do with the processing of animals, which is a spread business. They should be able to capture their value added in both low and high price environments. Once a cow hits the age of 90 days, they are fed a diet of grain, hay, and water. The following charts sourced from indexmundi.com shows the price of beef relative to the price of wheat and corn, which we use as a proxy for the price of grains and hay.
These charts show the price of the end product has risen in relation to the cost of feed, which explains some of the financial performance of protein producers like TSN. The chart below shows the price of chicken relate to the price of corn, indicating that it is strong as well.
Pork is one product that is not outperforming the price of grains. The chart below shows that the price of pork is flat relative to the price of corn.
At this point, there is no indication for a mean reversion in the price of protein to grains. As a result, we think profitability will remain stable for the foreseeable future.
In the final analysis, we think TSN is a good company performing well. If you own the stock we suggest you keep it. If you do not, we suggest you do some additional homework and add it to your portfolio if it fits within you risk parameters and diversification requirements. If you would like to take advantage of a move higher price using options, we suggest you consider selling a put spread. With the stock trading at $65.24, we recommend the following structure.
To initiate this trade, the investor will collect $170 up front per put-spread. The breakeven level is $63.30, which is 3.0% below the current price. The efficient market hypothesis suggests there is a 57% chance of success on this trade. The most one can lose on the trade is $330. This would occur if the share price were trading below $60 at expiration, which is 8% below the current share price.
Over the past 5 years, TSN has traded with a positive bias in its price distribution. The histogram in the chart below shows the historical distribution of share prices going back 5 years for a typical 93-day holding period. We chose to use 93-day periods in this chart, as this is the time to expiration for the put spread written. Notice the historical distribution has a truncated left-hand tail, as compared to a random walk. Using the historical probability distribution there is about a 75% probability of success on the trade.
