Savvy investors know conference calls are more informative than quarterly earnings releases because they offer color and insight about the business in question. So it makes sense to pay attention to these events. One of my favorites is the Tyson Foods (NYSE:TSN) call, and if you're reading this, it's probably one of yours, too.
CEO Donnie Smith offered plenty of interesting nuggets regarding the third quarter in the company's conference call on July 28. Here's a rundown of the most important things Smith had to say.
No. 1: The Hillshire Brands acquisition is transformative
I'd like to say a few words about the Hillshire acquisition. Several of us had the opportunity to spend some time in Hillshire in Chicago and we're beyond impressed with their team. We're excited about taking their expertise and combining it with ours to create a prepared foods business with strong stable margins and steady growth. As we execute our prepared foods strategy, we're estimating the impact of the synergies with Hillshire along with the cost savings and production efficiencies associated with the plant closures will be more than $225 million in fiscal 2015 and should exceed $500 million by the end of year three.
The gaudy $225 million in cost savings will grab headlines, but the success of the Hillshire acquisition will depend on how smooth the integration goes. At $7.7 billion, Tyson's purchase equals more than half its market cap, so there's plenty of room for error. In fact, it's the largest meat deal on record, so we should expect plenty of bumps along the way. But if the two companies can work together, the combined entity will have plenty of shelf space in your local supermarket. And as you know, shelf space equals sales.
No. 2: Accidents hurt volume
So let's take a look at our segments, because we had some issues and there's room for improvement. The chicken segment had a 6.9% return on sales in Q3. Pricing was down 1% due to the untimely and unfortunate events that resulted in the loss of volume in our high-margin value-added products. In February of this year, we experienced a fire at one of our fully cooked processing plants. Fortunately, no one was injured. But the damage to the infrastructure was more serious than we had originally thought. And our ability to supply products suffered. The mechanical repairs are now complete and the plant is back to producing normal volumes.
Additionally in Q3, a second sizable fully cooked processing plant experienced a series of operational issues and the volume in supplies has been significantly affected. New equipment has been ordered and is being installed and we expect to be back at full production volume in the early weeks of our fiscal Q1 of '15. On our Q2 call, you'll remember that I mentioned that we're completely out of fully cooked capacity in our chicken business, which is why we weren't able to move production to other facilities following either event. So we've endured ... long sizable production shortfalls in one of our highest revenue, most profitable business during a time when high-priced beef and pork accelerated the demand for chicken.
Aside from day-to-day operational misfires, you have to wonder why management would be comfortable with most of its plant volume coming from only a couple of locations. When things inevitably go wrong, Tyson should be able to maintain supply.
On the flip side, the company doesn't seem to be wasting money on facilities that aren't essential to its operation. Controlling costs and eliminating waste are critical for this kind of business. Overall, I think the manufacturing disruptions taught Tyson a lesson, and that steps will probably be taken to prevent these issues from arising again.
No. 3: Tyson is raising cash
Also regarding our International segment, we announced this morning that we're selling our operations in Mexico and Brazil to JBS for $575 million. Although these are good businesses with great team members, we haven't had the necessary scale to be a market share leader in either country, which is our preferred position. The sale represents an attractive price and the proceeds will be used to pay down debt associated with the Hillshire acquisition.
When you buy a company that is half your size, liquidity becomes very important. One way to raise cash is to sell noncore assets. I think management made the right decision selling a second-tier operation that wasn't big enough. Getting more than $500 million for it was a nice coup.
No. 4: A low-margin business can still generate a hefty return
Moving on to the beef segment, which had a 2.4% return on sales. The quarter got off to a slow start, but finished strong as the summer grilling season brought robust demand despite record high pricing. And even with those high prices, we were successful in promoting our premium branded beef programs. Our commitment to operational excellence and revenue-enhancing programs continues to work well. People often forget that a business with the 2% return on sales can still generate a pre-tax ROIC of 15% if you maximize the efficiency of your assets to turn your capital quickly, which is what we do.
Obviously, beef has taken a back seat to chicken offerings at Tyson. It's also a lower-margin business, so care is needed if beef is to remain profitable. It's ultra critical to push the higher-margin premium brands, which will help keep profitability afloat. It's also important to run a tight ship and control costs. By putting plants close to feed lines in the grain belt (or more near the cattle), Tyson is making a smart move to maximize profits.
No. 5: Despite the headwinds, pork is doing fine
Turning to the pork segment, we had a record third quarter with a 7.2% return on sales. We've managed the supply challenges created by the PED [porcine epidemic diarrhea] virus very well. We were able to move supply among our facilities, adjust orders and maximize revenue. In fact, our volume was up 5% versus the same quarter of a year ago, and demand remained strong as indicated by pricing that was up 26%. Looking ahead into fiscal '15, four factors indicate that we should have an adequate supply of hogs, portending another solid performance from that segment.
Futures prices indicate the industry is expecting more hogs later this fall. Hog weights are already very heavy and we would expect that to continue. PED seems to have slowed through the warmer months, but of course may reappear as we head into winter. And finally, lower price corn may incentivize some level of expansion into 2016.
Tyson did a nice job navigating the PED scare and maintained volume despite all the issues. The four drivers for pork supply are the price of feed, size of the hogs, futures prices (which help to determine costs), and disease. Management expects smooth pork sailing through next year.
Foolish final words
Tyson is a lean, mean, operation. While this may sometimes hurt business (like when the company ran out of capacity after the plant fire), it's good to know management is paying attention. Whether it's a 15% return on a 2% margin business or putting up a plant close to animals, Tyson has a laser-like focus on costs. I also like the way management makes common-sense decisions to raise cash, such as by jettisoning noncore businesses with an inferior market position.
One caveat: I'm not a fan of large, transformative acquisitions. That's because it's very hard to integrate a massive operation into an existing business. But this team seems so focused on costs that it should be able to pull off the Hillshire deal. You don't have to be an industry insider to understand that adding $500 million of profit (via cost savings in just three years) is exceptionally impressive. Tyson (with Hillshire) is taking over your local supermarket, which should be great for business.
Wade Michels has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.