Though we believe that Tyson (TSN) has failed to create a moat, given a lack of pricing power and scale-based cost advantage, we think the nearly 25% discount to our $67 fair value estimate affords a reasonable margin of safety. Tyson operates with a diverse mix of protein businesses--beef (20% of profit), chicken (35%), and pork (15%)--and packaged foods (30%), which offers more earnings stability than other meat processors.
Tyson is the largest U.S. producer of beef and chicken, but several factors out of the firm’s control affect costs (weather, herd/flock health, global trade), and its margins tend to align with its smaller peers. Despite this, we applaud Tyson’s efforts to penetrate the prepared-foods segment, where profits exceed its more commoditized fare. These products are priced like typical packaged goods and thus tend to be more stable. Operating margins are 10%-12% compared with 2%-3% for beef and around 8% for chicken and pork. The firm has continued to expand its reach in this area with the 2017 acquisition of AdvancePierre and the 2018 purchase of Keystone Foods. We expect expansion in this segment will continue to be a strategic priority, but don’t believe this will outweigh its commodity business.
Our valuation is underpinned by our outlook for higher chicken prices this year (due to updated contracts to account for higher freight and feed) and a return to growth in pork (up 2.5% after a 7% shortfall the year prior) as strong secular demand in China coupled with an outbreak of African swine flu in its own herds increases demand for U.S. pork, despite tariffs. These trends should help chicken and pork margins recover over the next two years from currently depressed levels. However, beef margins are currently above the normalized level due to ample cattle supply and strong consistent demand, which we believe is unsustainable. Long term, we forecast 2%-3% sales growth and high-single-digit operating margins.
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Rebecca Scheuneman, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.