Shareholders in meat-processing giant Tyson Foods (NYSE:TSN) have enjoyed a nice ride over the past few years, thanks to rising sales and consistent operating profitability. The company has been a prime beneficiary of strong anecdotal demand for a protein-based diet around the world, especially in areas of growing affluence like China and Brazil.
However, Tyson has been waiting for the right opportunity to come along that would allow it to gain significant scale in the prepared-foods area, an opportunity that arrived through the recent auction of Hillshire Brands (UNKNOWN:HSH.DL), which Tyson appears to have won over the advances of competitor Pilgrim's Pride. So, after a blockbuster deal, is Tyson a good bet?
What's the value?
Tyson is one of the world's largest meat-processing empires, operating a large network of chicken, beef, and pork processing facilities around the world. Like its competitors, the company has anecdotally benefited from higher protein demand from a growing global population, which has led to rising sales over the past few years. In addition, capacity restrictions on the supply side, due to weather and disease-related factors, have generally led to rising product prices for Tyson, culminating in a relatively strong gross margin.
In its latest fiscal year, it was more of the same for Tyson, highlighted by a 4% top-line gain that was a function of a rise in prices across its major product categories. Despite higher feed costs and sales volume declines in its beef and pork segments, the company rode a better product-pricing environment to a slight pickup in operating profitability, with its operating income up 6.9% for the period. The net result for Tyson was a solid increase in operating cash flow, helping to fund its various growth initiatives, including investments in its international chicken processing capabilities.
Looking into the crystal ball
Of course, most of the company's focus for future growth lies in the prepared-foods arena, a segment that accounts for roughly 10% of its total sales. While the prepared-foods segment has been a lackluster performer for Tyson lately, evidenced by a steep drop in profitability during the current fiscal year, the acquisition of Hillshire Brands looks to be a potential game changer for Tyson.
Since splitting off from Sara Lee in 2012, Hillshire Brands has been upping its game, cutting extraneous overhead costs and investing in growth areas, like snacks and frozen meals, highlighted by its introduction of Jimmy Dean-branded frozen entrees and sandwiches. The company has also been actively investing in the natural/organic area, recently buying Van's, a manufacturer of organic snacks and cereals. The net result for Hillshire Brands has been a more profitable enterprise, evidenced by an operating margin that tips the scales at slightly more than 10% compared to roughly 4% for Tyson.
A better way to go
Unfortunately, Tyson is paying a pretty penny to add bulk in the prepared-foods arena, coughing up an estimated 16.7 times earnings before interest, taxes, depreciation, and amortization for Hillshire Brands, a price tag that was higher than desired due to the recently completed bidding war. Consequently, Tyson really needs to quickly generate operating synergies in order for the deal to be a winner for its shareholders over the near term.
As such, investors might be better off looking elsewhere for profits in the packaged-food sector, like with Pinnacle Foods (NYSE:PF). The company thought that it was going to join the Hillshire Brands family, after agreeing to a merger back in mid-May. Instead, it looks like Pinnacle Foods will pocket an estimated $160 million merger-termination fee and will continue to focus on building out its product portfolio, which includes Birds Eye frozen vegetables and Duncan Hines bake mixes. That is good news for the company's investors, who get to maintain a stake in one the sector's most efficient operators. They can look forward to higher shareholder value in the future from a management team that is concentrating on growing a profitable business through new product development and niche acquisitions.
The bottom line
Tyson's purchase of Hillshire Brands was undoubtedly a blockbuster acquisition, immediately doubling the size of the company's prepared-foods segment and positioning it for improved future profitability. That being said, Tyson paid a rich price for its prize and took on a sizable amount of debt, putting pressure on management to find the cost savings that was part of the rationale for the deal. As such, investors should probably wait for management to deliver a bit on its promise prior to taking a position in Tyson.