EUR 850.00 For Business Accounts Only

Morningstar | No-Moat Tyson Expects Benefits From African Swine Flu; Shares Fairly Valued

After no-moat Tyson reported second-quarter results, we anticipate making a mid-single-digit increase to our $68 fair value estimate to account for sustained strength in beef margins, lower-than-expected feed costs, and time value of money adjustments. However, after the stock’s 40% year-to-date return, we view Tyson as fairly valued and suggest investors await a more attractive opportunity to build a position.

Management struck a bullish tone regarding the potential impact that China’s African swine fever outbreak will have on Tyson’s business over the next two years. Given the scale of protein to be culled from the system (150 million-200 million hogs by management’s estimation, over twice the size of the entire U.S. hog population), the firm expects the 5% drop in global protein supply to boost prices and margins for all three of Tyson’s protein businesses: beef, chicken, and pork, collectively 70% of profits. However, margins in the prepared foods segment (30% of profits) will likely be squeezed, as the contract pricing in this segment is not expected to reset as quickly as input costs inflate. The net benefit should be decisively positive. Our model already reflects these expected flu impacts in Tyson’s pork, chicken, and prepared foods segments, although we had expected beef--which has been reporting 6%-7% operating margins over several quarters, well above its 2%-3% long-term average--to revert to low-single-digit margins in the next few years. We will reassess this assumption, given the pending drop in global protein supply. We also expect to adjust our forecast to reflect the benefits of lower feed costs, as the decreased size of the China pig herd has lowered demand and prices for soybean meal. While this supply disruption is expected to boost Tyson’s pricing and margins, we view this event as not strengthening the firm’s competitive positioning but simply the result of operating in volatile commodity businesses.

Second-quarter results were largely in line with our expectations. The firm reported 6.9% acquisition-driven revenue growth; we estimated a low-single digit organic lift. Adjusted operating margin fell 0.8 percentage point to 6.3% primarily due to lower margins in the chicken segment, which fell 530 basis points to 4.4% due to short-term U.S. protein oversupply. We believe the second quarter should mark the trough in chicken margins, and management said that is its expectation as well. We expect Tyson to report a 6.4% operating margin for the chicken segment in fiscal 2019 and about 7% in 2020.

Management announced plans to launch alternative plant-based protein products on a small scale this summer, expanding the business more significantly into the fall. While this business will initially be immaterial to Tyson’s large profit base, we applaud the firm’s efforts to enter this growing category that is on trend with consumers' evolving preferences. In 2016, the company announced it had taken a 5% stake in Beyond Meat, but earlier this year, Tyson disclosed it had exited the venture. We think it is likely that Tyson’s decision to exit is related to the internal development of its own plant-based lineup.