When you look at the performance of some hotter food stocks over the past year such as Buffalo Wild Wings (BWLD), El Pollo Loco (LOCO) and Chipotle Mexican Grill (CMG), you might notice one underlying theme: All these casual-dining companies spotlight chicken.
And given their success, you might consider trying to ride them higher, sure … but you also might want to consider investing one step further up the chain, in fresh chicken producer Tyson Foods (TSN).
Tyson just came off a record quarter for earnings, and TSN stock is trading on the cheap.
Besides, if you don’t get in, you’ll be missing out on the rest of what Tyson President and CEO Donnie Smith characterized as “what looks to be the best year in our company’s history.”
Tyson’s Brilliant Game of Chicken
Aside from this year’s blockbuster $7.8 billion acquisition of Hillshire Brands, the reason for the optimism surrounding Tyson probably has more to do with the tailwind of declining feed costs tied to chicken production, which should lead to margin expansion going forward.
First, though, you’ll need to look beyond the margin decline in the fiscal third quarter, which came as a result of “isolated” production-related issues at its chicken facilities. The company is working through these issues, which is good news given the favorable macro and industry conditions.
Tyson’s feed costs in the fiscal third quarter fell by $120 million, and by $460 million through the first three quarters of fiscal 2014.
However, back in fiscal 2013, feed costs were on the rise — in response, Tyson passed those expenses onto consumers in the way of price hikes. But despite the hike, sales in fiscal 2013 actually increased to nearly $34.4 billion from about $33 billion in the prior fiscal year.
Now, with feed costs moving lower — a trend that is expected to persist in 2015 — you can look toward margin expansion at Tyson, which in and of itself could lead to greater returns.
Here’s the equation.
For fiscal 2015, the company expects chicken production to increase by 2% over fiscal 2014 levels on solid demand. But there won’t be a “meaningful increase in chicken supply until around July 4 or so next year,” Tyson execs said on the Q3 conference call. Meanwhile, feed costs in fiscal 2015 are expected to fall another $400 million or so versus current-year levels, which are already on the decline — the result of which will be an operating margin for the chicken segment of at least 10%, which some analysts say is on the conservative side.
In a best-case scenario without the production issues at its chicken facilities, Tyson’s operating margin in fiscal 2014 would be somewhere around 8%-9%, analysts suggest.
Beyond chicken, there are more reasons to like TSN stock.
Tyson whittling away its debt, evidenced by the recent sale of underperforming chicken facilities in Latin America, from which it generated $575 million in cash to use toward strengthening its balance sheet. And at the end of last month, TSN announced the closure of some U.S. prepared foods facilities in an attempt to be more efficient in light of the recent Hillshire addition.
And while Tyson isn’t only chicken — it also has beef, pork and prepared-foods businesses — it is widely known for its poultry. Take a look around: Chicken is hot right now, thanks to rising prices for beef and pork, and that’s benefiting chicken companies both at the retail level and in casual dining.
This has pushed stocks like CMG to all-time highs, BWLD near all-time highs (though Buffalo Wild Wings has pulled back a bit of late), and LOCO to a successful IPO. However, Chipotle and Buffalo Wild Wings are sporting forward earnings multiples of about 50 and 28, and El Pollo Loco — which doesn’t expect any earnings for next year — is trading at a frothy 4 times sales. Meanwhile, TSN trades at just 13 times next year’s earnings and merely 0.35 times sales, and with plenty of fundamental growth on tap for fiscal 2015.
If only Tyson supplied the chicken wings to the trendy fast-casual chains; alas, that doesn’t appear to be the case. Buffalo Wild Wings, for instance, uses McLane Foods, a fully owned subsidiary of Berkshire Hathaway (BRK.B), for much of its food supplies, while Chipotle sources much of its food locally. El Pollo Loco has contracts with a pair of unnamed chicken suppliers extending through December of this year and January 2015.
Still, those companies are just illustrative of the growing love of chicken. Tyson’s fine without them.
A Potential Headwind
Something to keep in mind is that for all the wind at its back, Tyson does face a potential headwind on the retail side.
In a word, it’s Walmart (WMT).
In fiscal 2013, Walmart accounted for 13% of Tyson’s consolidated sales. In its fiscal 2013 annual report, Tyson explains:
“Any extended discontinuance of sales to this customer could, if not replaced, have a material impact on our operations. No other single customer or customer group represented more than 10% of fiscal 2013 consolidated sales.”
That becomes increasingly meaningful when you consider the Bentonville, Arkansas-based retailer has been suffering from sales declines across its U.S. stores.
With a trend of lofty beef and pork prices expected to persist for the foreseeable future, chicken is looking like the way to play the meat space going forward.
And Tyson, based on its low valuation coupled with projected fundamental growth and margin expansion seems like an attractive way to go.
As of this writing, Gerelyn Terzo did not hold a position in any of the aforementioned securities.