Krause Fund Research Spring 2017 , Inc. (NYSE: TSN)

Recommendation: BUY

Consumer Staples April 17, 2017

ANALYSTS Yue Li Current Price: $64.46 [email protected] Target Price Range: $74.00 – $78.00 Hannah Hendricks [email protected] Rachel Langholz KEY INVESTMENT HIGHLIGHTS [email protected] • Favorable Market Environment: Given the COMPANY OVERVIEW prevailing low commodity costs and strong demand for its Tyson Foods, Inc. (NYSE: TSN) is one of the world’s products, we believe TSN is well positioned to benefit foremost meat processors operating within the broader from the current favorable environment over the short-term food products industry. Founded in 1935 and horizon. headquartered in Springdale, , TSN currently • Increasing Demand of Lean Protein Foods: As employs approximately 114,000 across both its consumers are becoming more health-conscious, we foresee domestic and foreign operations. TSN’s operations are a growing preference towards chicken as the primary source separately reported in four operating segments: chicken, of protein. We thus expect the long-term growth of the beef, pork, and prepared foods. The firm’s high market chicken segment to outpace other meat segments, with a CV penetration is facilitated by its vertically integrated year growth rate of 2.69%. chicken operations as well as its recognizable packaged • Product Innovation: TSN has long been proactively food brands such as , Hillshire Farms, and reacting to consumer demand shifts through market Ball Park. After the acquisition and consolidation of the research and product development. As consumers attach Company in 2014, TSN’s brand more value to healthy value-added products, we anticipate leadership was solidified and its value-added packaged that TSN’s continued product innovation will drive the food segment became a primary driver of value going prepared foods segment to grow at 3.30% in the CV year. forward. • Price Fixing Investigation: TSN’s involvement in SEC price fixing subpoena has put downward pressure on STOCK PERFORMANCE HIGHLIGHTS its stock price since the announcement on February 6, 2017. 52 Week High $55.72 We factor a contingent liability related to this allegation into 52 Week Low $77.05 our valuation, lowering our target price to be in line with Beta Value 0.86 analysts’ estimates. Average Daily Volume 2.76 m ONE-YEAR STOCK PERFORMANCE SHAREHIGHLIGHTS Market Capitalization $23.66 b Shares Outstanding 286.95 m Book Value per share $26.01 EPS (Trailing Twelve Months) $4.96 Trailing P/E Ratio 13.00 Dividend Yield 1.06% Dividend Payout Ratio 13.58%

COMPANY PERFORMANCE HIGHLIGHTS ROA 8.44% ROE 19.70%

Sales $36.91 b Source: Yahoo! Finance EXECUTIVE SUMMARY 1.9%. iii This upward revision is largely supported by higher-than-expected consumer spending. As the economy Our team is issuing a BUY rating for Tyson Foods, Inc. continues to grow, we expect real GDP to reach an annual (NYSE: TSN) for the Krause Fund portfolio since we growth rate of 2.3% in six months. We further believe real foresee TSN maintaining its steady growth under the GDP will experience slow yet steady growth to an average favorable market environment. We believe that TSN is well annual growth rate of 2.5% into 2020. This would lead to a positioned to benefit from the rising demand for protein- sustainable economy that is favorable for corporate rich foods, especially in the chicken segment given the operations and employment conditions yet not trigger higher perceived level of healthiness associated with unnecessary concerns over potential inflation. chicken. We further believe that the Hillshire acquisition continues to create value for TSN in addition to operational As the overall economy is expected to strengthen going synergies and product diversification. As customers attach forward, we believe that moderate real GDP growth more value to innovative and healthy products, we believe indicates a healthy economic environment where that TSN’s investments in the prepared food segment will unemployment is low and inflation is minimal. Low pay off in terms of enhanced profitability. However, the unemployment would be translated into higher wages, and recent SEC subpoena over the price fixing issue in the thus people would demand higher standards of living. chicken industry has raised a downside risk that we should Minimal inflation would lead to increased buying power, account for. Incorporating all these factors into our which is viewed postively by both consumers and valuation model, we get a target price range of $74.00 – producers. All these factors would create a favorable $78.00. Compared to its current undervalued stock price, consumption environment, enabling companies within the we believe it is optimal to keep holding TSN in the sector to achieve higher growth in corporate revenues. portfolio. Inflation Inflation is the upward movement in prices for goods and ECONOMIC ANALYSIS services and the corresponding depreciation in purchasing power.iv It is an important driver since moderate inflation Gross Domestic Product is healthy for the consumer staples sector.v Consumer Price Real gross domestic product (GDP) is a measurement of Index (CPI) and Producer Price Index (PPI) are two the inflation-adjusted value of all goods and services indicators widely used to gauge inflation at the retail level produced by a country within a year.i Given that more than and the wholesale level, respectively. three-fifths of the total GDP is contributed by personal consumption expenditures, of which 30% is spent on nondurables, ii real GDP is an important indicator to consider when evaluating the consumer staples sector.

Source: Bureau of Labor Statistics

According to the latest news release from the Bureau of Labor Statistics, the CPI is up by 2.4% over the 12-month

Source: Federal Reserve Economic Data period ending March 2017, which is higher than the average of 1.8% over the last decade.vi Despite that the PPI Since the recovery from the financial crisis in 2009, there Finished Goods fluctuates for the past few years, it has been a steady growth in the U.S. real GDP. In the fourth generally keeps the pace with the CPI, as evidenced by the quarter of 2016, real GDP has increased at an annual rate graph above. With that being said, consumer staples of 2.1%, as compared to the prior preliminary estimate of companies are capable of passing on input price increases

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to consumers over the last two years, relieving them from an unfavorable environment for the consumer staples sole cost absorption. sector. Consumer spending weakens since consumers are more inclined to save their disposable income to earn In view of the growing U.S. economy, we believe that the higher interests. Additionally, higher interest rates create a CPI will continue to increase by 0.2% in six months, more expensive environment for capital expenditures. eventually reaching an annual inflation rate of 2.5% in two to three years. We interpret this level of inflation as a good Unemployment sign for the consumer staples sector. Given that food, Although firms operating within the consumer staples beverages, tobacco, household and personal products are sector produce fundamental goods and services, a steady necessities that are less price elastic, a marginal increase in demand for their respective products is largely ensured by price would not impose a negative effect on customer a reliable source of discretionary income from consumers. demand. Therefore, companies within the sector are able to Consumers spend more on high-margin products when maintain units sold while charging more for products, they have a higher proportion of disposable income ultimately realizing higher revenues. available. x Hence, low unemployment serves as an important factor