Tyson Foods flying high

by Josh Sosland
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Donnie Smith, president and chief executive officer, is upbeat on the future of Tyson Foods.

SPRINGDALE, ARK. — With its largest business far more profitable and a major integration on track, the top executive of Tyson Foods, Inc. is upbeat on financial prospects for the company’s fiscal 2015.

“We’ve set ourselves up for another record year, and we are building momentum that will take us into fiscal 2016,” said Donnie Smith, president and chief executive officer.

Tyson first-quarter earnings were lifted by dramatically improved margins in its Chicken and Prepared Foods segments. Net income in the first quarter ended Dec. 27, 2014, was $309 million, equal to 77c per share on the common stock, up 22% from $254 million, or 76c per share, during the first quarter of fiscal 2014. Weighted shares outstanding in the quarter grew to 416 million from 354 million, following a share offering in July 2014.

Quarterly net sales were $10,817 million, up 23% from $8,761 million. The higher sales reflected the first full quarter of results of Hillshire Brands, acquired by Tyson in August in an $8.7 billion transaction.

At least briefly, investors reacted with enthusiasm to the Tyson results. In active New York Stock Exchange trading Jan. 30, Tyson shares opened up $1.28 per share, rising to a new 2015 high of $42. During a down day for the S.&P.500, sentiment darkened quickly, and Tyson closed the day down $1.17, to $39.04. In trading volume that exceeded 10 million shares (versus an average of less than 5 million), the closing price was the lowest for the company since Jan. 5.

Operating profits of the Chicken segment in the first quarter rose to $351 million, up 39% from $253 million in the first quarter a year earlier. Operating margins grew by a third to 12.6% from 9.5%. Chicken sales were $2,780 million, up 4.7%, comprising a volume gain of 3.1% and a price increase of 1.5%.

Looking forward, Tyson said U.S. chicken production was expanding at a rate faster than anticipated but said robust demand diminished the risk posed by the expanding supply.

“While the current U.S.D.A. (U.S. Department of Agriculture) forecast is for a 3% increase in production, recent supply data point to a greater increase in supply,” the company said. “Last quarter Tyson pointed to the 2% to 3% production increase forecast by the U.S.D.A. Tyson believes demand will keep pace with the supply change. While many of Tyson’s contracts are formula based and shorter term, the company believes there may be some lag before pricing changes take effect. Feed costs are expected to be down $400 million year over year (prior estimates were for a $300 million benefit). Tyson expects the Chicken segment operating margin to be above 11% for the remainder of fiscal year 2015, implying a full-year forecast of at least 11.4%.”

Elaborating on the company’s optimism, Mr. Smith was more expansive in remarks during a Jan. 30 conference call with investment analysts. He said his optimism was buoyed by macro trends affecting the food and beverage category.

“In the past quarter, consumer confidence, lower gas prices and unemployment data were tailwinds that we expect will continue to favor food spending in the new year,” he said. “But pressures like long-term unemployment and limited wage growth still weigh on a lot of people.

“We’ve talked about this situation before as the bifurcated consumer, or the barbell economy, and it factors into consumer spending habits which, in part, drive our innovation agenda. We continue to see consumers moving from red meat to poultry, and 68% say the cost of red meat is the reason they’re making a shift. However, beef prices have remained at record levels because demand has been so strong among people who can afford it.

“Chicken is the only protein to grow annual consumption during the past four years. Lower fuel prices appear to have benefited food purchases, both at grocery and food service, mainly at Q.S.R. (quick-service restaurants) and casual dining, which saw traffic growth in our Q1 for the first time since the recession.”

Digging deeper into away-from-home eating trends, Mr. Smith said chicken demand strength was not limited to quick-service restaurants. He specifically cited chicken’s strong presence in lodging, deli and health care. Annual growth rates in certain of these segments have been in the 3.5% range, he said.

Mr. Smith added that if lower gas prices continue into the summer, food service could see even more recovery.

“Seeing casual actually grow traffic for the first time since the recession is a very good sign,” he said. “Frankly, if you take out one large Q.S.R., Q.S.R. grew by 3.6%. There’s a lot in that. It’s interesting to note, in food service, that you’re seeing the younger brands outperform the more mature brands. That’s an interesting dynamic that we’ll be able to take advantage of.”

But despite his assurances demand would outstrip supply, several investment analysts who participated in the call were wary of the impact greater supply may have on earnings.

“With our pricing structures and the balance of how we go to market, we’re still in good shape if (chicken) supply increases above what a 3% excess might indicate,” Mr. Smith said. “Our buy versus grow strategy is we care a lot more about how much chicken we sell than how much chicken we grow. If you look at the last three weeks supply slaughter, we’re over 1 billion slaughter pounds.

“Since the beginning of the year, slaughter has increased something on the order of 7%, and if you look at particularly front half pricing, wings, tenders and breast meat, that’s up 15%. So there’s every indication that demand is more than going to offset the supply increases.”

Even as Tyson results in the first quarter eclipsed Wall Street estimates, skepticism about the outlook amid the expanding poultry supply persisted following the call. For example, Robert Moskow, an analyst with Deutsche Bank, acknowledged that Chicken segment profits were $80 million higher in the first quarter than D.B. had forecast.

“During the quarter, industry dollar growth for retail fresh chicken was up 8%, and Tyson’s growth was in-line with the industry,” Mr. Moskow said. “Tyson has No. 1 market share for branded chicken in fresh, individually frozen, and Cornish chicken. Demand remains strong for retail chicken, especially in tray packs where Tyson is short of supply.”

While Mr. Moskow predicted Tyson would raise its earnings guidance for the current year from the $3.30 to $3.40 it had issued earlier, Deutsche Bank is lowering its longer-term forecast for 2016 — at least preliminarily.

“We have developed a $3.07 estimate for 2016 (down from $3.40) based on chicken margins at almost 9%, Prepared Foods profits of $520 million and an interest expense reduction of $24 million,” Mr. Moskow said. “However, it is probably too soon to gain a high degree of conviction given the historical volatility of chicken, beef and pork.”

In addition to this unpredictability, Mr. Moskow said it is possible that, with Hillshire, Wall Street will “reward (Tyson) a higher multiple” once the company proves that its value-added strategy will better insulate earnings from industry cycles.

“The market has been reluctant thus far to be generous in that regard,” Mr. Moskow said.

With Hillshire, the Prepared Foods segment of Tyson is nearly as large as Chicken as measured by sales, but not yet by profitability.

Prepared Foods operating profits, reflecting the Hillshire transaction, blossomed to $71 million, from $16 million. Operating margins widened to 3.3% from 1.8%. Sales were $2,133 million, up from $907 million.

Adjusted for extraordinary items (including costs associated with a pre-acquisition fire at a Hillshire plant and merger and acquisition transaction costs), operating income was $111 million during the quarter.

“We achieved $60 million in synergies in the first quarter, and we are confident we will exceed the $225 million synergy target for this fiscal year,” Mr. Smith said.

While Chicken and Prepared Foods thrived in the first quarter, progress was more difficult to discern in the Beef and Pork segments.

Beef, in particular, had a tough quarter. The segment sustained an operating loss of $6 million, versus a $58 million profit in the first quarter of fiscal 2014. Sales were $4,391 million, up 21%, but volume was down 2.7%.

Pork operating income was $122 million, nearly unchanged from $121 million in the first quarter of 2014. Sales were $1,540 million, up 7%, with volume up 1.1%.

Tight raw material supplies have dogged the meat and poultry category for the past few years. The national cattle herd has been at historic lows. The hog market has been hindered by the effects of the PEDv virus, and the chicken segment has been struggling to grow supply after implementing reductions throughout the economic downturn. But now it appears the tide may be turning, at least for chicken and pork, and companies like Tyson Foods are strategizing on how to address the shifts.

In addition to noting the poultry supply seems to be growing faster than U.S.D.A. forecasts, Mr. Smith said projected hog supplies may increase 2% to 3% during the year. Only the beef market is expected to remain tight as producers work to grow the national herd.

“In terms of beef, the supply will probably be flat to down 1% again in the next year, and I think it may take four or five years to rebuild the herd back to the 2013 level,” Mr. Smith said during the call.

With more chicken and pork available for processing, it stands to reason additional pressure will be on meat processors to maintain margins, and Mr. Smith believes his company is in a position to do so.

Mr. Smith added that the company stands to benefit if pork prices decline as it will provide a benefit in its Prepared Foods business unit, which now includes the recently acquired Hillshire Brands.

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