Market Cap (B) $23.11 Drivers of Thesis. 12 Month Performance Company Description TSN S&P 500

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1 The Henry Fund Henry B. Tippie School of Management Venkat Ravichandran Tyson Foods (TSN) March 09, 2017 Packaged Foods and Meats Consumer Staples Stock Rating Buy Investment Thesis Target Price $68.00-$74.00 Henry Fund DCF $73.81 Presence in all three business segments of meat namely beef, pork and chicken Henry Fund DDM $68.92 guards the company from adverse trends/incidents in any one segment. Tyson Relative Multiple $67.94 operates as an integrated manufacturer in chicken isolating itself from sudden Price Data increases in chicken prices due to supply constraints. Moreover, the company s Current Price $62.31 increasing focus on prepared foods serves as a potential revenue generator for 52wk Range $ Tyson Foods. Through acquisition of Hillshire Brands, the company has nearly doubled its presence in high-margin packaged foods segment. All three Consensus 1yr Target $67.75 valuations unanimously state that the stock is currently undervalued. Key Statistics Market Cap (B) $23.11 Drivers of Thesis Shares Outstanding (M) $ Revenue is expected to decline by -2.6% in 2017, increase by 1.61% in 2018 and grow around 2% from 2019 to settle at a long-term growth rate of 1.7%. Expansion of product portfolio in the packaged foods segment should fuel the growth with the segment s long-term operating margins of 12%. This segment is expected to grow at a terminal rate of 2%. According to DCF, the stock has an upside of 18%. Risks to Thesis Alleged price-fixing of chicken has caused the stock price to decline. According to the model, the recommendation may change from BUY to HOLD if the penalty crosses $3 Billion. Institutional Ownership $8.51B Five Year Beta 0.75 Dividend Yield 1.38% Est. 5yr Growth 3.00% Price/Earnings (TTM) Price/Earnings (FY1) Price/Sales (TTM) 0.64 Price/Book (mrq) 2.34 Profitability Operating Margin 7.68% Profit Margin 4.80% Return on Assets (TTM) 7.81% Return on Equity (TTM) 18.29% 20 TSN Meats Consumer Staples Company s operating costs are highly correlated to the costs of animal-feed ingredients such as corn and soybean. With the rise in crude oil prices, operating margins may shrink due to increase in feed price costs Earnings Estimates Year E 2018E 2019E EPS $2.3 $3.34 $4.9 $4.72 $4.90 $5.40 growth 1.64% 45.07% 49.96% -3.70% 3.80% 4.84% 30% 20% 10% 0% P/E ROE EV/EBITDA Source: FACTSET 12 Month Performance Company Description TSN S&P % M A M J J A S O N D J F Source: Yahoo Finance Tyson Foods, Inc. (TSN) is one of the world s largest food companies that produces fresh meat and processed/frozen food products primarily made from beef, chicken and pork. It has a portfolio of leading brands such as Tyson, Jimmy Dean, Hillshire Farm, Sara Lee, Ball Park, Wright, Aidells and State Fair. Tyson reports under four segments namely Beef, Chicken, Pork and Prepared Foods. 1 Important disclosures appear on the last page of this report.

2 EXECUTIVE SUMMARY Though revenue is expected to fall in 2017 due to a decrease of sales in prepared foods, beef and pork segments, the revenue is expected to grow around 2% from 2019 to settle at a long-term growth rate of 1.7%. In the long-run, we see a stable volume growth in all four segments of 0.5-2% and stable revenue/unit volume growth of 1% across all segments. We believe that an evergrowing US population s protein needs will increase at least at this pace. Moreover, we expect the price increases to be supported by better product mix and inflation. Expansion of product portfolio in the packaged foods segment should fuel the growth of the company with longterm operating margins of 12%. According to Discounted Cash Flow model, the stock has an upside of around 18%. Hence we recommend a buy for this company with a target price of $74. COMPANY DESCRIPTION Tyson Foods, Inc. (TSN) is one of the world s largest food companies that produces fresh meat and processed/frozen food products primarily made from beef, chicken and pork. It has a portfolio of leading brands such as Tyson, Jimmy Dean, Hillshire Farm, Sara Lee, Ball Park, Wright, Aidells and State Fair. Tyson reports under four segments namely Beef, Chicken, Pork and Prepared Foods. Its business depends on the demand for its products, customer-relationships, product innovation, accessibility of international markets, market prices, the cost and availability of live cattle and hogs, raw materials, grain and feed ingredients and operating efficiencies of the facilities Segment-wise Revenue-2016 (in M) (Source: Bloomberg segment-wise data) Beef Chicken Pork Prepared Foods Beef segment earns the highest revenue with a share of 38.54% of the total revenue followed by the Chicken segment which constitutes 29.85%. Prepared foods and Pork each have a share of 19.11% and 12.5% respectively. The company earned a revenue of $36.88B in Chicken In this segment, Tyson operates as a fully vertically integrated chicken manufacturer including operations comprising breeding stock, contract growing of broilers, animal-feed production, meat processing and transportation of chicken and other related products, including animal and pet food ingredients. Through its wholly owned subsidiary, Cobb-Vantress, Inc., Tyson functions as a leading poultry breeding stock supplier in the world U.S Per capita Chicken Consumption (in pounds) 83.3 (Source: Statista) The above graph shows the growth in US per-capita chicken consumption from 89.5 pounds to 91.5 pounds by 2024 at a CAGR of 0.3% 11. The per capita consumption of chicken has risen at a CAGR of 2.1% over a span of 57 years ( ) 7. Going forward, we believe that this growth is not sustainable. Hence the predicted growth of per capita consumption is assumed at 0.3%. The graph below shows the list of leading manufacturers of chicken and chicken substitutes in the US. According to the data, Tyson Foods has a market share of 24% 15 and we expect the company to retain the market share in the near future. Hence it can be assumed that increase in per-capita chicken consumption and increase in the US population will proportionately impact the chicken sales of Tyson Foods. Moreover, currently 89% of the total installed chicken manufacturing capacity is being used and Tyson is expected to increase its utilization to account for the increase in demand in the near future. Page 2

3 Private Label Tyson Foods Perdue Farms Gold`n Plump Pilgrim`s Pride Heinz North America AdvancePierre Foods Harvestland Gold Leaf of Nebraska Gardein Protein International Use of Corn for Feed and Residual Purposes (in Billion Bushels) (Source: Statista) The population of US is expected to grow at a CAGR of 0.68% till Hence it can be deduced that the chicken volume consumption will grow at ~1% on a year-on-year basis. The price of chicken is primarily dependent on the costs of animal-feed, majority of which is corn and soybean. The graph below shows the total supply of corn in the US. Supply of corn is expected to decrease to Billion bushels in 2017 from 16.94B bushels in 2016 which can put an upward price pressure on the price. Going forward, the total supply of corn is in a downward trend till 2019 after which it is expected to increase in This graph indicates that the cost of chicken may rise for Tyson Foods in the near future. (Source: Bloomberg and WASDE) 3 The graph below shows the 10-year average, 10-year high & low, 2016 and 2017 price of corn ($/bushel). As per this graph, it is evident that the price of corn is at its 10-year low. Given the decreasing total supply of corn, the upward price pressure outweighs the increase in supply available for animal-feed. Hence corn prices are expected to rise marginally or stay constant and certainly not fall. PRICE OF CORN ($/BUSHEL) Supply of Corn (in Billion Bushels) (Source: Bloomberg and WASDE) (Source: Bloomberg and J.P.Morgan 18 ) Similarly, we analyze the price of another animal-feed which is soybean. The graph below shows the total supply of soybean and it can be seen that the supply does not have significant changes going forward to However, the graph below shows that the corn available to manufacture animal-feed is expected to increase from 5.55B bushels in 2016 to 5.63B bushels in Moreover, the supply of corn for animal-feed is on a continuous upward trend reaching 5.80B bushels by Page 3

4 Total Supply of Soybean (in Billion Bushels) CHICKEN TO CORN PRICE RATIO (Source: Bloomberg and WASDE) As it is evident in the graph below, the price of soybean increased from $8.95 to $9.6/bushel and is expected to remain almost stagnant or rise marginally (~6.5% in 4 years) going forward to 2020 where it is predicted to be priced at $10.25/bushel Price of Soybean($/bushel) 13 (Source: Bloomberg and WASDE) The graph below shows the Urner Barry whole-bird price index of chicken. The price of chicken is above the 10-year median price and 2016 price. URNER BARRY WHOLE BIRD PRICE INDEX (cents/pound) (Source: J.P. Morgan and Bloomberg 18 ) The above chart shows the price of chicken per pound /corn price ratio. A high ratio compared to the historical average signifies that the chicken prices are inflated. Hence either the corn price will increase to catch-up with the chicken price or the chicken price may fall in the near future. The ratio is above the 10-year median and close to 10-year high. Hence going by the above charts, the price of animal feed (especially corn) is set to increase and the price of chicken is already above last year s price and 10- year median. So we are skeptical about the probability of chicken price increase as of now. These conclusions provide us the insight that price/unit volume of chicken may remain constant at best and the operating margin for chicken is expected to shrink to 10.5% in 2017 from ~11% in Beef Tyson Foods Beef segment covers operations related to processing live fed cattle and fabricating dressed beef carcasses into primal and sub-primal meat cuts and caseready products that are marketed domestically to food retailers, foodservice distributors, restaurant operators, hotel chains and noncommercial foodservice establishments such as schools, healthcare facilities, the military and other food processors, as well as to international export markets. 1 (Source: J.P. Morgan and Urner Barry 18 ) Page 4

5 Share of slaughter capacity Beef Packers (daily slaughter capacity) 30.0% 24% 25.0% 22% 20.0% 15.0% 10.0% 5.0% 0.0% Tyson FoodsJBS USA 19% 10% 25% Cargill National Beef Other CATTLE ON FEED (in thousands) (Source: Statista) The chart above shows the share of beef packers in terms of total heads slaughtered per day. Tyson Foods has a share of 24% and is expected to retain this share of the market Per Capita Beef Consumption (in pounds) (Source: J.P.Morgan and USDA 18 ) The above graph shows the cattle on feed and this represents the cattle that are in one stage prior to being slaughtered (marketed). A value close to 10-year low indicates that there could be a supply constraint in the market. However, according to the graph below which shows the percentage of feed-cattle marketed, the value is close to 10-year high. CATTLE MARKETED AS %AGE OF CATTLE ON FEED (Source: Statista) As shown in the above graph, the per-capita beef consumption is expected to rise by a CAGR of 0.3% going forward until Overall, the beef volumes are expected to rise by ~1% for the next three years and settle down at a growth rate of 0.5% in the long-run keeping in mind the effective substitution of beef by chicken. Tyson has a capacity utilization of 76% which shows there is enough room for expansion (81% in the past) 1. Any growth in demand is assumed to be satisfied with the expansion in capacity utilization. Since we have established the demand of beef, supply is the other determinant of the price of beef in the market. (Source: JP Morgan and Bloomberg 18 ) In other words, the cattle that is placed on feed is at its low whereas the percentage of cattle being slaughtered is at its high. This creates a supply constraint as there isn t enough cattle on feed to be slaughtered in the near future. This supply constraint may raise the price of live cattle. Page 5

6 BEEF INVENTORY IN COLD STORAGE (In Million Pounds) BEEF PACKERS GROSS MARGINS (Source: J.P. Morgan and USDA 18 ) However, the above graph shows the beef in cold storage (inventory) in million pounds. As per the data, the inventory is close to its 10-year high and this is expected to ease the price pressure caused by low supply of beef. In fact, we predict the revenue per unit volume of sale to decline by 6.5% in 2017 keeping in trend with the decline of ~15% in In the long run, the price should settle at a stable growth rate of 1% per year. When it comes to the gross margins of beef packers, it is currently close to 3% and is expected to remain in this range. According to Tyson s management, the normal range for gross margins in beef is 1.5%-3% and the 10-year average too implies the same. Currently Tyson s beef gross margin is 2.44% and it is expected to stabilize at 2.5% going forward. But in the first quarter of 2017, Tyson recorded beef gross profit margin of 8.5%, which is way above the normal range. The company has said that the abundance of cattle has led to fall in prices. This can also be witnessed in the graph below where the margins were high during Jan Going forward, we expect the beef margins to reduce to 2.5% in the long run and stay there. (Source: Bloomberg, USDA and J.P.Morgan 18 ) Pork This segment covers the company s operations related to processing live hogs and fabricating pork carcasses into primal and sub-primal cuts and case-ready products % 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% (Source: Statista) Marketshare of Pork Packers 25.25% 19.71% 17.72% 8.08% 4.72% 24.53% The above graph shows that Tyson Foods ranks 3 rd with 17.72% market-share of the daily average of the number of heads slaughtered. Page 6

7 Per Capita Pork Consumption (in Pounds) PORK IN COLD STORAGE (MM pounds) (Source: National Chicken Council) The pork consumption is expected to increase at a CAGR of 0.31% until With the assumption of Tyson s market-share remaining constant, we can assume this CAGR for Tyson s long-term pork volume sales. Historically, the normal range for gross margin of pork packers has been 10-12% as shown in the graph below. However, this year has started with a high gross margin of around 30% and Tyson Foods reported an operating margin of 19.7% in its first quarter due to fall in pork prices. We consider this to be a temporary phenomenon and expect the margins to settle in the 10-12% range in the long run. (Bloomberg and JP Morgan 18 ) Prepared Foods This segment covers operations related to manufacturing and marketing frozen and refrigerated food products. This segment includes brands such as Jimmy Dean, Hillshire Farm, Ball Park, Wright, State Fair, Van's, Sara Lee and Chef Pierre, as well as artisanal brands Aidells, Gallo Salame, and Golden Island 9. Products comprise of pepperoni, bacon, breakfast sausage, turkey, lunchmeat, hot dogs, pizza crusts and toppings, flour and corn tortilla products, desserts, appetizers, snacks, prepared meals, ethnic foods, soups, sauces, side dishes, meat dishes, breadsticks and processed meats. 1 This segment had a share of 19.11% in the total revenue of Tyson in 2016 and an operating profit margin of 10.50%. (Source: USDA and JP Morgan 18 ) Moreover, Pork in cold storage (graph below) which represents the inventory is close to the 10-year low. Hence we can perceive supply side pressure to lift the prices up and hence shrink the margins of pork packers. Due to these factors, we can expect the pork margin of Tyson Foods to be around 11% for 2017 and continue to be in that range going forward % % 80.00% 60.00% 40.00% 20.00% 0.00% % Prepared Foods Revenue Growth (in %) 17.99% (Source: Statista) % 0.94% 1.97% 3.00% 2.51% -6.26%-3.87% * 2018* 2019* 2020* 2021* Page 7

8 The above chart shows the growth of prepared foods from 2014 to This segment had a spike of 100% growth in 2015 as Tyson Foods acquired Hillshire Brands for $8.5Billion in August 2014 and consolidated all its operations. As a result, the volume of sales of this segment increased 76% in 2014 when compared to Tyson Foods expects to expand significantly in the prepared foods segment with the brands owned under the Hillshire umbrella. With innovative products such as Tyson Tastemakers (mini-meal category) and ground chicken, the company is trying to increase its sales in the processed foods segment 13. The company has a list of product launches lined-up for 2017 and we expect the results to show up partly in 2017 when the decline in sales slows down from -6% in 2016 to -4% in We expect the product launches to improve the segment sales by 1% in 2018 when the volume of sales increases by 3% and the revenue per unit volume decreases by 2% to increase the initial appeal of the products. In 2016, this segment had a volume decline of -2.8%. Going forward, we expect the sales volume to decline by -1% and increase at a constant pace of 1% year on year in the long term. Similarly, we expect the revenue per unit volume to decline by 3% accounting for the fact that Tyson may be careful in pricing to attract new customers to its new range of products. However, we expect the prices to increase at a constant 1% year-on-year in the long-term. As shown in the chart below, after acquisition of Hillshire Brands, the share of prepared foods in the total revenue of Tyson Foods increased from 10% to around 19%. In the long run, we expect the share to hover around 20%. RECENT DEVELOPMENTS Divestment and International Outlook Tyson Foods sold its Brazil and Mexico operations to JBS SA for $575MM in cash. Moreover, the company s meat processing operations in China have not been as profitable as expected. The company recorded an impairment of $169MM in the property, plant and equipment in China in As of October 01, 2016, Tyson Foods had $204MM in long-lived assets primarily in India, China and Brazil. The export sales from the United States totaled $3.5B in 2016, ~9.5% of total sales. Sales of products manufactured outside the United States was less than 10% of the consolidated sales. However, with a conservative estimate, we expect the overall revenue of the company to decline by -2.6% in 2017 which is after factoring in the volume and price declines in various segments. Chicken Price-Fixing Tyson Foods revealed in February 2017 that it has received a subpoena from the SEC over alleged chicken price-fixing by Tyson Foods, Sanderson Farms and Pilgrim s Pride. RETAIL BROILER INDEX Prepared Foods (% of Rev) 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% Prepared Foods (% of Rev) (Source: Company 10K and Model Forecasts) (Source: Bloomberg) The allegation states that the above mentioned three companies and a few others deliberately cut down supplies to create artificial demand and boost the prices. In addition to the above charges, the aspect of illegality arises as SEC suspects these firms have acted in collusion with the data from Agri Stats, a private service that gathers information from poultry producers and disseminates the information to all stakeholders for a fee. As can be witnessed from the chart above, the prices have been on a constant rise from 2008 except for a few pull-backs around This was not the case historically as Page 8

9 periods of high growth in chicken prices are usually followed by a decline in prices as the market supply increases significantly in periods of price increases to take advantage of the higher profitability. The report also alleges that the buy-vs-grow strategy adopted by Tyson Foods in which the company bought the chicken from its competitors instead of growing its own stock was an indirect attempt to create artificial demand. Moreover, the report also mentions instances where the eggs were exported to Mexico to create a demand in the US. As the case does not mention clearly about the extent to which the prices were rigged, the penalty cannot be estimated. However, we have carried out a sensitivity analyses of the price of TSN stock with respect to the amount of penalty. In varying the amount of penalty from 100MM to 5Billion. It is seen that the stock price varies from $73.87 to $ Moreover, the stock price is $62.51 when the penalty is $4 Billion, which states that the company will remain to be at HOLD rating if the fine is below $4 Billion. Focus on Packages Foods and NAE Chicken The company claims that more than 90% of the people snack multiple times a day. Hence Tyson is launching new products in this space in 2017 like ground chicken, minimeals (Tyson Tastemaker), scrambles, etc. The company believes that refrigerated meals is under-represented in the breakfast segment 15 and this is due to lack of innovation. Hence the company has come up with a host of options to cover this market gap. Since this segment returns high-margins and has a lot of scope to introduce premium variants, this approach can prove beneficial in the long run and may help the company to diversify its risks away from the fresh-meats segment. Furthermore, Tyson Foods announced that all of the chicken used in its production will be of No Antibiotics Ever category, indicating a shift towards healthier and safer chicken option. This provides the company an opportunity to charge a premium for its products. First Quarter Earnings Tyson Foods reported its first quarter earnings for the FY 2017 on February 6, The company reported an EPS of $1.59, beating the analysts consensus by $ The overall profitability was led by record margins in the beef and pork segments (8.5% and 19.7% respectively). Operating income increased by 27% year-on-year and the company reported $40 Million of incremental synergy in this quarter from its acquisition of Hillshire Brands. The company has given an EPS guidance of $4.90 to $5.05 for the FY2017, a 12% increase from the adjusted EPS of FY The company has come up with its guidance for FY2017. From the prediction of 1% growth in sales during the previous guidance, the company has stated that the sales will remain flat in The volume of meat is expected to grow across all the segments and the company expects lower cost mainly due to lower beef prices. Tyson expects the US meat production to grow by 2-3% and reiterated its stance on the synergy realization of $675 Million from the acquisition of Hillshire Brands. The number of share repurchases authorized is 31.7 Million, revised from 40.3 Million shares. Domestic production of chicken is predicted to grow by 2%, margins to remain ~10.5% - 11% and feed costs to remain similar to that of In the beef segment, cattle supply is expected to grow by 3-4%, revised from 2-3% estimate given earlier. Beef margins are predicted to be at 5% against a normal rate of 3%. In the pork segment, the hog supply is expected to grow at 3-4%. Pork margins have been revised from 10% to ~12%. In the prepared foods segment, the margins are expected to be below FY INDUSTRY TRENDS Preference towards White Meat As it can be witnessed in the graph below, the consumption of beef had been on a constant decline since late 1970s. In the same period, a clear increase in the consumption of chicken indicates that it is increasingly replacing beef as the preferred source of protein. Furthermore, International Agency for Research on Cancer, in its report published in October , declared processed meats hot dogs, bacons, sausages, etc. as carcinogenic (cancer-causing) and the red meat present in them as the main carcinogen. Though World Health Organization classified processed red meat as a Group 1 carcinogenic along with tobacco and alcohol, the panel stated that the level of risk posed by these products are not the same and consumption of processed meat may be lesser on a scale of risk compared to alcohol or tobacco. Moreover, the panel confirmed that the conclusions are based on limited evidence and the association was mainly for colorectal cancer. If stronger evidence is presented in this case, the demand for white meat such as chicken and fish may increase exponentially as a substitute for red- Page 9

10 meat, which may have a material impact on Tyson s sales as the company derives only 32% of its revenue directly from chicken sales. PER CAPITA MEAT CONSUMPTION IN THE US (Source: US Department of Agriculture) Campbell invests in Habit Campbell Soup invested in nutrition-focused start-up called Habit 26. The company provides personalized diet recommendations to people based on the DNA test carried out by the company s at-home test kit. The differentiating factor that links food service to Habit is that it serves as a meal-kit delivery service as well. Hence Habit analyzes the requirement of nutrients for every person and delivers meal kits that satisfy the personalized need of every customer. This is a trend that is different from the onesize-fits-all strategy and proves as a culmination of food, well-being and technology. Habit does not have plans of going on a full-scale till next year and the technology is in its nascent stage. However, integration of technology with food can prove to be the next big area of development. Disruptive innovations can happen when personalized health-tracking devices such as fit-bit are linked with the dietary needs of the consumer and a food-service company can keep a track of these changes to provide personalized monthly updates of the combination of protein, carbohydrates, fats, vitamins and minerals necessary for the individual. This can be a high-margin business and early lead in this trend can prove to be highly beneficial to companies. This should be an area of expansion for Tyson as the company should adopt to the technological demands of its consumers to retain its appeal and market-share. Organic and Non-Animal Meat There are two trends in the meat market. The first one is organic meat. Organic meat is the meat from animals that are raised on organic land and have outdoor access. USDA mandates that the organic meat should be from animals that were not given growth hormones, anti-biotics or genetically modified food/grains. As an indication of organic produce, US Department of Agriculture permits the use of USDA-Organic label if the food contains 95% 100% organic ingredients. Foods that contain at least 70% organic ingredients can indicate that they contain organic ingredients. Organic meat/poultry has seen a volume growth (in pounds) of 29.3% in 2015 when compared to In terms of dollar sales, organic meat has grown at a CAGR of 30.1% from Unfortunately, Tyson Foods has not forayed into this market. The second trend is that of non-animal meat. This isn t an established one to disrupt the market, yet there are laboratory tests being carried out in full-scale to produce plant-based protein products that taste and smell like animal-based protein such as beef and chicken. Beyond Meat is one such company in which Tyson Foods has invested. This is a trend to watch-out for as this captures the proportion of people who convert to vegans and retains them as customers of Tyson though they have moved out of animal consumption. This clever strategy may prove to be beneficial to maintain the sales numbers for Tyson when this trend begins to look dominant in the market. MARKETS AND COMPETITION Meats is a mature market in the US and the per-capita consumption of meat is expected to grow at a CAGR of 1% in the next five years. Hence top-line expansion can happen through selling premium value-added products and organic/non-genetically modified organism food. Revenue growth is also expected to happen through acquisitions that result in increased economies of scale. Vertical integration where a company is present in more than one stage of the supply chain, is another characteristic of the current meats market. The consumer market for meats processing industry is divided into five major categories as follows: Page 10

11 MAJOR BUYERS OF US MEAT Peer Comparisons The market consists of four major players (viz) Tyson Foods, JBS SA, Smithfield Foods and Cargill Inc. Other players with less than 5% market share include Hormel Foods (HRL), Pilgrim s Pride (PPC) and Sanderson Farms (SAFM). (Source: IBIS World) Poultry, beef and pork wholesalers constitute 44.5% of the industry followed by other meat processors and frozen food manufacturers. Animal food manufacturers and food service firms (restaurants) occupy 8% and 7.4% respectively. However, the wholesalers are being gradually replaced as more hypermarkets such as Walmart source the products directly from the meat processors bypassing the wholesalers. Hence there is a shift of buyer bargaining power from the wholesalers to hypermarket chains and large-order customers. Tyson Foods has stated that Walmart is responsible for 17.5% of the sales of the company and any disruption in this relationship may have a material impact on the company s revenue and profits. Moreover, almost 63% of the market share is retained by private label companies and local manufacturers. There is a strong bargaining power with the buyers who can influence the price of meats they purchase from the processors. On the other hand, large-scale meat processing companies such as JBS SA and Tyson Foods have significant influence on their suppliers and maintain long-term contracts to prevent uncertainties in supplies. Tyson Foods has entered into long-term supply contracts with cattle and pork breeders. Moreover, the company indulges in purchases from the spot-market. Hence the supply of cattle and swine play an important role in the company s cost of sales. In terms of poultry, the aspect that has the most significant impact on costs is the price of animal-feed. With the costs of animal-feed predicted staying constant as the best case scenario, it is prudent to account for marginal increases in the prices while forecasting the company s costs. JBS is a Brazilian animal-based protein manufacturer that operates in the US through its holding company JBS USA Holdings. Its US divisions are JBS USA Beef, JBS USA Pork and Pilgrim's Pride, its chicken segment that JBS recently acquired 21. Hormel Foods produces a variety of meat and food products. It reports under five segments (viz) Grocery Products, Refrigerated Foods - which sells pork, beef, chicken, and turkey products; Jennie-O Turkey Store, which processes and sells turkey products; Specialty Foods sells nutritional and private label shelf-stable products; and International and Other which sells to international markets % 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Hormel Foods' net sales worldwide $9.5B 48.81% Refrigerated Foods 17.70% 17.70% Jennie-O Turkey Store Grocery Products 10.43% Specialty Foods 5.37% Internationa l & other (Source: Bloomberg) Through its refrigerated products, the company is involved in the sale of beef and pork. The company is present in the poultry industry through its sale of turkey predominantly in the Jennie-O-Turkey Store segment 20. Sanderson Farms is a poultry processing company engaged in the production, processing, marketing and distribution of fresh and frozen chicken and processing, marketing and distribution of prepared chicken items 22. Smithfield Foods, predominantly a pork-manufacturer was acquired by the Chinese meat processor Shuanghui Page 11

12 International in 2013 following which it was delisted from the New York Stock Exchange. Moreover, the company sold its beef and turkey manufacturing units in 2015, increasing its dependence on pork. Hence when compared to a more diversified firm such as Tyson, Smithfield is at a risk of having a severe impact on its sales when pork industry is affected 23. Cargill Inc. meat division is Cargill Meat Solutions Corp. Cargill is a privately held company. Hence we focus on the financials of the four firms whose majority of business is in the US and are publicly traded 24. Taking the chart below as a representation of the total sales of various meat categories in US, beef, chicken and pork are the three largest 10. Hence a company that s present in these three segments or a company that derives its revenues majorly from beef and chicken can be considered to be safe investments. We expect a welldiversified company to be guarded against the downturns in one or two of the segments. Going by this logic, Tyson Foods and Hormel Foods are considered diversified when compared to Smithfield, Pilgrim s Pride and Sanderson Farms. Gross Income Net Income Sales Company Name Growth (5Y) Growth (5Y) Growth (5Y) Tyson Foods A Pilgrim's Pride Hormel Foods Sanderson Farms (Source: FACTSET) Total EPS 1Yr Price Change Return (10 Company Name Growth (3Y) Yr) Tyson Foods A % % Pilgrim's Pride % 16.01% Hormel Foods % % Sanderson Farms % % (Source: FACTSET) 25,000 20,000 15,000 10,000 5,000 0 U.S. retail sales of fresh meat (in $/store/week) 19,898 10,166 5,455 2, Company Name Div Yield PEG Ratio P/B Actual Actual P/E Actual Tyson Foods A 0.90% 2.04x 2.36x 11.92x Pilgrim's Pride x 6.46x 13.31x Hormel Foods 1.52% 2.59x 3.99x 20.92x Sanderson Farms 1.00% 1.44x 2.03x 12.16x (Source: FACTSET) (Source: Statista) Let s compare the financial metrics of these companies. As a word of caution, Tyson is four times larger than its closest competitor Hormel Foods in terms of revenue. Moreover, Tyson Foods is present in all four segments of meat unlike the other companies. Hence it may not be useful to compare Tyson with other companies based on a few financial metrics as its sheer size may change the competitive space. The first chart shows the overall 5 year growth of sales, gross and net income of the companies. Though Hormel Foods has a sales growth that beats Tyson Foods, the Net Income and Gross Income growth of Tyson Foods is ahead of Hormel Foods which proves that the company is expanding its bottom-line at a greater pace. According to the second chart, Tyson Foods is clearly better in terms of the EPS growth, Price Change and Total Return that includes dividends. In terms of the relative valuation ratios such as Price/Equity, Price/Book and PEG ratio, Tyson Foods appears to be undervalued. Given the fact that Tyson is four times bigger than Hormel in terms of revenue, it can be argued that Tyson Foods is relatively Page 12

13 cheap for its size of operations when compared to Hormel Foods. Per Capita GDP ECONOMIC OUTLOOK U.S Per Capita GDP (in 1000s) Population of US US Population (in M) (Source: Statista) Per Capita GDP is expected to increase from $57,290 in 2016 to $65,870 in This positive expansion increases the disposable income in the hands of the consumers which in turn has an impact on the expenditure on meats. An increase in income can result in preference towards value-added and organic variants that have higher margins than the normal variants of meat. Moreover, this increase in disposable income will be able to offset the marginal increase in price of meat due to increasing cost of raw materials such as corn and soybean. Consumer Price Inflation (Source: Statista) The population of US is expected to increase to M by 2020 a CAGR of 0.68% 27. This should increase the demand for meat in the long run as given the marginal increase in per-capita meat consumption by 2020, this growth in population should have a significant multiplier effect. Crude Oil Price (WTI) Crude Oil Price (WTI) * 2018* (Source: Knoema.com and TradingEconomics) Consumer Price Inflation is expected to increase to 2.5% in 2017 and decline to 2.1% in Going forward, we expect the companies to pass-on this increase in the price to the customers. Page 13 (Source: Statista) The crude oil is an influencing factor of meat prices as it directly impacts the cost of corn and soybean which are raw materials for animal feed. An increase in crude oil can increase the prices of corn and soybean which are used for manufacturing biodiesel and ethanol. This increases the price of meat as the cost of animal feed is on the rise. Hence the increase of crude oil from $43.33 in 2016 to $55.18 in 2018 can inflate the price of meat. However, given the increase in per capita disposable income, the companies are expected to pass this price increase to the consumers without affecting their sales and profits.

14 CATALYSTS FOR GROWTH The company has seen an increase in the share of prepared foods in the revenue from 10% to around 19% after the acquisition of Hillshire Brands. Tyson has been innovative in new product launches such as Tyson Ground Chicken, BallPark Prime Franks which is a higher quality hot dog, etc. The company has tried to identify the gap in breakfast segment and has lined-up new products to be launched in 2017 such as scrambles, breakfast bowls, eggwhite omelets, etc. The company has new introductions in the snacking segment too. Hence the company expects to increase the revenue from prepared foods segment, which can be seen as a catalyst for growth. In general, preference towards poultry is witnessed given the preference of people towards white-meat and lowcarb high-protein diet. Within this segment, value-added products such as cooked meat, boneless chicken, etc. should fetch higher margins for the company. INVESTMENT POSITIVES Well-diversified company with presence in all four segments chicken, beef, pork and packaged meats leading to greater stability in revenues. Innovation in identifying market gaps and launching new products to meet the consumer needs. Good portfolio of brands with acquisition of Hillshire Brands in 2014 which adds ammunition to the strong meat manufacturing capacity of Tyson. INVESTMENT NEGATIVES Revenues decreased by 10% in 2016 and we predict the revenues to decrease for another two years due to a mix of factors that includes decrease in price and volume of sales of the four segments of the company There is a possibility of the company being indicted for alleged chicken price-fixing. Though the company earns less than 10% from its foreign operations, continued losses in its business in China may further reduce the profitability of the company in the short-term VALUATION We valued the company with DCF/EP model, Relative P/E valuation and Fundamental Dividend Discount Model. The intrinsic values of the stock according to these valuation techniques are $73.81, $67.43 and $68.96 respectively. At the current price of $62.31, the stock seems to be undervalued in all the three methods of valuation. The company reports under four segments namely beef, chicken, pork and prepared foods. In terms of the growth in volume of sales, we predict the chicken and beef segments to grow around 1%, pork to remain almost constant and prepared foods to decline by 1%. Consumption of beef has been on a constant decline since 2012 and we anticipate this trend to reverse in 2017 with a decrease in the cattle prices and increase in demand reported in the first quarter results of the company. With new launches in the prepared foods segment happening in 2017, we expect the numbers to show up in the revenue in 2018 with the sales volume increasing by 3% compared to Long-term volume growth rate of prepared foods is expected to be at 2%. The long term volume growth of chicken, beef and pork are expected to hover around 0.5%, 0.3% and 0.3% respectively as per the increase in overall per-capita meat consumption. In terms of prices, we expect the revenue per unit volume of sale from beef, prepared foods and pork to decrease and that of chicken to stay constant as we had discussed earlier. The company will be careful in pricing its products in the prepared foods segment since the company plans to capture customers for its various new product launches. After accounting for the price and volume growth predictions, the revenue is expected to shrink by -2.7% in 2017 and then expand by 1.61% in The long-term revenue growth rate is expected to be around %. The long-term operating margins for beef, chicken, pork and prepared foods are 2.5%, 11.0%, 8.0% and 12.0% respectively. The company recorded a high pork operating margin of 19% and beef operating margin of 8.5% in Q Hence we expect the net operating margin to be slightly on the higher side in 2017 before they settle down in the normal range. The company expects an overall synergy benefit of $675MM (cumulative) from the acquisition of Hillshire Brands. $580MM has already been realized and we expect the rest of the benefits to be realized in We have Page 14

15 taken into account this factor while calculating the operating margins. The company has given the guidance of capital expenditure till 2020 beyond which we assume it to grow by 2% year-on-year. This results in a capex/revenue of 2.1% in the long run which correlates with the company s history of long-term capital expenditure that includes the acquisitions as well. The operating leases of the company significantly increased in 2016 following which it became 48% of revenue from just 8% a year ago. We assume the operating leases to grow proportional to the capital expenditure. The company announced that the board has decided to increase the dividend of the company annually by at least $0.10. This has been taken into consideration in the model. The company has given a guidance of EPS of $4.90-$5.05 for Analysts estimates of EPS are at $5.01, $4.99 and $5.04 for 2017, 2018 and 2019 respectively. However, with our conservative estimates, we predict the EPS to be $4.72 for 2017 and $4.90 for The negative aspect of Tyson Foods is that it is being investigated for involvement in chicken price-fixing. If the company is found guilty, the penalty may affect the company s valuation. KEYS TO MONITOR 1. Interest rate rise may have an adverse impact on the assets of Tyson Foods. Hence this is a key parameter that needs to be monitored. 2. Disease outbreaks are potential disruptors of business. Latest incident of avian flu has been reported in Tennessee. Outcome of this event is important in determining Tyson s profits for Tyson is being investigated for alleged chicken pricefixing. If proved guilty, the judgement may affect Tyson financially and in terms of its brand image. REFERENCES 1. Tyson Foods 10K, Business Description 2. Bloomberg - Tyson Foods Financials 3. Statista Population US 4. Bloomberg Intelligence and WASDE data on Corn 5. IRI-Freshlook, 52 weeks ending 11/1/15 6. Nielsen Perishables Group FreshFacts p?news_id= National Chicken Council Per Capita Consumption of Poultry 8. FACTSET Comparable Companies and Financials of Tyson 9. Mergent Company Definitions 10. Statista - US Retail sales of fresh meat by type, Statista US Per Capita Meat Consumption from Statista Meat, Poultry and seafood packaging demand in the US from 2007 to Tyson Consumer Analyst Group of New York (CAGNY) Presentation Feb 21, Knoema.com- US Inflation Forecast and upto 2060, Data and Charts. Trading Economics- United States CPI Forecasts Statista Processed Meats Dossier 16. Statista Tyson Foods Dossier 17. Bloomberg Tyson Foods Earnings Summary Feb 6, JP Morgan North America Equity Research, Charcuterie 19. JP Morgan Research Report on Tyson Foods 1Q Earnings Call 20. Hormel Foods 10K 21. Mergent Company Synopsis - JBS 22. Mergent Company Synopsis - Sanderson 23. Mergent Company Synopsis - SmithField 24. Mergent Company Synopsis Cargill 25. IARC Monographs evaluate consumption of red meat and processed meat, International Agency for Research on Cancer 26. Campbell Soup Invests in Nutrition Tech Start-up, Oct 26, 2016 fortune.com 27. Statista Total Population in the United States, IMPORTANT DISCLAIMER Henry Fund reports are created by student enrolled in the Applied Securities Management (Henry Fund) program at the University of Iowa s Tippie School of Management. These reports are intended to provide potential employers and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of Henry Fund students. Henry Fund analysts are not Page 15

16 registered investment advisors, brokers or officially licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold a financial interest in the companies mentioned in this report. Page 16

17 Key Assumptions Ticker Symbol TSN Current Share Price $62.31 Current Model Date 2/21/2017 Fiscal Year End Oct 01 Cost of Equity 6.84% Pre Tax Cost of Debt 2.30% Beta 0.75 Risk Free Rate 3.05% Equity Risk Premium 5.06% CV NOPLAT Growth 0.75% CV ROIC 5.00% Current Dividend Yield 1.38% Marginal Tax Rate 38% Effective Tax Rate 29% WACC 5.74% Investment Rate 35% Share Price (DCF/EP Models) $73.81 OPERATIONAL VARIABLES Terminal Operating Profit Margins Beef 2.50% Chicken 11.00% Pork 8.00% Prepared Foods 12.00% Terminal Volume Growth Beef 0.50% Chicken 0.30% Pork 0.30% Prepared Foods 2.00% Terminal Capex Growth 2% A/P as %age of Sales 4%

18 Revenue & Oper Profit Decomp E 2018E 2019E 2020E 2021E 2022E 2023E 2024E Revenue Revenue Growth 9.33% 10.09% 10.86% 2.61% 1.61% 2.17% 2.17% 2.02% 1.90% 1.71% 1.70% Beef Chicken Pork Prepared Foods Operating Income Beef Chicken Pork Prepared Foods Operating Profit Margin 3.81% 5.24% 7.68% 7.57% 7.58% 7.64% 7.67% 7.69% 7.63% 7.58% 7.59% Beef 1.72% 0.93% 2.44% 2.50% 2.50% 2.50% 2.50% 2.50% 2.50% 2.50% 2.50% Chicken 8.19% 12.32% 11.12% 10.50% 10.50% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% Pork 7.62% 7.66% 11.45% 11.00% 10.50% 10.00% 9.50% 9.00% 8.50% 8.00% 8.00% Prepared Foods 1.67% 7.82% 10.42% 10.50% 11.00% 11.00% 11.50% 12.00% 12.00% 12.00% 12.00% Revenue/Unit Volume (in $) Beef (heads) Chicken (heads) Pork (heads) Prepared Foods (pounds) Volume Sales (in M) Beef (heads) Chicken (heads) Pork (heads) Prepared Foods (pounds) Volume Sales Growth % Beef (heads) 0.40% 0.30% 1.10% 1.00% 1.00% 1.00% 0.50% 0.50% 0.50% 0.50% 0.30% Chicken (heads) 2.60% 4.20% 2.60% 1.30% 1.00% 0.80% 0.60% 0.40% 0.30% 0.30% 0.50% Pork (heads) 0.80% 0.80% 2.50% 0.10% 0.20% 0.30% 0.30% 0.30% 0.30% 0.30% 0.30% Prepared Foods (pounds) 10.40% 70.70% 2.80% 1.00% 3.00% 3.00% 3.00% 2.00% 2.00% 2.00% 2.00% Revenue/Unit Volume Growth% Beef 12.80% 6.90% 14.90% 6.50% 1.50% 2.00% 2.00% 2.00% 1.50% 1.00% 1.00% Chicken 1.40% 1.60% 1.50% 0.00% 0.50% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% Pork 15.70% 15.80% 4.40% 1.00% 0.00% 0.50% 1.00% 1.00% 1.00% 1.00% 1.00% Prepared Foods 7.10% 16.70% 3.40% 2.90% 2.00% 1.00% 0.00% 0.50% 1.00% 1.00% 1.00%

19 Income Statement Fiscal Years Ending E 2018E 2019E 2020E 2021E 2022E 2023E 2024E Currency Millions Millions Millions USD USD USD USD USD USD USD USD Scale USD USD USD Millions Millions Millions Millions Millions Millions Millions Millions Sales Cost of sales Gross profit Selling, general & administrative expenses Depreciation Amortization Operating income (loss) Interest income Interest expense Other income (expense), net Total other income (expense) Income (loss) from continuing operations before income taxes Current income tax expense (benefit) Deferred income tax expense (benefit) Income tax expense (benefit) Income (loss) from continuing operations Income (loss) from discontinued operations, net Net income (loss) Less: net income (loss) attributable to noncontrolling interest Net income (loss) attributable to Tyson NI Growth 11.05% 41.20% 44.92% -5.34% 1.93% 3.56% 2.94% 2.72% 1.42% 1.32% 2.24% EPS Book Value Tangible Book Value Dividends Dividends per class A common share Dividends per class B common share Year end outstanding shares Class A Year end outstanding shares Class B Total Shares Outstanding Total Dividend Avg Dividend Per Share