Tyson Foods reported strong third-quarter results, as easing input cost pressures and strong chicken demand are allowing the company to reap the full benefits of operational improvements. While reported revenue (up 5%) was in line with our expectations, beef segment profitability (segment margin came in at 3.1%, versus 2.0% reported in the previous year and a loss in the second quarter) was better than anticipated. Analysts think the strong beef performance reflects solid execution coupled with reduced industry supply (because of a competitor’s plant closure).
Chicken segment performance was also very strong, with sales increasing more than 10% and segment profit margin reaching 7.0%, matching the high end of management’s guidance for normalized chicken margins (5%-7%). These factors helped to drive 70 basis points of consolidated operating margin expansion, which reached 4.8% in the quarter.
The meat processing industry is very competitive, and we think Tyson lacks an economic moat primarily for this reason. However, Tyson is one of the best operators in the industry, and management has done a solid job of improving the firm’s profitability over the past few years. Morningstar intends to increase the fair value estimate to $27 per share from $24 to reflect cash generated since our last update, management’s guidance for $36 billion in fiscal 2014 revenue (versus our previous forecast for a little over $35 billion), and chicken margins above normalized levels.
Chicken demand remains robust (chicken is a relatively cheaper protein), and we think this tailwind could drive chicken segment profitability above normalized levels. Tyson’s shares still trade at a modest premium to our fair value estimate. Our base-case forecasts assume that Tyson can sustain normalized segment margins at the low end of management’s guidance over the long term; however, these base-case estimates could prove too conservative if the firm is able to consistently generate margins in the middle to top end of this range.
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