Value Investors Club / TYSON FOODS INC -CL A (TSN)

Description

According to the Chinese calendar, 2019 is the Year of the Pig. It is turning into

quite the ominous year for swine.

African swine flu (ASF) is currently ravaging China, the world’s largest hog market,

and creating a global supply shock that will take several years to work through.

Pork represents about 40% of the global protein market, and China produces and

consumes about half the global pork volumes. As of now, official estimates indicate

that China has lost 15% of its pork supply, but there seems to be unanimous belief

that the actual figure is far worse.

As Chinese consumers shift consumption to other proteins (chicken mostly, but also

beef and fish) and global protein producers work to fill protein supply gaps, many

companies stand to benefit.

While VIC members may choose from a variety of names, Tyson Foods (TSN) makes

a compelling long in this environment. It is the largest, most liquid, and among the

most diversified of global protein suppliers. TSN also provides several other ways

for investors to win, making the long even more compelling than an ASF-only play.

ASF Outbreak:

ASF outbreaks were first reported in a few provinces in China in August 2018. Over

the next several months, ASF had spread to every province in China. And the

prognosis for continued spreading within China is not good. ASF is an airborne

virus, it can linger and spread within in area for several weeks after introduction

through farm equipment. It can also survive frozen in pork for several years. And

as of now, there are no known cures for the disease. The only known treatment for

farms infected is to cull herds.

Since August 2018, China Ministry of Agriculture estimates that the total Chinese pig

herd has fallen by 50 million (from 350 million) and sow herds (breeding female

pigs) have also fallen. Multiple media and expert sources suggest that the official

estimates are too low. And while the extent of impact on local Chinese hog

populations is unknown, there is no debate that this is a bid deal.

It is also clear that addressing this problem will take a long time. First, ASF

outbreaks need to stop. When this happens is impossible to predict, though late

2019 or early 2020 seems like a best case scenario for Chinese herds stabilization

and infection eradication. From there, the typical hog breading/production cycle

takes approximately 20 months from gilt to sow to breeding to weaner to pig for

slaughter. So late 2021 or early 2022 look to be best case scenarios for China herd

recoveries.

Hog Price Moves:

Hog and pork prices have started to react. Lean hog futures in the US have

increased by 35%+ (depending on contract used) over the last 2 months. Global

pork prices have seen similar moves recently as well.

However, the full magnitude will take time as herd culling is still in process, and AFS

infected pigs can still be eaten (i.e., we are in inventory liquidation phase, actual

supply deficits do not exist yet until the full impact of not being able to replace

slaughtered herds becomes more real and immediate.)

Protein Consumption Shifts:

How will China respond as pork supplies are reduced? Probably by eating more

chicken. Both logic and history suggest this to be true. First, everyone knows pork

as the other white meat. So go for the “one” when “the other” is not available.

Second, chicken and pork are similar price points and chicken is actually slightly

cheaper, so substitution of chicken for pork makes economic/budgetary sense (beef

in China costs about three times chicken and pork in China for equivalent weights).

Protein substitution also favors chicken over beef as it takes about 1 year to create

new poultry supply versus almost three years for beef. Finally, in the last swine

epidemic (not ASF but a lesser disease) in 2007-2008, chicken share of consumption

absorbed most of the lost pork with beef also benefiting some.

Protein Supply Shifts:

Exactly where the protein comes from to replace Chinese hog and pork production

is really not important. The US, EU, and Brazil can replace some of the Chinese pork.

Chicken and beef are available from the US and Brazil. But the exact shifts are not

critical, as supply chains globally are fairly tight and global agricultural products are

fungible. So for example, if more Brazilian pork goes to export to China, local and

export Brazilian pork, chicken and beef prices will all have upward pressure. And

this will have impact into all other markets.

All of this comes at an interesting and critical time for the US and China in their

trade negotiations. China has instituted tariffs on US beef and pork and has banned

import of US poultry. News reports have speculated that a US and China trade deal

could remove agricultural tariffs and shift import tariffs to other products (which

would further benefit US protein companies beyond the supply shock).

Long-Term Impacts:

A further interesting and longer term impact of ASF would be a permanent altering

of the global protein supply chain. Agriculture is one area where China is

uncompetitive versus the United States (and South America). Chinese protein costs

are almost double those in the US for example. And China is almost fully self reliant

in pork production. A re-thinking of this strategy to allow for lower cost imports

and possibly safer supply (or at least more diversified supply), would benefit global

protein players outside of China dramatically.

Tyson Positioning:

Tyson is broadly positioned across the protein space. It has similar exposures in

beef and chicken, and both are 50%-100% larger than pork (depending on whether

you are measuring sales or EBIT). Almost all Tyson production is in the United

States. And its recent purchase of Keystone gave Tyson near $1b of international

poultry foodservice exposure, much of it in Asia.

Whether directly supplying export to China, or filling out other supply gaps created

by ASF, Tyson is positioned well to benefit.

Impact on Financials:

This is the hardest part of this thesis. It is clear that global protein prices are set to

lift (as hog/pork prices already have in the last 2 months). The extent of lift is

dependent on many variables, and it would be hard to gain strong conviction in

numbers at this point. However, the bias is clearly higher for international protein

suppliers. The magnitude can be meaningful as price jumps to date have already

been large in the pork markets and this is before the real impact on protein supply is

felt in h2 2019 or h1 2020.

Further, to the extent that supply chains adjust more permanently in the case of

China import strategy, multiples also have room to adjust higher, as protein

companies globally (Tyson included) trade at undemanding multiples versus the

market.

Tyson guided 2019 earnings assuming no benefit to either a positive outcome in a

China trade deal or any benefit from ASF to the protein complex

Tyson Valuation:

Tyson today trades at

10x to a high of 17x over the last 5 years.

The current multiple of Tyson is a 20% discount to peers including commodity

peers like Pilgrims Pride and branded and packaged food peers like Campbell,

General Mills, and Smucker.

Tyson has been slowly transitioning more of its commodity mix within beef and

chicken to prepared food and higher margin portions of the commodity business.

Clearly the multiple has yet to benefit.

While it is difficult to quantify at this point the extent of upside to numbers, the

risk/reward appears compelling from here with an opportunity for earnings upside,

relative valuation re-rating, and absolute value re-rating.

Catalysts:

Global protein price moves

US/China trade deal

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Global protein price moves

US/China trade deal

Agriculture tariffs removed in China

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			2019	2020
Price:	73.50	EPS	0	0
Shares Out. (in M):	366	P/E	12.4	11.6
Market Cap (in $M):	26	P/FCF	0	0
Net Debt (in $M):	11	EBIT	0	0
TEV (in $M):	36	TEV/EBIT	11.9	11.3