Tyson Foods expected to post solid earnings, but market challenges loom in 2016

Tyson Foods is most likely going to impress with its 2015 revenue and income thanks to the added business with the Hillshire Brands merger. But it’s not all sunshine and roses. Weak export markets, Avian flu fallout and price deflation with branded products could diminish the shine, according to analysts with Credit Suisse.

Wall Street expects Tyson Foods to post fiscal fourth quarter income of roughly $370 million for period which ended Sep. 30, with total revenue of $10.35 billion. The consensus estimate compares income of $310 million last year without the full benefit of Hillshire Brands. Revenue is expected to be 2.4% higher than the $10.1 billion reported in the same period last year. Tyson Foods will report its fourth quarter and fiscal 2015 earnings on Monday (Nov. 16) prior to the market opening.

“Tyson stock has been on a tear heading into fourth quarter results presumably because the market is anticipating a positive earnings surprise. While commodity pork and beef may fuel a small beat in the quarter, we see more downside risk to consensus estimates than upside for the following year,” said Robert Moskow, an analyst with Credit Suisse who is neutral on Tyson Foods stock.

Shares of Tyson Foods (NYSE: TSN) closed Wednesday (Nov. 4) at $45.15, down 19 cents. The Tyson share price has risen 12.62% since Jan. 1, with a majority of that gain coming in the last 90 days. During the past 52 weeks the share price has ranged from a $47.71 high to a $37.10 low.

Moskow said the “strong U.S. dollar has hammered beef exports and drop credits (value of hide, head, organs) and our Nielsen data indicates that the Hillshire division has yet to reverse significant volume declines.” As a result, Credit Suisse raised its fourth quarter earnings per share estimate above 90 cents per share, versus Wall Street’s 87-cent consensus. Conversely, Moskow said his fiscal 2016 earnings per share estimate of $3.30 is well below the consensus $3.53.

He said the bull case on Tyson’s stock is that the higher value branded prepared foods division will become a much bigger part of the mix in fiscal 2016 fueled by incremental benefits of $250 million in lower commodity costs and $100 million in incremental synergies. 

According to Moskow, Tyson faces unexpected and deep price cuts in its branded lunchmeat and sausage business. Moskow said deflationary pricing in commodities has fueled competition. The turkey business is experiencing a shortage of supplies related to bird flu issues and Tyson has a large lunchmeat business for sliced turkey breast product in Tyson branded and Hillshire Branded products.

“We think Tyson will struggle to achieve the lofty expectations investors have for this division. Tyson might have to invest more in Hillshire than investors realize,” Moskow said.

FATTER PORK
Credit Suisse thinks the bright spot in the fourth quarter for Tyson Foods will be the pork segment. Moskow said strong commodity pork margins has meant more profits than previously expected.

“Hog prices have fallen significantly since 2014 while strong foodservice demand for bacon has driven pork belly prices higher. Ham prices have moved higher as well. The positive impact of these trends is more than offsetting the negative impact of weaker exports,” he said.

Tyson Foods is expected to report fourth quarter operating income of roughly $110 million in pork thanks to the higher margins in the recent quarter. Hedger’s Edge said pork packers like Tyson Foods saw their processing margin per head rise from roughly $5 per head in July to $15 per hear in August before peaking at $25 per head in September.

BETTER BEEF
As promised by Tyson executives in the last quarter, the company’s beef margins have continued to improve. According to the Hedger’s Edge data, the implied September fiscal fourth quarter margin/head for the industry improved to $25/head, better than the $4/head in the June and getting closer to the $29/head in year-ago period.

Credit Suisse has forecast beef operating income of $35 million in the fourth quarter, above the $33 million implied by Tyson’s guidance for break-even results in beef for the fiscal year.

Moskow said Tyson management was expecting margin spreads to improve in August and September, but he thinks the magnitude of improvement is better than expected.

CHICKEN LITTLE
Most of the chicken industry has seen falling profits and margin erosion from excess supplies of large birds on the market and reduced export demand for large bird dark meat. Tyson Foods is not expected to feel the same ding as its competitors Pilgrim’s Pride and Sanderson Farms, because in recent years it has shifted production to smaller birds, used in fresh retail.

Much of the 4% to 6% increased pounds of chicken on the market this year are in large birds which are deboned, according to Sanderson Farms.

Moskow said since the oversupply is more likely to take place in an area where Tyson does not focus, the company will be less impacted if total chicken supply starts to exceed demand next year. He reminded investors that Tyson also purchases a large amount of commodity breast meat in its buy-versus-grow strategy. He said Tyson could benefit from excess supply of boneless, skinless breast and reduced prices next year.

Composite chicken processing margins have been relatively flat for much of this year around the 35-cent per pound range. Margins dipped down to 30 cents per pound in August which was part of Tyson’s fiscal fourth quarter. Leg quarter pricing continues to slump this year without the export demand. Wholesale leg quarters were priced at about 45 cents a pound during Tyson’s fourth quarter. Breast meat prices have continued to decline since peaking around $1.90 a pound in August. Wing prices are also on the decline, falling from $1.70 per pound down to $1.50 per pound during the quarter, according to Georgia Dock pricing.

Moskow said Tyson’s small bird strategy is likely a shield during what is challenging pricing for other larger bird processors. He expects Tyson’s chicken segment will post operating income of $330 million in the fourth quarter, better than the $206 million in the same period of 2014.

PREPARED FOOD HICCUPS
Moskow said Tyson management set its prepared foods expectations low for the fourth quarter, and Nielsen tracking data indicates the challenges are real.

“We are reducing our fourth quarter prepared foods sales and income forecast due to continued negative volume trends. Our new operating income for the quarter is $165 million down from $175 million, previously forecast,” he said.

He attributes the downward move to lingering impact oof Avian Influenza (AI) on turkey lunchmeat, and increased investment in marketing. He said recent Nielsen data indicates continued challenges in categories where price gaps with competition have

widened. Hillshire brands sales declined 1.6% over the past 12 weeks, compared to a 1.9% upward trend over the past 52-weeks.

Sausage is one area of concern in the Hillshire division (17% of sales) and Jimmy Dean (17% of sales). Hillshire has taken action to manage the price gaps, according to Moskow. After PEDv ( a deadly pork virus) limited pork supply in 2013 and drove up input prices Hillshire increased prices, but the competition did not follow. Since then the large increases in supply have caused reductions in the cost of the underlying commodities, and Hillshire had to cut pricing twice on the way back down, Moskow said.

Turkey lunchmeat volumes remain extremely negative (7% of sales) as Tyson has

passed through the higher cost of tighter turkey supplies caused by (AI). During its last earnings presentation, Tyson management noted there would be a $25 million to $30 million impact to its prepared foods earnings during fourth quarter 2015 related to AI.

Moskow said much of Tyson Foods’ upside potential was tied to its prepared foods segment and the branded Hillshire products which now are demonstrating challenges to the former profitability expectations.

“The market has maintained the view that this prepared foods division can meet or exceed management’s targets for fiscal 2016 even though the competitive environment has become increasingly challenging. Right now it is scrambling to adjust to unexpectedly circumstances beyond its control,” Moskow said.