Ethanol Production Could Threaten Tyson Earnings

With bird flu fears receding, Tyson Foods Inc. now can turn its attention to another rising problem in the poultry industry: ethanol.
The growth of ethanol production in the United States could become another tough nut for chicken producers to crack. Corn is the main ingredient in chicken feed, and it is used to make the renewable fuel ethanol.
By 2008, 25 percent of U.S. corn produced could be used for ethanol, Stephens Inc. analyst Farha Aslam wrote in a report released Oct. 6.
“This increased demand for corn could cause prices to rise rapidly, hurting [poultry] producers’ margins,” she wrote. “Every $0.10 change per bushel of corn costs chicken companies three-tenths of a cent per pound of breast meat.”
Tyson doesn’t seem to be too worried, though.
“Short-term prices may be higher,” Bill Lovette, senior group vice president of poultry and prepared foods for Tyson, said at a National Chicken Council conference earlier this month. “Farmers have become more productive; it only takes 1 million acres to make 420 million gallons of ethanol. With increased acres, higher yields and improved genetics, farmers should be able to mitigate risk.”
The Springdale protein producer already is weathering a difficult year, with losses in its second and third quarters totaling nearly $200 million on revenue of $19.1 billion. In 2005, Tyson reported net income of $372 million on revenue of $26.014 billion.
This year’s losses are blamed on fears of avian influenza overseas, which created an oversupply of chicken. Concern over a flu pandemic that hasn’t materialized is expected to subside next year and Tyson should return to profitability, Aslam said.
Others believe it’s difficult to tell what the poultry market is going to do.
“There’s not a whole lot of visibility with a company like Tyson. So much of what it does is in the commodities market, which changes very rapidly,” said Ann Gilpin, an equity analyst for Morningstar. “Because things change so quickly, it’s very difficult for anybody to really predict things reliably.”
Flu Fears Cut Demand
Earlier this year, demand for chicken fell as the avian flu virus spread from Asia to the Middle East, Europe and Africa, according to a February Morningstar report by stock analyst Greggory Warren. That led to a decline in the export market for chicken and an increased domestic supply.
As fear of the flu rose, Tyson’s profits dropped. The company had income of $190 million during the quarter that ended Oct. 1, 2005; the next quarter’s income was off by 40 percent.
In February, more than 1.2 billion pounds of poultry were in storage in the United States, up 24 percent from the previous year, Warren said.
“This has placed pressure on poultry prices, limiting sales and profitability for the chicken processors and offering consumers a much cheaper alternative to other meats,” Warren said.
Tyson and other poultry-producing companies started cutting back on production, but it was too late to avoid a glut.
“We already had birds in production,” said Dan Cunningham, a poultry science professor at the University of Georgia. “The one way you continue to move product is to lower the price on it.”
Tyson and other poultry producers dropped their prices.
“They geared up and were preparing for a specific market situation that changed because of the avian influenza,” Cunningham said. “I think that has been the primary impact on many of them.”
Tyson reported a net loss of $146 million in its second quarter, which ended April 1. Its poultry sales continued to fall, down 2.2 percent from $2.056 billion for the quarter that ended with December to $2.01 billion three months later.
“Concerns about the Asian strain of avian influenza in other parts of the world temporarily disrupted some of [the] chicken export markets earlier this year,” Tyson spokesman Gary Mickelson said in a response to e-mailed questions.
Sales didn’t improve in Tyson’s third quarter. Poultry sales dropped to $1.92 billion in the quarter that ended in June, down 7.8 percent from the same quarter in 2005.
Quiet on the avian flu front has some poultry experts predicting a better year in 2007 — but no one is making any guarantees.
“But you can appreciate that disease is very difficult to predict,” said Paul Aho, a poultry consultant who owns Poultry Perspective in Connecticut. “It can go away and [you might] never hear from it again, or it could last for a few more years. We just don’t know.”
Tyson Sees Changes
In May, John Tyson unexpectedly stepped down as president and CEO, and Richard Bond, former CEO of IBP Inc., stepped into the roles. Tyson bought IBP, the country’s largest beef producer, in 2002. The combined company immediately became the leading domestic producer of meat. It now has a 27 percent share of the beef market and is No. 2 in the market for producing pork. Tyson also is the No. 1 producer of chicken and has 23 percent of that market.
But being so big hasn’t insulated Tyson from the volatility of the commodity markets, Morningstar’s Warren wrote in April.
And getting into fresh-cut and packaged meats has been difficult for Tyson because other meat producers are doing it too, Warren wrote.
“This is bad news for Tyson, which has struggled to generate operating margins in excess of 3 percent per year over the past five years and has posted returns on invested capital in just the 6 percent to 7 percent range during the same time frame,” Warren wrote in his report.
Bond planned to make some changes when he took over. Within two months of his promotion, Bond announced a $200 million cost-savings plan that included cutting 420 jobs and leaving 430 more unfilled.
Mickelson said Tyson looked at all aspects of its business and also reviewed suggestions from its employees on how to run the company more effectively.
Other money-saving plans include cutting recruiting costs, consulting fees and travel.
“Virtually all of the saving measures should be in place by the end of the calendar year,” Mickelson said. “We believe more than 90 percent of these annual savings will be fully delivered in fiscal year 2007.”
Aslam said the belt tightening was necessary to return the company to profitability.
It’s still too early to say how Bond is going to do as CEO, said Morningstar’s Gilpin.
She suggested most of the major decisions still would be made by Don Tyson, who is a director and owns 80 percent of the stock in the company. And John Tyson, who stepped down as CEO, remains chairman of the board — and the chief financial officer reports directly to him. That organizational chart “is kind of different from the structure we’ve seen at other companies,” Gilpin said.
Corn Diverted to Ethanol
More ethanol production in the United States could affect the price of feed in the future as more corn gets diverted into ethanol production.
Currently, there are 102 ethanol plants in the U.S. with another 48 under construction, Stephens’ Aslam said in her report.
“It’s hard to say that it’s had any impact yet, but it certainly has the potential,” said Richard Lobb, spokesman for the National Chicken Council in Washington, D.C.
Lobb said it might be possible to produce ethanol without corn, but no one knows for sure.
Still, all meat producers are concerned about ethanol because animal feed is the largest cost in raising livestock. The price of grain is about 25 percent of the total cost of producing chicken.
“Grain price is always something that people watch,” the poultry consultant Aho said. “The poultry industry is concerned right now about ethanol and how fast is that going to grow and could that affect grain prices.”
But Tyson Foods said it hadn’t speculated specifically on how much ethanol production might impact corn prices.
“Even though we have a great corn crop now, it appears, there is no doubt that over time ethanol is going to put more pressure on corn,” CFO Wade Miquelon said in a September presentation on the ethanol issue. “And in terms of what that means for pricing, nobody knows.”
Miquelon said that higher corn prices didn’t necessarily mean lower margins. An increase in corn prices helps justify raising the price of poultry, he said. And it might force some of the smaller operators out of the mix.
He also said the diet of Tyson chicken could change with the market. One alternative to corn would be soybean meal.
“I think over time, depending on what happens to corn and other grains, we will continue to evolve the portfolio in the best way, shape or form we can,” Miquelon said.