Tyson Foods expected to ring up healthy first quarter earnings

Tyson Foods is expected to earn more than $352 million in net income for its first quarter of fiscal 2016 even with weak chicken and pork prices, according to Wall Street analysts.

Before the market opens on Friday (Feb. 5), the Springdale-based meat giant is expected to report 87 cents a share, a gain of more than 16% over the 77 cents it earned a year ago.

Analysts say chicken profits will be the bright spot in the report comprising roughly 75% of the company’s overall gains, despite lower seasonal poultry prices. Tyson’s chicken segment is expected to report an operating income of $270 million, which is considerably lower than the record $351 million reported a year ago.

Robert Moskow, an analyst with Credit Suisse, remains neutral on Tyson Foods, but said Tyson management is positioned to hit the 10% chicken margin forecasted in late 2015. He also believes Tyson has set itself up for sustainable margins “given that about 80% of its chicken business is based on contracts that are either grain-cost-plus, Georgia Dock plus margin, or simply a margin that is locked in through synthetic means.” He said about 52% of Tyson’s chicken business is consumer retail, which includes tray packs, deli rotisserie, Grilled and Ready items, and frozen value-added and commodity chicken which carry higher margins than wholesale commodity chicken.

About 16% of chicken sales are to food service national accounts. Products include eight-piece cut up and batter-breaded chicken and partially and fully fried/cooked tenders, wings, and breast items. Tyson has contracts and other margin-protecting mechanisms in place for about 20% of this business, Moskow noted to investors. Another 17% of chicken sales are in broader foodservice, such as hospitals and schools. That leaves around 15% which is in lower margin commodity product sales such as bulk leg quarters.

Moskow said Tyson does a good job of keeping commodity sales low through its buy-versus-grow program. Over the past five years Tyson Foods has reduced it exposure to excess supplies of dark mark meat by 50% because of the program – buying only the breast meat parts it needs to fill some customer orders. Moskow said without buy-versus-grow Tyson would be stuck trying to unload an addition 4 million pounds of leg quarters a week amid a declining commodity market. He also expects weaker exports for chicken and other meats this year given the strong dollar and slowing Asian economy.

BEEF & PORK
The challenged beef segment is also expected to have a better showing as it reverses losses from a year ago. Moscow estimates the beef segment will have operating income of $42 million, which is a welcome site after the $6 million loss the company reported a year ago. Beef sales are also expected to rise to $4.43 billion, up slightly from the $4.39 billion reported a year ago.

Tyson expects industry fed cattle supplies to be flat to slightly higher this year compared to last. That said the company also lowered its long-term growth estimate for the business to between 1.5% and 3%, down from the 2.5% to 4.5% historical level. Tyson said fiscal 2016 should be in the low range of the new forecast.

The pork business is expected to flat with a year ago with $122 million expected in operating income for the quarter. Pork sales are expected to decline to $1.27 billion amid weaker demand and lower overall pricing. Tyson expects industry hog supplies to increase 2% to 3% this year. Operating margins should be in the normalized range of 6% to 8% throughout the year, which is unchanged from 2015.

PREPARED FOOD
After the Hillshire Brands acquisition, Tyson’s prepared foods segment is not expected to perform that well as more investment is needed, according to Moskow. He expects the prepared foods segment will report operating income of $190 million, improving from higher overall margins coming from the Hillshire products. A year ago this segment reported $111 million in operating income.

That said, Moscow believes overall sales revenue in the segment will be down substantially from a year ago. Projected sales revenue of $1.984 billion, down from the $2.133 billion reported a year ago. Moskow said Tyson ‘s management has not lowered the guidance for its commodity beef business enough to take into account the difficult environment. He believes this will result in lost sales for this segment that uses beef parts in hotdogs, sausages and other products.

Moskow said Tyson is realizing more $100 million in savings from lower grain costs year-over-year and also another $100 million in synergies from the Hillshire acquisition. But given the launch of new snacking products, much of that money will be used in promotions. He said lost marketshare in lunch meats and sausages is also forcing the company to increase its marketing budget for fiscal 2016 to try and close the gaps.

Morningstar analyst Zain Akbar expects the prepared food operating margin to be relatively stable at 6.5%, which is less than 10% Tyson forecast for the year. Akbar does believe that the segment will likely be the company’s economic engine by adding products while also achieving more Hillshire-related synergies to boost margins.

“Despite the Hillshire acquisition, which brought several value-added products, Tyson still relies on hard-to-differentiate, commodified products for a large portion of sales. Margins are slim and the company has little pricing power, resulting in average returns that only slightly exceed its cost of capital,” said Akbar.

While Tyson is better positioned to withstand shifts among major protein categories that could leave other meat processors vulnerable, Akbar said if market conditions for one protein deteriorate, the risk associated with Tyson Foods is high.

Moskow said the stock has enjoyed a rally over the past year, helped along by promise of a dividend boost and ample share repurchases through next year. While he gives Tyson’s management accolades for the work done so far, he doesn’t feel comfortable with the company’s earnings guidance through 2016 and he remains on the sidelines.

Tyson Foods shares (NYSE: TSN) closed Tuesday at $53, down $1.31. Shares are up 35% from a year ago, while they are flat year-to-date amid a very volatile market. For the past 52-weeks shares have ranged from a $37.10 low to a $54.59 high. Analysts expect the average target price for Tyson Foods at $55.27. The high target is an estimated $65, with the more bearish view being $45.

Two brokerage houses have recently downgraded Tyson Foods shares to a neutral position from a previous “buy” position. Eleven analysts polled by Thomson/First Call give the company a recommendation rating of 1.9, with 1.0 being a strong buy and 5.0 being a strong sell.