TSN might be too expensive to be a good defensive investment

When markets become volatile, it usually means that investors are becoming increasingly uncertain and nervous. Uncertainty can come from all kinds of different things – concerns about inflation, wage growth, central bank monetary policy, earnings trends, and geopolitical events. For most of the last three months, most of the uncertainty in the market has revolved around the spectre of trade war between the U.S. and its biggest trading partners. That fear seems to have raised its ugly head once more this week as new economic reports indicate the U.S. economy is slowing. Even as new trade discussions are set to begin between the U.S. and China this month, uncertainty is increasing as the conclusion most investors seem to be drawing is that tariffs between the world’s two largest economies are finally being felt in a real way to curb growth in a U.S. economy that’s been expanding practically without interruption for a decade.

When economic concerns increase, investors often start to look for investments that are defensive in nature; that is, they’ll usually start moving money into less volatile, more “secure” assets like Treasury bonds and T-bills, or into stocks that they think should be less cyclical in nature and so have less risk than other stocks. Food companies, including Packaged Foods, which is the industry that Tyson Foods, Inc. (TSN) sits in, often fits into that description. The company’s fundamental profile shows important signs of strength, including increasing liquidity and expanding operating profits. The effects of African Swine Flu over the past year are generally seen as a positive for the company, as the outbreak has reduced pork supply around the globe, most notably in China. That increases reliance on other sources of protein, which works in TSN’s favor as the world’s largest manufacturer of protein products. China is the world’s biggest consumer of pork, it also means that TSN is in a unique position under current trade conditions, since the massive reduction of pork supply in China means that country will be forced to look to U.S. companies to make up the protein difference that it can’t cover on its own. They also can’t rely on other countries than the U.S. since the shortfall is so big, America is the only producer with enough protein production to compensate.

Those are great reasons to think that TSN could be a fantastic stock to pay attention to if the market does, in fact turn bearish enough to finally reverse its long-term upward trend. The risk, however is that the elements I’ve just mentioned have already been factored into the stock’s price is a big way; TSN is up nearly 54% year to date. It has dropped about -5% in the past month, but still remains at valuation levels that suggest it still might not represent a very good value right now. That means you might want to keep paying attention to the stock for a better price, but to be cautious about how quickly you jump into TSN for a long-term investment. Let’s dive in.

Fundamental and Value Profile

Tyson Foods, Inc. is a food company, which is engaged in offering chicken, beef and pork, as well as prepared foods. The Company offers food products under Tyson, Jimmy Dean, Hillshire Farm, Sara Lee, Ball Park, Wright, Aidells and State Fair brands. The Company operates through four segments: Chicken, Beef, Pork and Prepared Foods. It operates a vertically integrated chicken production process, which consists of breeding stock, contract growers, feed production, processing, further-processing, marketing and transportation of chicken and related allied products, including animal and pet food ingredients. Through its subsidiary, Cobb-Vantress, Inc. (Cobb), the Company is engaged in supplying poultry breeding stock across the world. It produces a range of fresh, frozen and refrigerated food products. Its products are marketed and sold by its sales staff to grocery retailers, grocery wholesalers, meat distributors, warehouse club stores and military commissaries, among others. TSN has a current market cap of $30 billion.

Earnings and Sales Growth: Over the last twelve months, earnings actually dropped -2%, while sales increased about 8.3%. Things look much better in the last quarter, as earnings increased by 22.5% while sales grew a little over 4%. TSN operates with a modest margin profile that appears to be strengthening; in the last twelve months, Net Income was 5.27% of Revenues and increased to 6.21% in the last quarter.

Free Cash Flow: TSN’ Free Cash Flow is generally healthy, at almost $1.3 billion. That number has decreased over the past year from about $1.6 billion, and was about $1.9 billion in June of 2018.

Debt to Equity: TSN has a debt/equity ratio of .74, which is pretty conservative. Cash and liquid assets increased from about $170 million in June of 2018 to $406 million in the last quarter. The increase is a positive sign, but TSN also carries about $10.4 billion in long-term debt, which means that liquidity could be an issue in the event of a shortfall in company’s operating profits, however for now their balance sheet indicates operating profits are more than sufficient to service their debt.

Dividend: TSN pays an annual dividend of $1.50 per share, which at its current price translates to a dividend yield of 1.8%. TSN’s dividend has also increased from $1.20 per share a year ago.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for TSN is $38.78 per share. At the stock’s current price, that translates to a Price/Book Ratio of 2.12. TSN’s historical average Price/Book ratio is 2.21, implying the stock is only about 4% below its fair price. It is also nearly at par with its historical Price/Cash Flow ratio, which means that long-term upside could be limited for TSN – especially if broad market sentiment remains bearish.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The diagonal red line outlines the stock’s upward trend beginning in January of this year to its peak in early September. It also provides the baseline for the Fibonacci retracement lines on the right side of the chart. The stock hit a high point at the beginning of September at around $94, but has dropped back sharply over the past month, and is just a few dollars away from recent pivot support at around $80.50. If the currently bearish momentum continues, a drop below $80.50 could see the stock drop to about $77, where the 38.2% retracement line sits, with further downside at around $72 at the 50% line. In order to show any signs of sustainable bullish momentum, the stock would need to push above its recent pivot high at around $89, to $89.50 at least; the next test from that point of any kind of useful bullish long-term opportunity would be seen at the stock’s 52-week high at $94.

Near-term Keys: From a long-term perspective, it’s hard to see a lot of long-term upside in TSN, despite its generally strong fundamental profile. The market’s uncertain conditions right now mean that despite TSN’s generally good defensive positioning, it is likely to be sensitive to market volatility; the stock’s drop over the past month is a strong reflection of that reality. It also the reason that looking for a bullish short-term trade in TSN offers a very low probability of success. The best signal to look for would come from a drop below the stock’s current support at $80.50; if that happens, consider shorting the stock or working with put options, with an eye on $77 as a short-term exit target, and $72 or even $67 at the 61.8% retracement line if bearish momentum really picks up. If the stock does drop to around $67, that might be a good time to start considering the stock as a strong long-term value play, since TSN would be discounted by about 20% below its historical Price/Book ratio at that point.