Should You Buy Tyson Foods After Its Recent Drop?

Tyson missed profit estimates in the second quarter and shares crashed. Is this a buying opportunity?

May 20, 2014 at 3:54PM

Meat-processing company Tyson Foods (NYSE:TSN) was having a great time in 2014, but weak second-quarter results sent its shares crashing. Tyson dropped more than 10% after it missed the Street's profit estimate. However, this might be a temporary setback--Tyson's overall business performed well, and the company reported good revenue growth.

Moreover, Tyson enjoys a strong industry position as compared to peers such as Pilgrim's Pride (NASDAQ:PPC) and Sanderson Farms (NASDAQ:SAFM) due to its diversified business. So, should investors consider capitalizing on the company's recent drop by purchasing more shares? Let's find out.

Looking beyond the miss
Tyson's second-quarter revenue rose to approximately $9 billion from about $8.4 billion last year, beating the $8.8 billion consensus estimate. Also, the company's net profit more than doubled from just $95 million last year to $213 million in the quarter. Hence, even though the bottom line was below estimates, it grew remarkably. According to Tyson CEO Donnie Smith:

Our second quarter is usually our most challenging. We had a lot to overcome, including a harsher than normal winter, but I'm satisfied with the results

However, with the winter behind us, there should be an improvement in Tyson's business going forward. But it won't be easy.

Challenges ahead
Outbreaks of the bird flu and hog virus in China will be a concern for Tyson. The company expects this year's pork supplies to fall 4%, slightly more than previously anticipated, due to a deadly piglet virus outbreak. The porcine epidemic diarrhea virus (PEDv) reduced hog supplies in Tyson's second quarter, but this was partially offset by heavier animal weights.

Also, Tyson is facing continued weakness in China, where it has made significant investments to build poultry operations. Weakness in the country accounted for the majority of the $30 million loss in its international business during the second quarter. 

On the food-service side, Tyson saw some positives. Despite the bad weather, an increase in prices that affected demand, and sluggish food-service traffic, volume in this segment was up around 3% from the year-ago period. But there might be some weakness over here as well in the future.

According to management, the piglet virus will restrain Tyson's hog supplies going forward as the disease spreads across swine farms in the U.S. In addition, a decline in cattle herds to the tune of 3% in 2015 is also expected. However, Tyson management claims that despite bottlenecks in beef supply, the company has enough cattle to address demand. Also, there might be some weakness in the chicken business, as Tyson says that it won't be able to increase supplies significantly until 2015 to satisfy rising demand.

In addition, Tyson's operations in Brazil were also a concern. The company said that its performance in the country suffered as a result of poor decision making. However, management has restructured its Brazilian team to improve the operational focus by replacing the country manager, production manager, and the plant manager. Now, Tyson has implemented a new organizational structure in Brazil, which is focused on key elements of its strategy to accelerate growth and reinforce its operational excellence.

Competition and valuation
It is evident that Tyson is facing certain challenges. In addition, the company is seeing an increase in competition from the likes of Pilgrim's Pride. Driven by partnerships with the likes of ConAgra, Sysco, Burger King, and Yum! Brands, to which it supplies its products, Pilgrim's has a strong distribution mechanism.

Also, the company is focusing on antibiotic-free, or ABF, chicken. After seeing robust demand for ABF chicken, Pilgrim's decided to move into this market and is now one of the biggest producers. The market for ABF chicken is still in its nascent stage, as it accounts for only 9% of the $10 billion fresh chicken market, as per IRI/FreshLook. So, Pilgrim's move in this area is a concern for Tyson.

Tyson is also more expensive when compared to peers. Both Sanderson and Pilgrim's Pride are cheaper on a trailing P/E basis. Pilgrim's Pride trades at a trailing P/E ratio of just 10.8. In comparison, Tyson is quite expensive at 15 times trailing earnings. Sanderson, on the other hand, is also cheaper at 11.7 times earnings. Moreover, Sanderson has a stronger dividend yield of 1% as compared to Tyson's 0.8%. Sanderson also sports a stronger net profit margin of 6.2% as compared to Tyson's 2.8%.  

Bottom line
There are some worries for Tyson in the short term as we saw above. Considering its valuation, which is expensive as compared to peers, it might not be a wise idea to buy the stock on the dip right now. Until and unless there are concrete improvements in the company's business, investors should consider staying away from Tyson.

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Shirish Mudholkar has no position in any stocks mentioned. The Motley Fool owns shares of Sanderson Farms. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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