Tyson Foods expected to ride rising meat prices to record profits

The 2014 fiscal year is shaping up to be another record year for Tyson Foods thanks to potential gains from rising meat prices and the $8.5 billion purchase of Hillshire Brands.

Even the biggest of naysayers have come back around in recent days with respect to profit potential of the pro-forma company. Robert Moskow, analyst with Credit Suisse, initially made no secret of the fact Tyson was too optimistic about the synergies of its deal with Hillshire Brands.

On Oct. 1, Moskow noted to investors that three pieces of new information regarding fundamentals in the protein markets had led him to raise his earning estimates back in line with consensus and upgrade Tyson Foods to “neutral” from “under perform.”

“While we remain skeptical regarding management's ability to achieve its lofty synergy targets for the Hillshire Brands acquisition, we feel more comfortable that the strong demand and high margins in the core protein business (80% of EBIT) will smooth over the bumps in the road during the integration,” Moskow noted. (EBIT refers to earnings before interest and taxes and is a gross profit metric used by financial professionals.)

He raised the target share price of Tyson Foods to $42 citing a lower-than-expected forecast of chicken production across the industry, higher beef operating margins and optimal sow pricing for Hillshire Brands.

Shares of Tyson Foods (NYSE: TSN) closed Wednesday (Oct. 8) at $41.52, up 47 cents. During the past 52 weeks Tyson shares have ranged from a low of $27.33 to a high of $44.24.

Tyson reports its fiscal 2014 earnings results on Nov. 17. Wall Street expects Tyson to earn 75 cents per share in the quarter and $2.82 for the full year. Consensus is up 7% and 24.7%, respectively year-over-year.

CHICKEN PRODUCTION
Moskow cited a new 2015 outlook by EMI, a closely watched consulting firm, that pared down the forecast of the U.S. Department of Agriculture. The USDA expected a 3% increase in chicken production in 2015, but EMI trimmed that 1% because of the slow pace breeders are taking to rebuild the grandparent stock.

On Sept. 22, the USDA reported total frozen poultry supplies as of Aug. 31 were up 1% from July but remained 14% lower than a year ago. Total stocks of chicken were down 13% from last year. Total pounds of turkey in freezers were down 15% from Aug. 31, 2013.

Moskow said producers are now talking about tight supplies continuing into late 2015. The combination of tight supplies and strong demand has kept commodity chicken prices above their normal seasonal patterns. Poultry prices usually pull back at this time of year but have not slumped so far because retailers are heavily promoting chicken, keeping demand strong, said BB&T Capital Markets analyst Heather Jones.
“The strength seems to have caught many by surprise, as the (boneless, skinless) market tends to become sluggish this time of year,” Jones said.

She said some large processors limited buying this summer in anticipation of weaker pricing in early fall, but their inventories became too tight, forcing them to buy aggressively to fill orders. Tyson is a processor that also buys meat on the open market for further processing, a practice Tyson Foods CEO Donnie Smith will continue.

Chicken prices typically drop as autumn approaches, but pricing has slid just 1% since August, compared to a 5% decline a year ago. Jones is forecasting production will increase by 4% or more in the last three months of the year. She notes that breeder stock is up about 2% and some large companies are not cutting back on production as they typically do in the late summer.

In the short term, Jones expects there to be a softening in boneless, breast meat prices because that is when promotional demand wanes. That said, Jones said the large bird spot margins are still running at two times last year’s level and should remain positive in the fourth quarter because of lower feed costs than last year.

CHICKEN MARGINS
Chicken margins have been high this entire year and Ken Zaslow, analyst with BMO Capital Markets, expects they should hold above historical averages for the foreseeable future.

Zaslow warned there could be softening in leg quarter pricing following the Russian ban on U.S. legs. He said the sanction will likely pressure leg quarter prices by 5 cents to 7 cents until other countries absorb Russia’s export demand. Retail demand for leg quarters has not increased much despite dark meat’s relative cheapness to white meat and competing protein sources, Zaslow wrote in a note to clients.

Zaslow said there will be support for margins from limited production growth and strong demand. He noted that Georgia Dock whole bird prices remained at record levels thanks to ongoing demand amid tight competing meat supplies and limited supply of small birds. Georgia Dock whole bird wholesale prices on Oct. 2 were $1.14 a pound, up 8.5% from a year ago and 20% higher than the same week in 2012.

Zaslow said quick-service restaurant promotions continue to support whole birds prices. He said boneless skinless breast prices are likely to decline into this fall, reflecting retailers holding ample supplies to meet demand through the end of summer. He also expects higher soybean meal costs to help offset high wing prices and lower corn costs. Wholesale wing prices were quoted by Georgia Dock at $1.63 per pound on Oct. 1, up 12.5% from a year ago.

Georgia Dock pricing on Oct. 1 for boneless, skinless breast meat was $2.19 per pound, down a from an annual high $2.24 in mid July. A year ago the Georgia Dock price was $1.90 per pound, up 24.3% year-over-year.

RED MEAT MARGINS
Moskow notes that it would take more high chicken prices for him to raise his outlook on Tyson, but the meat giant is also getting help from rising beef margins.

“Industry beef margins have jumped into the high end of the normalized range. One beef processor we spoke to says that they recently pushed through higher pricing in the beef markets, thus setting them up for strong margins for the rest of the calendar year. We expect Tyson to enjoy similar benefits,” he noted.

The USDA reports total red meat supplies in freezers were down 7% from a year ago
Total pounds of beef in freezers were down 20% from last year. Beef packer margins declined $50 per head in September as they paid more for cattle and saw wholesale beef prices decline nearly $1 per hundredweight.

Sterling Beef Tracker reports beef packer profits totaled $30 per head last month, significantly higher than $22 per head profits they earned last year. Cash prices for fed cattle are nearly $38 per cwt. higher than last year, and negotiated hog prices are $6 per hundredweight higher than last year.

Pork packers saw a $5 per head decline in profit margins to $4.90 per head. Moskow said falling sow prices bodes well for Hillshire Brands' profit margins in its first quarter under Tyson Foods. Frozen pork supplies were down slightly from last year, according to the USDA report. Stocks of pork bellies were down 29% from last month, but up 136% from last year.

CONSUMER PINCH
While meat companies are making more money from higher prices, consumers are feeling the pinch in their wallets. The American Farm Bureau Federation said U.S. consumers are paying more for several food items according to an informal survey dated Oct. 2.

The bureau estimated consumers are paying $54.26 for 16 common items, up about 2%, from a year ago. Prices increased for seven items in the basket, which included meat, eggs and milk, while nine were less expensive.

“Several beef, pork and dairy products rose in price during the second half of the year, accounting for much of the increase in the market basket,” said John Anderson, AFBF’s deputy chief economist. “We’re seeing higher beef prices, which can be attributed to lower production.”

Darrell Peel, beef market analysts with Oklahoma State University, notes that beef prices have rallied throughout this year at nearly three times the historical 20-year average. He said drought in Texas and Oklahoma in 2012 pushed cattle slaughter forward and the national herd is at a 54-year low.

The Farm Bureau notes that sirloin tip roast posted the largest increase from a year ago, up 27%, to $5.52 per pound, followed by ground chuck, which rose 17%, to $4.31 per pound. The price of bacon jumped 9% and shredded cheddar cheese rose 6%. 

Items declining in price include Russet potatoes, bagged salad mixes and vegetable oils, each selling from 10% to 15% below the prices of year ago, according to the Farm Bureau report.