Quick Thoughts – TSN, Rate of Change is What Matters
This morning, TSN reported Q2 ’14 EPS results of $0.60 per share, falling shy of consensus by $0.03 per share. Revenue, a less important metric given the volatility of the company’s margin structure, was +7.2% year on year, beating consensus handily ($190 million).
- With most staples companies, EPS shy of consensus but a healthy revenue growth result would likely cause a muted negative or perhaps even positive stock price reaction, but TSN is a very different animal (pun intended) despite what we have heard from some investors and, to some degree, from the company itself.
- Our belief is that the company is much closer to the end of a very favorable margin cycle driven by a substantial downdraft in input costs (corn and soybeans) following the drought-inflated prices of the recent past.
- Even with the stock down ~8% this morning, we struggle to get any more constructive on the name and, if anything, feel more comfortable with TSN’s position squarely on our least preferred list. We expect that the name will get some defenders and may likely bounce back above $40 per share, but we would only use such a move as an opportunity to short/sell the name.
Operating income increased an impressive $125 million, year over year, but a distressing $175 million of that (140%) was due to lower input (feed costs). Similarly, last quarter, operating income increased $108 million, $170 million of which was driven by lower feed costs (157%). When combined, the company’s year to date (two quarters) of operating income is $773 million, with 44.6% of that comprised of lower feed costs.
- Further, the company revised lower by $100 million (to $500 million from $600 million, revised upward by the same amount only last quarter) its estimate for the benefit of lower feed costs.
- This is wholly consistent with our thesis on higher input costs negatively impacting margins at the protein processing companies.
Rate of change is what matters – As demonstrated above, the company has struggled to grow operating income these past two quarters without the benefit from lower costs, and with the expectation of a full year windfall of $500 million ($345 million in 1H) now 69% realized, the balance of ’14 gets more challenging even absent a material increase in grain prices from current levels. Unless grain prices break down from current levels in dramatic fashion, the company will almost certainly be unable to duplicate the operating income growth of the last two quarters.
The bottom line for us is that we continue to see TSN as a name with broad ownership, a short interest that has declined dramatically since December, and unreasonable margin expectations as contemplated by consensus. There is a reason that TSN refers to “normalized margins” and we believe that every day that goes by is one day closer to the company’s chicken segment returning to “normal”.