Tyson Foods - New Position Initiated At An Attractive Valuation

A great many companies in which I wish to increase my exposure or to initiate a position are currently trading at unrealistic valuations which does not bode well for the purpose of generating attractive long-term investment returns. Tyson Foods, Inc. (TSN), however, is currently attractively valued. I have, therefore, initiated a position within one of the accounts for which I do not disclose details.

Summary

  • Tyson Foods, Inc. (TSN) recently reported solid Q4 and FY2020 results.
  • The current valuation is attractive and an improvement in the company's valuation to the average evidenced over the past 10 fiscal years would generate an attractive return before taking into consideration the current ~2.74% dividend yield (based on the current ~$65 share price).
  • Debt reduction is a priority and within the next 12 months I think it is realistic to expect an upgrade in TSN's long-term debt rating extended by Moody's to a level that is comparable to that extended by S&P Global.

Introduction

In several previous articles I have expressed my reluctance to increase my position in companies where I currently have exposure, or in which I wish to initiate a position, because the 'greater fool theory' is alive and well! For those unfamiliar with this theory, this theory states that it is possible to make money by buying securities, whether or not they are overvalued, by selling them for a profit at a later date because there will always be a greater fool who is willing to pay a higher price.

I recognize not everyone reading my articles has similar investment goals and objectives as me, and therefore, not everyone is hesitant to invest in unprofitable/marginally profitable companies which have no competitive advantages and which trade at unrealistic valuations. I, however, look to investing in companies with a 'forever' time horizon; my investment decisions take into consideration future generation(s).

Although I am actively accumulating cash which can be deployed if we get a broad market correction, I am still looking to invest if I can identify great companies which are attractively valued. This brings me to the new position I initiated today in Tyson Foods, Inc. (TSN).

TSN has issued Class A and Class B Common Stock but only the Class A shares are publicly traded. Any reference to investor returns is, therefore, solely related to Class A shares.

If you look at Item 1A. Risk Factors - Business and Operational Risk Factors found in TSN's FY2020 10-K, one the identified risks is 'Tyson Limited Partnership can exercise significant control'. The ownership structure is such that investors can only acquire Class A shares on the open market because the Class B common stock is not publicly listed for trade on any exchange or market system. While the risk description indicates:

'As a result of these holdings, positions and directorships, the partners in the TLP have the ability to exert substantial influence or actual control over our management and affairs and over substantially all matters requiring action by our stockholders, including amendments to our restated certificate of incorporation and by-laws, the election and removal of directors, any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. This concentration of ownership may also delay or prevent a change in control otherwise favored by our other stockholders and could depress our stock price.'

I like to think that the shareholders which hold a significant majority of the total voting power of the TSN's outstanding voting stock will make decisions that are in their best interests. Their best interests would likely be in the best interests of the company since TSN very likely makes up a significant percentage of the Class B shareholders' net worth. In essence, I think their decisions will be decisions that will, like my situation, impact their future generations.

Business Overview

I highly recommend anyone unfamiliar with TSN read about the company in Part 1 - Item 1 in the FY2020 10-K.

Readers of this article may be aware that seven management employees at TSN's biggest pork processing plant in Waterloo, Iowa ran a betting pool on how many workers could get infected with COVID-19. I find this truly appalling and am confident the actions taken by these 7 deranged individuals does not reflect the company's policy and that of senior management and management at other plants. I am pleased to see that after an internal investigation, these individuals were terminated.

FY2020 Results and FY2021 Outlook

TSN's Q4 and FY2020 results and FY2021 outlook can be accessed here with the Q4 FY2020 Earnings Presentation accessible here.

On the FY2020 conference call with analysts, senior management indicated that annual revenues of $42B - $44B are projected for FY2021 versus $43.185B in FY2020.

CapEx of $1.2B - $1.4B is projected with the majority of this spending being toward previously announced capacity additions in TSN's beef, chicken, prepared foods, and international businesses.

From a liquidity perspective, TSN expects to manage liquidity in excess of its historical target of $1B and the focus will continue to be on deleveraging with $0.5B of 2.25% Notes due August 2021 expected to be fully repaid.

The effective tax rate is expected to be ~23% and net interest expense is expected to be ~$0.44B versus ~$0.475B in FY2020.

COVID-19 costs are expected to be lower on a run rate basis than in Q4 2020, although personal protective equipment and employee related payments, amongst other costs, are expected to continue while COVID infections remain active. It is still very early in FY2021 and a host of factors could impact the accuracy of management's assumptions, including the duration of the pandemic but for now, ~$0.33B of COVID costs for FY2021 are projected. OUCH!

Some COVID-19 costs could end up being structural in nature, such as team member wages in certain production locations, so some increased labor costs can be expected as the company strives to attract and retain talent in the competitive labor markets in which TSN operates.

TSN's new plant in Humboldt will commence operations in FY2021 and as is normal with plant startups, substantial ramp-up costs will be incurred.

Management expects consumption behavior will continue to orient towards meals at home and unless COVID-19 causes widespread shutdowns, a continuing gradual recovery in food service volume throughout the year is expected. Naturally, this is dependent on the extent of the pandemic's spread, the broad availability of a vaccine, and any local or federal regulatory restrictions.

Credit Ratings

Investors would be wise to evaluate the level of risk they are assuming when making an investment. Far too often, however, I read articles in which the writer has given little/no attention to risk and has focused solely on the potential for capital growth or dividend income. When reading these articles I often wonder if the readers even consider that as an equity investor, the level of risk is greater than that of bondholders for which the credit rating agencies assign ratings!

As an equity investor I look at a company's debt ratings and then make a judgement call as to whether the risk I am prepared to assume relative to that of bondholders is suitable for my risk tolerance.

Interestingly, Moody's rated TSN's long-term debt at the A3 level (lowest tier of the upper medium grade level) from the mid 1990s to the early 2000s. Its rating deteriorated over the next several years to the point where a B2 rating was assigned from November 2008 to September 2010; this rating is the middle tier of the highly speculative non-investment grade category. Essentially, TSN's debt rating was downgraded 7 tiers within a matter of a few years. Fortunately, TSN's long-term debt rating has improved significantly this past decade to the point where in mid-November 2016 Moody's upgraded TSN's long-term debt rating to Baa2; this rating has been reaffirmed three times subsequent to that date with August 21, 2018 being the most recent date when this rating was reaffirmed. NOTE: a Baa2 rating is the middle tier of the lower medium grade range which is an investment grade level.

S&P Global last reviewed TSN's long-term debt rating in February 2020 at which time it affirmed a BBB+ rating which is one notch higher than that assigned by Moody's.

We see the following total debt to capitalization levels for FY2017 - 2020: 49.1%, 43.5%, 45.6%, and 42.1%. Debt reduction has been a topic touched upon in several recent quarterly conference calls with analysts. This gives me some comfort that an improvement in TSN's long-term credit ratings is not an unrealistic expectation. In fact, with TSN's focus on debt reduction and the repayment of $0.5B in long-term debt by the end of August, I think it is not out of the realm of possibility that Moody's could upgrade TSN's long-term debt to Baa1 before the end of 2021.

Valuation

In FY2020, TSN generated $5.86/share in diluted EPS. Having purchased shares at just under $65/share I get a PE ratio of ~11.1. Looking at historical PE levels for FY2010 - 2019 of 7.12, 10.48, 11.41, 14.48, 16.92, 18.08, 13.62, 16.92, 6.52, and 16.49 we get an average historical PE during this 10 year timeframe of ~13.2. Based on historical results TSN appears to be attractively valued.

Looking at diluted EPS of $1.97, $1.58, $2.12, $2.37, $2.95, $4.53, $4.79, $8.19, $5.52, and $5.86 for FY2011 - Fy2019, we can see that TSN's results have fluctuated wildly which makes it difficult to predict future earnings.

TSN has not provided FY2021 earnings guidance but based on one of my sources, 15 analysts have provided FY2021 adjusted diluted EPS estimates ranging from $5.35 - $6.37/share with a mean of $5.70. If we use this estimate and presume that TSN's valuation approaches ~12.5 we would expected to see a share price of ~$71.25.

TSN is certainly not a business which operates in an industry which would warrant a high PE multiple akin to that evidenced with high tech companies. Having said this, the current ~11.1 PE leaves margin for error and I would expect FY2021's PE to end up closer to ~13.2 versus a deterioration to FY2018's level of 6.52.

Suppose TSN generates diluted EPS of $5.70 in FY2021 and its valuation expands to ~13.2, we could reasonably expect a share price closer to $75. Were the share price to reach this level we would be looking at a ~15% improvement in TSN share price from the current ~$65.

Dividend, Dividend Yield, and Share Repurchases

TSN's dividend history can be accessed here. The dividend history found on TSN's website only goes back to 2016. For a dividend history going back further in time you should look here.

As I write this article, the dividend history page on the company's website is outdated in that the last dividend showing is $0.42/share which was distributed June 15, 2020. We know, however, that TSN distributed a $0.42/share dividend on September 15 and in the recent Q4 2020 earnings release, we see that effective November 13, 2020, the Board of Directors increased the $0.42/share quarterly dividend previously declared on August 6, 2020, to $0.445/share on its Class A common stock; the increased quarterly dividend was payable on December 15, 2020 to shareholders of record at the close of business on December 1, 2020. The Board also declared a quarterly dividend of $0.445/share on its Class A common stock payable on March 15, 2021 to shareholders of record at the close of business on March 1, 2021 and indicated the remaining quarterly dividends in FY2021 will be $0.445 on its Class A stock. This represents a ~6% increase from FY2020.

On the basis of my recent stock purchase price of just under $65/share, the annual $1.78/share dividend provides a yield of ~2.74%. Since these shares are held in a registered account I will incur no withholding tax on the quarterly dividend payment.

I certainly have no way of knowing whether dividend increases of the magnitude witnessed in recent years will continue but I trust management will do what is best for the company and its shareholders.

Looking at TSN's weighted average shares outstanding I see 293 million Class A and 70 million Class B shares and a total of 365 million diluted shares in FY2020. This compares favorably with 335 million Class A and 70 million Class B shares and a total of 413 million diluted shares in FY2015.

Final Thoughts

Many companies are currently trading at lofty valuations where the probability of generating decent returns over the next few years is unlikely. When a high quality companies are grossly overvalued, everything has to work out perfectly.

Based on my analysis, I think TSN shares are currently valued at a level where a reasonable return is highly probable. If we presume a ~15% improvement in TSN's share price by the end of 1 year as I prsented under 'Valuation' and add in the ~2.74% dividend yield it is entirely possible that the shares I acquired in one of the accounts for which I do not disclose details could generate a ~17.74% return in 1 year.

TSN, is certainly not a 'sexy' business but investing is not about being 'sexy' but about making money. Shares are attractively valued, a reasonable dividend yield is provided, great progress has been/is being made to reduce leverage, and business conditions should hopefully improve once effective COVID-19 vaccines have been rolled out en masse. This bodes well if an investor desires to generate a reasonable investment return without taking undue risk.

Although many investors may have concerns that effective control rests with 'insiders', I take comfort in this. I suspect the value of TSN shares represents a significant percentage of the wealth of these 'insiders' and I can not envision why these 'insiders' would make decisions to jeopardize TSN. I think the business is being operated with the long-term in mind which is perfectly fine by me.

In my opinion, investing in TSN at the current level gives me comfort that I will not end up being the 'greatest fool'.

Stay safe. Stay focused.

I wish you much success on your journey to financial freedom!

Note: Thanks for reading this article. Please send any feedback, corrections, or questions to [email protected].

Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

Disclosure: I am long TSN.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.