(Editor's note: Updates to reflect today's earnings release from Tyson.)BOSTON ( TheStreet) -- Tyson ( TSN - Get Report), the world's largest meat company, is satisfying protein-hungry diets outside the U.S. That led to fiscal first-quarter sales jumping 15%, and profit margins widening almost 50%. Yet, with commodity prices on the rise, Tyson will have to keep passing those costs on to customers if it wants to keep improving. Tyson reported fiscal second-quarter profit of 42 cents per share today, falling slightly short of analysts' estimates of 43 cents. Revenue of $8 billion exceeded expectations of $7.54 billion, yet gross margins narrowed to 6.7% from 8.2% Tyson has made great strides. Key initiatives such as better inventory control and a focus on efficiency at production plants has led to $600 million in performance improvements in its chicken business alone over the past three years. Investors have taken notice, with the stock up 13% this year, easily exceeding the performance of the S&P 500 over the same period.
The problem now is that aside from an increase in grain prices relating to the chicken segment, high hog and cattle prices are an additional worry. With feed prices on the rise, farmers have been less inclined to place their cattle in feed yards. This, in turn, has brought production levels way down and prices up. Yet, Tyson reported impressive results in both its pork (revenue up 30% in a year) and beef units during the first quarter. With supplies down, Tyson has benefited from the location of its regional plants, which are near key feeding zones (such as Nebraska and Iowa) for cattle and hogs, areas considered to be more efficient for farmers. Despite increased cost pressures, TheStreet Ratings' quantitative model has a "buy" rating and a $25.60 target on Tyson, offering a potential 33% upside from current levels. The company scores best for growth, driven by a big improvement in earnings. Our model also picked up on Tyson's healthy balance sheet. Management has retired nearly $1 billion in debt over the past year, leading to an expected decrease in net interest expenses of $90 million (a 27% drop) in 2011. Tyson earns excellent scores for valuation. Tyson management has guided for similar results in fiscal 2011 as compared with fiscal 2010. If Tyson can hit management's guidance of $2.06 EPS for fiscal 2011, the stock looks cheap, trading at just 9.3 times fiscal 2011 estimates. If assuming just 5% growth in earnings ($2.16) for 2012 (Tyson has said it doesn't see meaningful volume growth for the industry until 2012), the stock trades at a very reasonable forward multiple of only 8.9 times earnings. Estimating Tyson's intrinsic value based on the historical five-year price-to-earnings average for the group (of 12 times) and the 2012 estimate of $2.16, would lead to a potential price for the stock of $26. Tyson also appears extremely inexpensive on an EV/EBITDA basis, currently trading at roughly 4 times, compared with the current average of its competitors Hormel ( HRL - Get Report), Pilgrim's Pride, Sanderson Farms ( SAFM - Get Report) and Smithfield Foods ( SFD) of 7 times. Valuing Tyson at these normalized levels implies a valuation on the stock of $37.
Among Tyson's direct competitors, TheStreet Ratings' model also likes Hormel and Smithfield Foods, both rated "buy." Hormel, famous for the Jennie-O, Dinty Moore and Spam brands, is also facing increasing cost pressures, but like Tyson, the company has performed impressively. The company has a pristine balance sheet (13.7% debt-to-equity), yet trades at a premium to Tyson at 17.5 times earnings. Tyson's other poultry competitors, Pilgrim's Pride and Sanderson Farms, are rated "hold" by our model. Tyson's valuation has been pressured due to worries over increasing commodity costs, yet the company has reported impressive results. With management taking all the right steps to improving operational efficiencies, paying down debt, investing in its foreign operations and managing feed-contract costs, I believe the worries have been overblown. While the commodity-price risks are real, the company appears well-positioned to benefit from the rising consumption of chicken and increased protein demands internationally. At current valuations, the reward outweighs the risk, and I'd be a buyer at these levels. Readers Also Like: >>3 Commodities Stocks Investors Should Dump >>Priceline's Big Run May Just Be Starting