Tyson Foods, Pilgrim’s play pricing game with market share push

Sitting pretty on fat balance sheets, the nation’s two largest chicken companies are it again, strategically planning to grow market share in the highly fragmented poultry industry.

Tyson Foods is ranked No. 1 in market share with 22% of the nation’s chicken production. No. 2 ranked Pilgrim’s has 20% of the market, according to Watt Poultry USA.

Both companies recently announced plans to expand their prepared foods segments and are investing heavily in international ventures – Tyson Foods in China and Pilgrim’s in Mexico. Industry analysts applaud the efforts and say the U.S. market is likely facing overproduction which could result in lower chicken prices for the consumer and lower chicken revenue for the industry.

PREPARED FOODS PUSH
Tyson Foods recently acquired Bosco’s Pizza Co., in its expanding prepared foods portfolio. Last year the meat giant acquired Circle Foods and Don Julio Foods giving it more access to Latino and Indian marketed products sold in the prepared foods segment. The meat company also is reportedly interested in Michael’s Food Group, an egg and dairy company being sold by a Goldman Sachs private equity arm. Tyson did not confirm a bid on Michael’s saying it doesn’t comment on rumor or pending activity.

Tyson Foods CEO Donnie Smith has said the prepared foods segment is the growth engine for the meat company and he recently split the unit away from the chicken segment which had previously shared leadership.

Donnie King was recently placed in charge of the prepared foods segment and given the go-ahead to grow the segment’s sales an estimated 7% to $3.553 billion by the end of 2014. That would be a 9.76% growth rate over the total segment sales in 2012. King previously served as president of the combined segment of chicken and prepared foods since 2009.

Smith told investors and analysts in the recent earnings call that this segment is already starting to contribute more to the company’s bottom line and by the end of this year to early 2015 many of the recent investments will be paying off.

Pilgrim’s CEO Bill Lovette told analysts during a Feb. 21 earnings call that Chad Baker, a former Smithfield Foods executive, was joining Pilgrim’s to head up the prepared foods segment. Lovette is a former Tyson Foods executive. Lovette said Pilgrim’s prepared foods, valued-added sales had decreased about 10% over the past three years. He said some of that business was not paying off which prompted the company to readjust.

“In order to make that business more impactful from a margin perspective, we set a strategy … now we're going to bring on the resources to grow that business in the right way in right implying are more profitable,” Lovette said in the call.

Pilgrim’s estimates about 30% of its sales are valued-add/prepared foods. That would equate to $2.52 billion. Lovette expects that number to grow in the next couple of years, but he did not give an estimate.

INVESTMENTS ABROAD 
Tyson has ramped up efforts to become fully integrated in China over the past year. Tyson operates three ventures and employs about 4,300 people in China, and first opened operations there in 2001.

In China, Tyson processes chicken sold wholesale into food service for clients such as Yum Brands! and McDonalds. Tyson also sells fresh chicken to Wal-Mart and Sam’s Clubs in China, extending those longtime U.S. relationships abroad.

Tyson said last fall it was processing about 1.3 million birds per week in China with a goal  to reach 3 million per week in 2014. Smith recently said the company was slowing the pace because there is an excess supply of chicken due to demand volatility from spikes in avian flu and other food safety concerns. He said Tyson is not giving up on China but is prepared to wait until market conditions improve before building out the rest of the chicken farms. He said the company will continue to acquire land rights and process the birds it owns. At this time Tyson’s two plants are running one shift with company originated birds. 

Smith said they had hoped to double that production by year end, using only company birds, but it is going to take longer than they thought.

Rob Moscow, analyst with Credit Suisse, said Tyson has a three- to four-year head start on other poultry companies wanting to invest in China. He said it’s a tough market and he has yet to see an agribusiness company successfully enter and make it big in China. However, he does credit Tyson with having an experienced Chinese national leading their operations. Arex Lee has 25 years of experience with one of Tyson’s Chinese poultry competitors. Moscow said it was Lee who initiated Tyson’s vertical control from egg to processed chicken in the retail channel.

Pilgrim’s recently announced plans to expand its footprint in Veracruz, Mexico. Lovette said the project will begin with live sales and work toward a new processing facility expected to come online by late 2015. Pilgrim’s has committed about $70 million toward expansion opportunities this year. They said the Veracruz area is showing increased chicken consumption along with robust population growth. It is also located near a port where grains are shipped. Pilgrim’s is staking out land for this new operation. 

“We'll build our feed mill and a hatchery, import hatching eggs and then build out our breeder supply there. And then the next step is we'll build a processing plant as the needs tell us to,” said Fabio Sandre, chief financial officer at Pilgrim’s.

MORE CHICKEN
Moscow is one of the analysts who expects domestic chicken excesses this year. He said after high levels of profitability in 2013 and many breeders now in the middle stages of rebuilding their grandparent stocks, chicken processors will be in position to substantially increase their production by early 2015.

He expects chicken prices to fall this year given rising egg set numbers and the 5.7% more poultry sitting in cold storage. The last time the industry faced declining chicken prices from over production was 2006 — a disastrous year for the industry. Tyson Foods lost $196 million for the year, and $127 million in the second quarter alone.

While Moscow said there has been many changes at Tyson since then, the meat giant is still vulnerable to falling chicken prices. He estimates that if chicken prices fall 10% and corn costs were to suddenly rise $2 per bushel the downside to Tyson Foods earnings would be 65 cents per share. For that reason he is neutral on Tyson Foods shares.

The U.S Department of Agriculture data show eggs set were up 5% from the prior year during the last four months of 2013. Broiler production is expected to increase about 3% this year across the industry. Analysts said heavier bird weights alone add 1% to the total production in pounds and lower grain costs this year are also likely to encourage higher weight per head. 

Smith has said many times the company will err on the side of caution and slightly under produce the chicken it needs, knowing it can buy the difference in the open spot market. 

While Tyson’s restraint is applauded, there is still a majority of the market where smaller processors may not hold back the temptation to grow more chicken coming off some very profitable quarters.

EARNINGS GUIDANCE
Tyson recently gave annual earnings guidance, an usual move given the volatility seen in grain and other commodity costs in recent years.

"While we don't typically provide earnings guidance, we do think we'll deliver at least $2.78 in fiscal 2014, which would be in excess of 23% earnings per share growth, and we're poised for at least 10% EPS growth in 2015 and beyond," Jon Kathol, Tyson's vice president of investor relation, said this past week at an investor conference.

Kathol said Tyson's business strategy centers on accelerating growth of domestic value-added products and international chicken production and innovation of products and services that customers want.

Moscow said the guidance is a little too aggressive for his modeling given the headwinds he predicts from overproduction. That said, Wall Street investors are bullish on the shares.

Tyson Foods (NYSE: TSN) shares closed Wednesday (March 5) at $40.42, flirting with its 52-week high price of $40.80. Tyson shares have rallied 73% in the past 12 months. 

Pilgrim’s (NASDAQ: PPC) shares closed Wednesday at $18.20, up 29 cents. The stock price has ranged between $7.82 and $19.23 during the past 52 weeks. Pilgrim’s shares are up 98% year-over-year.