8 – 10 minute read

Recommended Next Readings: The Risk Decision, What Do You Need to Know About: RESPs

WATCH: Nearly two years ago, Qube Investment Management invested in Consumer Staples company Tyson Foods. Why do we believe the company to be undervalued? Here are three offensive tactics our analysts uncovered in the valuation process.

Tyson Foods is part of the Consumer Staples sector in the stock market. Consumer Staples investments have lagged the markets in recent years, as the US economy boomed, and investment funds flooded to cyclical choices like technology and energy.

Consumer Staples are companies that sell products households always need: food, beverages, and hygiene products.

The chart below shows how in the past year, Consumer Staples (dark navy) have underperformed the entire market (brown) and the energy companies (light blue).

The following chart shows Tyson Foods from the beginning of COVID (Jan 2020) to the end of 2021. Tyson Foods (dark blue) stock lagged the stock market (light blue) by an enormous margin.

On the back of another solid year of stock market investing, our research team finds it increasingly challenging to locate undervalued companies. Despite these many headwinds, our defensive position in Tyson Foods has become an offensive move that we remain excited and optimistic about. 

Our investment of client funds into Tyson Foods was done on June 10, 2021, at $77.10 per share and has paid well thus far. On Jan 7, 2022, the price was $91.50, meaning that we had made 18.7% returns in USD–excluding dividends–in only 7 months. In this post, I will walk you through our valuation of Tyson Foods, explaining why we saw it valued at $118, and it still offers us even more upside potential.

Qube is one of the rare firms that has a dedicated in-house research team.

Overview of the Protein Sector & Tyson Foods

Total revenue for the US meat & poultry industry is estimated at $218 billion by IBISWorld.

This sub-sector within Consumer Staples is expected to regain its prior slow growth following the pandemic with the gradual reopening of restaurants and other foodservice establishments. IBIS predicts revenues to grow here at an annualized rate of 0.9% into 2026 for this sector when the general expectation on the economy is for growth of 3.5%.

Competition in this sector is rated as “medium concentration,” with almost half of the market being dominated by the four largest firms and an expectation that growth will continue from acquisitions of the smaller players. The four largest firms in the US market are Tyson Foods, JBS USA Holdings (Pilgrim’s Pride), Smithfield Foods, and Cargill, which all produce similar protein products.

It is difficult to differentiate between the simple, unbranded processed meat cuts as they are effectively indifferentiable from each other. Tyson Foods is the second-largest protein producer in the US behind JBS, a Brazilian multinational and the world’s largest animal protein producer.

Tyson Foods is a leading protein provider to many national restaurant chains, including quick service, casual, mid-scale, and fine dining restaurants. They also make products for other foodservice customers such as schools, military bases, hospitals, nursing homes, and other international consumers. In summary, the company processes and prepares cattle and hogs and turns them into marketable cuts of meat. They source beef and pork from nearly 6,000 independent ranchers and farmers while raising and processing their chickens into frozen, fresh, value-added products such as chicken fingers.

Tyson Foods also manufactures frozen and refrigerated food products, including ready-to-eat sandwiches, hamburgers, Philly steaks, pepperoni, bacon, sausage, turkey, lunchmeat, hot dogs, flour and corn tortillas, appetizers, snacks, prepared meals, ethnic foods, side dishes, meat dishes, breadsticks, and other processed foods.

In fiscal 2019, beef accounted for 36% of their $42.4 billion in revenue, while the chicken was a close second with 31%. Prepared foods was third with 20% and pork at 10%. International sales were roughly 5% of their revenue.

Overseas operations are in Australia, China, Malaysia, Mexico, the Netherlands, South Korea, and Thailand.

Market Trends in Protein: Butcher or Bigger?

Due to differences in perceived quality or other biases, consumers have divergent preferences for purchasing protein from stores or butcher shops. The primary differentiator Tyson Foods brings is convenience, offered to both retail and foodservice customers. Products from their Beef, Pork, Chicken, and Prepared Foods segments are readily available in most grocery stores across the US, where the average consumer is already shopping for other goods.

For foodservice clients, the convenience offered to them takes the form of scale. Scale refers to Tyson’s ability to prepare meat to their customer’s specifications, like a local butcher, but with much larger quantities quickly, consistently, and at a lower cost. The local butcher cannot operate on the same scale as Tyson.

Tyson Foods also adds value for their customers by offering a large variety of prepared goods that local butchers cannot: higher margin products like breaded chicken fingers or corn dogs, which butchers lack the time and know-how to create.

Regulation is the Friend of Large-Scale Producers

Multiple regulations need to be met at the local, state, and federal levels for USDA inspected protein processing facilities. For example, the facility must have potable water, a wastewater plan, regulatory performance standards, food safety monitoring plans, and proper food permits. All these regulations represent barriers to entry for commercial enterprises trying to compete with Tyson.

Tyson Foods’ Plan

Management of Tyson Foods state that their strategy is to “sustainably feed the world with the fastest-growing protein brands,” and they intend to do so by leveraging their large scale and delivering consistent financial performance through continuous growth and improvement. Growth is largely being sought internationally through multiple acquisitions events, and in 2019 Tyson Foods acquired two businesses for a total of $2.5 billion, including the Thai and European operations from BRF S.A. and Keystone Foods. This gained them four chicken processing facilities in Thailand, one in the Netherlands, and one in the United Kingdom.

In 2020, Tyson Foods also launched a restructuring program intended to improve the company’s financial fitness. This program works to eliminate overhead by consolidating certain functions of the business. This should maintain or improve profit margins.

Offensive Tactic #1: Loafing the Operations

Loafing, also called cherry-picking, is when a forward player skates behind an attacking team instead of playing defence in an attempt to create an easy scoring chance. We see Tyson Foods offering incredibly consistent financial performance as overlooked by too many investors. The next time the financial markets stumble, investors will flock to stable companies like Tyson as they repeatedly do during times of instability. This moment will convert what is normally considered a defensive company into an offensive money maker.

Our assumptions have been excessively conservative in our valuation model, and I can share two excellent examples of how fast these assumptions could boost the valuation of Tyson Foods.

Assumption 1 – Revenue Growth

Over the past 10 to 11 years, Tyson Foods has grown its revenue at just under 5% per annum and only had negative revenue growth in one of those years. As industry expectations for protein providers are only 0.9% revenue growth in the coming decade, we modelled Tyson Foods to collapse its revenue growth from 4% to 0.9% within 24 months and to then grow at 0.9% in the remaining years of the coming decade. This conservative assumption forms part of our valuation of Tyson Foods at $118.

Assumption 2 – Profit Margin Increase

Not only have margins increased over the past decade, but they have reached 9.4% in recent years, thanks to an internal improvement program. Our projection of Tyson at $118 sets future profit margins at only 7.4%, derived from an average of recent years’ experience.

We would have to project negative revenue growth on Tyson Foods to explain the current price. On the other hand, if we were to project revenue growth at 2% per annum (half of the historical levels) and profit margins at 8% (the midpoint of recent experience and historical averages), our valuation of Tyson jumps to $176.13, nearly double its current price and 50% higher than our valuation. The point being that operational productivity offers not just excellent defence on this stock but also strong offence.

Offensive Tactic #2: Headmanning Risk

The traditional method compares the price volatility of a stock to the other stocks trading in the market. The greater the relative price volatility, the greater the risk. While this may seem shallow, it has been shown to work. With Tyson Foods, we ran numerous regressions on price volatility and found its beta to stabilize around 0.82. This is its relative measure of risk (82% of the volatility of the general markets). Our valuation was based on this metric.

Another method to evaluate risk is to look at the risk levels of peer companies while adjusting for differing use of debt. This increases the sample size and brings potential context to the evaluation, as many other investors will invest based on such comparisons.

This method is referred to as a “bottom-up beta,” and for the packaged foods and meats sector, we had 29 peer companies to utilize, resulting in the beta estimate for Tyson at 0.54. This is an incredible difference from 0.82 and implies that Tyson could have a significant downward bias in its perceived risk estimate down the road. At a beta of 0.54, our valuation would increase from $118 to $218. Remember, it is currently trading at $91.50.

Offensive Tactic #3: Dividend Dump & Chase

Finally, we have the Dump and Chase tactic. The Dump and Chase is when a player shoots the puck into the offensive zone and then chases after it. It is part of a tactic called forechecking or attacking the opposition in their defensive zone.

This tactic is analogous to Tyson Foods’ current dividend position. The dividend yield secured when we invested in Tyson Foods was 2.2%, with a recent dividend of $1.80/annum.

Our analysis of cash flow analysis shows that Tyson can pay a higher dividend. Reinvestment requirements are flexible while Tyson maintains a high return on invested capital (ROIC). After reasonable levels of reinvestment and resulting growth, we can crudely calculate the potential dividend at $4.26/annum. A dividend at this level would shoot Tyson Food’s valuation to $150.53 per share. Another offensive possibility that excites us.

In Conclusion…

Re-opening restaurants and other in-person dining such as cafeterias will strengthen the demand for Tyson Food’s products. With the increases in vaccinations, a return to normal economics, and increased food service demand, we believe that Tyson Foods will see healthy price appreciation in the medium term. 

Our original investment was at $77.10 when we valued Tyson at $118. Tyson Foods is now at $91.50, and our updated valuation puts it conservatively at $140 with three potential tactics that could push its share price ever higher. Not bad for a defensive play!

Recommended Next Readings: The Risk Decision, What Do You Need to Know About: RESPs

DISCLAIMER

Qube Investment Management Inc. has authored the material presented above for the promotion of financial literacy and professional development. Qube makes no warranty for the accuracy, validity, or completeness of the above information. It is not intended to provide specific advice with respect to individual financial, investment, tax, legal or accounting matters.

 For advice specific to your situation, consult appropriate investment, legal or accounting professionals.

A Defence is our Best Offence:

Finding Undervaluation in a Staples Company

8 – 10 minute read

Recommended Next Readings: The Risk Decision, What Do You Need to Know About: RESPs

Published February 4, 2022

WATCH: Nearly two years ago, Qube Investment Management invested in Consumer Staples company Tyson Foods. Why do we believe the company to be undervalued? Here are three offensive tactics our analysts uncovered in the valuation process.

Tyson Foods is part of the Consumer Staples sector in the stock market. Consumer Staples investments have lagged the markets in recent years, as the US economy boomed, and investment funds flooded to cyclical choices like technology and energy.

Consumer Staples are companies that sell products households always need: food, beverages, and hygiene products.

The chart below shows how in the past year, Consumer Staples (dark navy) have underperformed the entire market (brown) and the energy companies (light blue).

The following chart shows Tyson Foods from the beginning of COVID (Jan 2020) to the end of 2021. Tyson Foods (dark blue) stock lagged the stock market (light blue) by an enormous margin.

On the back of another solid year of stock market investing, our research team finds it increasingly challenging to locate undervalued companies. Despite these many headwinds, our defensive position in Tyson Foods has become an offensive move that we remain excited and optimistic about. 

Our investment of client funds into Tyson Foods was done on June 10, 2021, at $77.10 per share and has paid well thus far. On Jan 7, 2022, the price was $91.50, meaning that we had made 18.7% returns in USD–excluding dividends–in only 7 months. In this post, I will walk you through our valuation of Tyson Foods, explaining why we saw it valued at $118, and it still offers us even more upside potential.

Qube is one of the rare firms that has a dedicated in-house research team.

Overview of the Protein Sector & Tyson Foods

Total revenue for the US meat & poultry industry is estimated at $218 billion by IBISWorld.

This sub-sector within Consumer Staples is expected to regain its prior slow growth following the pandemic with the gradual reopening of restaurants and other foodservice establishments. IBIS predicts revenues to grow here at an annualized rate of 0.9% into 2026 for this sector when the general expectation on the economy is for growth of 3.5%.

Competition in this sector is rated as “medium concentration,” with almost half of the market being dominated by the four largest firms and an expectation that growth will continue from acquisitions of the smaller players. The four largest firms in the US market are Tyson Foods, JBS USA Holdings (Pilgrim’s Pride), Smithfield Foods, and Cargill, which all produce similar protein products.

It is difficult to differentiate between the simple, unbranded processed meat cuts as they are effectively indifferentiable from each other. Tyson Foods is the second-largest protein producer in the US behind JBS, a Brazilian multinational and the world’s largest animal protein producer.

Tyson Foods produces approximately 20% of the beef, pork, and chicken in the United States, and nearly 20% of Tyson Foods revenue is generated from sales to Walmart. The company offers a broad portfolio of products and brands, including Tyson, Jimmy Dean, Hillshire Farms, Ball Park, Wright, Aidells, ibp, and State Fair.

Tyson Foods is a leading protein provider to many national restaurant chains, including quick service, casual, mid-scale, and fine dining restaurants. They also make products for other foodservice customers such as schools, military bases, hospitals, nursing homes, and other international consumers. In summary, the company processes and prepares cattle and hogs and turns them into marketable cuts of meat. They source beef and pork from nearly 6,000 independent ranchers and farmers while raising and processing their chickens into frozen, fresh, value-added products such as chicken fingers.

Tyson Foods also manufactures frozen and refrigerated food products, including ready-to-eat sandwiches, hamburgers, Philly steaks, pepperoni, bacon, sausage, turkey, lunchmeat, hot dogs, flour and corn tortillas, appetizers, snacks, prepared meals, ethnic foods, side dishes, meat dishes, breadsticks, and other processed foods.

In fiscal 2019, beef accounted for 36% of their $42.4 billion in revenue, while the chicken was a close second with 31%. Prepared foods was third with 20% and pork at 10%. International sales were roughly 5% of their revenue.

Overseas operations are in Australia, China, Malaysia, Mexico, the Netherlands, South Korea, and Thailand.

Market Trends in Protein: Butcher or Bigger?

Due to differences in perceived quality or other biases, consumers have divergent preferences for purchasing protein from stores or butcher shops. The primary differentiator Tyson Foods brings is convenience, offered to both retail and foodservice customers. Products from their Beef, Pork, Chicken, and Prepared Foods segments are readily available in most grocery stores across the US, where the average consumer is already shopping for other goods.

For foodservice clients, the convenience offered to them takes the form of scale. Scale refers to Tyson’s ability to prepare meat to their customer’s specifications, like a local butcher, but with much larger quantities quickly, consistently, and at a lower cost. The local butcher cannot operate on the same scale as Tyson.

Tyson Foods also adds value for their customers by offering a large variety of prepared goods that local butchers cannot: higher margin products like breaded chicken fingers or corn dogs, which butchers lack the time and know-how to create.

Regulation is the Friend of Large-Scale Producers

Multiple regulations need to be met at the local, state, and federal levels for USDA inspected protein processing facilities. For example, the facility must have potable water, a wastewater plan, regulatory performance standards, food safety monitoring plans, and proper food permits. All these regulations represent barriers to entry for commercial enterprises trying to compete with Tyson.

Tyson Foods’ Plan

Management of Tyson Foods state that their strategy is to “sustainably feed the world with the fastest-growing protein brands,” and they intend to do so by leveraging their large scale and delivering consistent financial performance through continuous growth and improvement. Growth is largely being sought internationally through multiple acquisitions events, and in 2019 Tyson Foods acquired two businesses for a total of $2.5 billion, including the Thai and European operations from BRF S.A. and Keystone Foods. This gained them four chicken processing facilities in Thailand, one in the Netherlands, and one in the United Kingdom.

In 2020, Tyson Foods also launched a restructuring program intended to improve the company’s financial fitness. This program works to eliminate overhead by consolidating certain functions of the business. This should maintain or improve profit margins.

Offensive Tactic #1: Loafing the Operations

Loafing, also called cherry-picking, is when a forward player skates behind an attacking team instead of playing defence in an attempt to create an easy scoring chance. We see Tyson Foods offering incredibly consistent financial performance as overlooked by too many investors. The next time the financial markets stumble, investors will flock to stable companies like Tyson as they repeatedly do during times of instability. This moment will convert what is normally considered a defensive company into an offensive money maker.

Our assumptions have been excessively conservative in our valuation model, and I can share two excellent examples of how fast these assumptions could boost the valuation of Tyson Foods. 

Assumption 1 – Revenue Growth

 Over the past 10 to 11 years, Tyson Foods has grown its revenue at just under 5% per annum and only had negative revenue growth in one of those years. As industry expectations for protein providers are only 0.9% revenue growth in the coming decade, we modelled Tyson Foods to collapse its revenue growth from 4% to 0.9% within 24 months and to then grow at 0.9% in the remaining years of the coming decade. This conservative assumption forms part of our valuation of Tyson Foods at $118.

Assumption 2 – Profit Margin Increase

Not only have margins increased over the past decade, but they have reached 9.4% in recent years, thanks to an internal improvement program. Our projection of Tyson at $118 sets future profit margins at only 7.4%, derived from an average of recent years’ experience.

We would have to project negative revenue growth on Tyson Foods to explain the current price. On the other hand, if we were to project revenue growth at 2% per annum (half of the historical levels) and profit margins at 8% (the midpoint of recent experience and historical averages), our valuation of Tyson jumps to $176.13, nearly double its current price and 50% higher than our valuation. The point being that operational productivity offers not just excellent defence on this stock but also strong offence.

Offensive Tactic #2: Headmanning Risk

The traditional method compares the price volatility of a stock to the other stocks trading in the market. The greater the relative price volatility, the greater the risk. While this may seem shallow, it has been shown to work. With Tyson Foods, we ran numerous regressions on price volatility and found its beta to stabilize around 0.82. This is its relative measure of risk (82% of the volatility of the general markets). Our valuation was based on this metric.

Another method to evaluate risk is to look at the risk levels of peer companies while adjusting for differing use of debt. This increases the sample size and brings potential context to the evaluation, as many other investors will invest based on such comparisons.

This method is referred to as a “bottom-up beta,” and for the packaged foods and meats sector, we had 29 peer companies to utilize, resulting in the beta estimate for Tyson at 0.54. This is an incredible difference from 0.82 and implies that Tyson could have a significant downward bias in its perceived risk estimate down the road. At a beta of 0.54, our valuation would increase from $118 to $218. Remember, it is currently trading at $91.50.

Offensive Tactic #3: Dividend Dump & Chase

Finally, we have the Dump and Chase tactic. The Dump and Chase is when a player shoots the puck into the offensive zone and then chases after it. It is part of a tactic called forechecking or attacking the opposition in their defensive zone.

This tactic is analogous to Tyson Foods’ current dividend position. The dividend yield secured when we invested in Tyson Foods was 2.2%, with a recent dividend of $1.80/annum.

Our analysis of cash flow analysis shows that Tyson can pay a higher dividend. Reinvestment requirements are flexible while Tyson maintains a high return on invested capital (ROIC). After reasonable levels of reinvestment and resulting growth, we can crudely calculate the potential dividend at $4.26/annum. A dividend at this level would shoot Tyson Food’s valuation to $150.53 per share. Another offensive possibility that excites us.

In Conclusion…

Re-opening restaurants and other in-person dining such as cafeterias will strengthen the demand for Tyson Food’s products. With the increases in vaccinations, a return to normal economics, and increased food service demand, we believe that Tyson Foods will see healthy price appreciation in the medium term. 

Our original investment was at $77.10 when we valued Tyson at $118. Tyson Foods is now at $91.50, and our updated valuation puts it conservatively at $140 with three potential tactics that could push its share price ever higher. Not bad for a defensive play!

Recommended Next Readings: The Risk Decision, What Do You Need to Know About: RESPs

DISCLAIMER

Qube Investment Management Inc. has authored the material presented above for the promotion of financial literacy and professional development. Qube makes no warranty for the accuracy, validity, or completeness of the above information. It is not intended to provide specific advice with respect to individual financial, investment, tax, legal or accounting matters.

 For advice specific to your situation, consult appropriate investment, legal or accounting professionals.