Valuentum Exclusive Analysis for the Discerning Investor

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Image Source: Tyson Foods Inc – Second Quarter of Fiscal 2020 Earnings IR Presentation

By Callum Turcan

On May 4, the major meat and prepackaged food provider Tyson Foods Inc (TSN) reported second-quarter earnings for its fiscal 2020 (period ended March 28, 2020) that missed consensus estimates on both the top- and bottom-line, sending its shares sharply lower during the regular trading session that day. The ongoing coronavirus (‘COVID-19’) is hurting its production capabilities, in particular the operations of its meatpacking plants as numerous confirmed COVID-19 cases (that unfortunately includes fatalities) have emerged at those facilities and the facilities of its peers across the US, prompting many to close or scale back. For instance, Tyson was forced to temporarily close a large pork plant in Waterloo, Iowa, starting in late-April as many workers were calling out sick. Here’s a key comment from Tyson’s management team during the firm’s latest quarterly conference call (emphasis added):

“In the current environment, we see strong demand and ample supply of hogs, but reduced industry processing capacity of nearly 50% to the COVID-19 has pressured the supply chain and dramatically reduced overall profitability. As pork plants across the country have continued to shut down, hog producers are met with much lower processor demand for their market-ready hogs. We recognize how this impacts our producer community and are anxious to safely resume operations at our facilities to provide them with an outlet for their hogs.” --- Dean Banks, President of Tyson

Operational Update

President Trump signed an executive order to keep meatpacking and processing facilities operational; however, questions remain over whether employees will want to continue showing up during the pandemic given rising COVID-19 cases and fatalities. The balancing act that is ensuring US food production can continue while making sure frontline workers (and we appreciate everything they are doing) can stay safe is an incredibly tricky one, given the need to maintain global food supplies as the US is often referred to as a “breadbasket of the world” due to its immense agricultural output (and net exports). That’s on top of needing to maintain domestic food supplies to meet domestic household demand for protein.

In East Africa, a swarm of locusts in early-2020 consumed vast amounts of farmland and severely weakened food security in the region. Another locust swarm, the spawn of the first locust swarm, is descending on East Africa again and further stressing food security in the region, likely beyond levels seen during the first swarm as the second swarm is even larger. This is one of many reasons why US agricultural production is very important (i.e. US agricultural exports can be used to fill voids in overseas agricultural output); however, putting frontline workers at risk is very problematic, thus social distancing (in the meatpacking plants, processing plants, and related facilities), testing, and other considerations need to be utilized as part of this great balancing act during these harrowing times.

Pivoting back to Tyson, here’s what the company’s management team had to say regarding operational hurdles during the firm’s latest quarterly conference call:

“The direct impacts of the virus have created operational challenges, including absenteeism, reduced production speeds, and selected idling of plants. The scope of our operations continued to provide us with flexibility and redundancy. This is a clear benefit to our Company’s scale.

COVID-19-related pressure has affected parts of the industry supply chain, especially pork. However, our diversity of protein provides our customers with options. In addition, our geographic diversity provided important lessons from China, where we first encountered COVID-19-related issues. This includes ways to maintain health and safety of our people, opportunities to pivot to retail, potential pathways for recovery.

We expect current conditions to continue during our third quarter with a gradual recovery beginning in the fourth quarter. However, all this depends on the extent to which businesses and schools are able to reopen. We’re well-positioned to operate during this period and to take advantage of increasing demand during the recovery.” --- Noel White, CEO of Tyson

Smithfield Foods, a wholly-owned subsidiary of the Chinese firm WH Group Ltd (WHGRF), was forced to temporarily close its pork processing facilities in Sioux Falls, South Dakota, for over two weeks and only recently began to restart operations at those facilities. Please note that those facilities are responsible for handling 4%-5% of America’s pork production, and that other facilities run by Smithfield Foods have been forced to close due to the pandemic. This is an industry-wide issue, and one with no easy solution given the absolutely essential need for domestic food production but also the very important need to take worker safety considerations into account as well.

Financial Overview

Shifting now to Tyson’s financial performance, the firm’s GAAP revenues rose by 4% year-over-year in the fiscal second quarter; however, its GAAP gross profit shrank by 14% year-over-year as the firm dealt with rising costs from the pandemic. Tyson’s top-line growth was supported by rising beef, pork, prepared foods, and ‘international/other’ sales, though its segment-level operating income declined significantly at those first three segments last fiscal quarter. As it relates to its international/other sales, that segment flipped from a marginal net operating loss to a marginal net operating profit during Tyson’s second fiscal quarter, but the improvement wasn’t enough to have a material impact on its company-wide results.

Tyson exited the second fiscal quarter with $0.4 billion in cash and cash equivalents on hand versus $1.1 billion in short-term debt and $11.0 billion in long-term debt. As the company has a large net debt position, operational hurdles can lead to financial distress if the situation isn’t remedied. The company generated just over $0.6 billion in free cash flow last fiscal quarter, which fully covered $0.3 billion in dividend obligations and $0.2 billion in repurchases of its common stock.

In our view, it would be prudent for Tyson to allow cash to build up on its balance sheet instead of repurchasing its stock given its large net debt load relative to its free cash flows (this appears to be management’s strategy now). Here’s some commentary from management on Tyson’s financial position and outlook from the firm’s latest quarterly conference call (emphasis added):

“We project CapEx spending of approximately $1.2 billion for the fiscal year as we progress with building additional processing capacity for case-ready fresh chicken, beef and pork. This is a reduction of more than $100 million from our previous guidance. We may elect to slow down parts of our CapEx spending where appropriate to ensure adequate liquidity.

Having said that, we expect liquidity in the back half of the year to remain well above our minimum liquidity target of $1 billion, especially after the issuance of the $1.5 billion term loan. Our capital allocation will continue to prioritize debt reduction. This includes approximately $1 billion of senior note maturities during Q3 and Q4. We [do] not expect to repurchase shares in the back half of the year, except for minor repurchases related to an employee stock ownership plan.” --- Stewart Glendinning, CFO of Tyson

Tyson’s net debt load is a product of its acquisitive history, and the firm should be able to pare down that burden by directing free cash flows that were previously going towards share buybacks and now are going towards deleveraging. We appreciate the strategic shift. Furthermore, reducing its expected capital expenditures for fiscal 2020 better positions Tyson to generate free cash flows given exogenous headwinds and operational hurdles. In late-March 2020, Tyson secured a $1.5 billion term loan that should provide the firm with the access to liquidity required to ride out the pandemic.

On April 1, Tyson fully drew down the aforementioned term loan, which matures in late-March 2022. Additionally, Tyson has a revolving credit facility that matures in March 2023 and carries total borrowing capacity of $1.75 billion. Tyson carries investment-grade credit ratings (BBB+/Baa2/BBB), which it must retain if the firm wants to keep the interest rates on its term loan and revolving credit line relatively low. After drawing down its term loan, Tyson used those proceeds to pay off all of its outstanding commercial paper borrowings and to reduce the borrowings on its revolving credit line according to its 10-Q filing covering its last fiscal quarter:

At March 28, 2020, amounts available for borrowing under our revolving credit and term loan facilities totaled $3.05 billion, before deducting amounts to backstop our commercial paper program. On April 1, 2020, we borrowed the full $1.5 billion available under the term loan facility and used it to repay $1.0 billion of outstanding commercial paper obligations and to repay the $200 million outstanding balance under the revolving credit facility. Our revolving credit facility is funded by a syndicate of 39 banks, with commitments ranging from $0.3 million to $123 million per bank. Our term loan facility is funded by a syndicate of 5 banks, with commitments ranging from $200 million to $350 million per bank. The syndicate includes bank holding companies that are required to be adequately capitalized under federal bank regulatory agency requirements…

Our commercial paper program provides a low-cost source of borrowing to fund general corporate purposes including working capital requirements. The maximum borrowing capacity under the commercial paper program is $1 billion. The maturities of the notes may vary, but may not exceed 397 days from the date of issuance. As of March 28, 2020, $1 billion was outstanding under this program with maturities of less than 15 days. On April 1, 2020, we repaid the outstanding balance of the commercial paper using proceeds from the term loan facility. Our ability to access commercial paper in the future may be limited or its costs increased, due to the current market environment which has been impacted in part by COVID-19.

These moves should put Tyson in a much better position to ride out the storm.

Concluding Thoughts

Shares of Tyson are now trading below the low end of our fair value range, as of this writing, after falling sharply during normal trading hours on May 4. If Tyson follows through with its deleveraging program and is able to get its production facilities back up and running, in a sustainable and safe manner, the firm’s outlook would improve materially; however, that isn’t for certain given the operational hurdles created by the ongoing pandemic and the need to keep its frontline workers safe. We’ll continue to keep a close eye on the space going forward, and hope everyone stays safe out there.

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Dollar Store and Department Store Industries – KSS M JWN BIG DG DLTR PSMT

Food Products (Small/Mid-Cap): CALM FLO FDP HAIN HRL JJSF LANC MKC SJM THS TSN

Food Products (Large/Mid-Cap): ADM BG CPB CAG GIS HSY K KHC MDLZ NSRGY UL UN

Food Retailing Industry – CASY COST CVS KR SYY TGT WBA WMT

Related: AMZN, WHGRF

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Callum Turcan does not own shares in any of the securities mentioned above. Dollar General Corporation (DG) is included in Valuentum’s simulated Best Ideas Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.