Tyson Foods: Grease Lightning

Tyson Foods (symbol TSN) wants a chicken in every gas tank. Well, not exactly, but that's the idea behind the plans of the world's largest meat company to turn its greasy waste into biodiesel fuel.

The Springdale, Ark., company plans to convert its fatty by-products, known as tallow, into fuel. Tyson has struck deals with oil giant ConocoPhillips (COP) and Syntroleum (SYNM), a tiny company that develops synthetic fuel technology, to process millions of gallons of animal grease each year. "Fat is the new crude," says analyst Timothy Ramey, of brokerage D.A. Davidson & Co. One-third of all animal fat in the U.S flows from Tyson's slaughterhouses. As far as biodiesel production is concerned, it makes no difference whether the fat is derived from beef, chicken or pork.

For Tyson, says Ramey, the biggest benefit of the biodiesel deals will be their impact on the market price of tallow. Ramey says that biodiesel adds a higher value use for tallow, which has been used to make other products, such as soap and livestock feed. And, although you can increase the production of corn by planting more acreage, there is no way to produce more tallow efficiently since it is a by-product of the meat industry. Plus, converting animal fat into biodiesel can take place in existing refineries using the same chemical processes employed to refine crude oil. "This is a huge advantage over other renewable fuels, like ethanol, that require large capital outlays," Ramey says. He adds that he expects tallow prices "to rise significantly, just as the price of corn rose in response to demand for ethanol."

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But profitability of animal-fat biodiesel depends on the cost of other fuels. "It's not clear to me that it's going to be economical," says Jack Robinson, manager of the Winslow Green Growth fund, which invests in alternative energy companies. "Before I get too excited about that, I'd want to spend more time understanding that technology. It's unproven."

Ramey says he doesn't expect the bump in tallow prices to affect Tyson's earnings in the current fiscal year, which ends in September. Tyson says it expects its joint venture with ConocoPhillips to start production in late 2007 and hit its stride by 2009. Once fully operational, Tyson forecasts, the venture will boost earnings by 4 cents to 16 cents per share annually, depending on tallow and energy prices.

As for the venture with Syntroleum, both companies plan to split the costs of a $150 million synthetic fuel plant over the next 2½ years. The plant is expected to begin operations in 2010. Tyson forecasts that the plant will generate between $35 million and $60 million in operating profits annually but doesn't have specific earnings-per-share projections. "This will be a small line in Tyson's business, regardless of how important alternative fuels become," says Matt Hougan, editor of the commodity investing site HardAssetsInvestor.com.

Tyson also aims to become an animal-fat broker. In addition to the ventures with ConocoPhillips and Syntroleum, Tyson will use its pull in the meat industry to collect fat drippings from other livestock processors and funnel tallow to its biofuel projects. That business offers interesting growth prospects for Tyson, Hougan says, but "it won't add 50 cents per share to earnings in next year or anything like that."

The speculative biofuel deals come as Tyson has turned around its main businesses. The company expects to earn 65 cents to 90 cents per share for the year ending September 30. In fiscal 2006, Tyson lost 37 cents per share, the result of a weak meat market, the bird flu scare and high feed prices. In response, the company cut unprofitable business lines and raised prices. Those moves placed all its segments -- beef, chicken and pork -- in the black. On the negative side, Tyson estimates that animal feed prices will rise more than 35% this fiscal year, mainly because of skyrocketing corn and grain prices due in part to-you guessed it-strong demand from ethanol producers.

Tyson shares have rebounded along with the business. The stock, which closed at $23.68 on July 6, is up 45% year-to-date and trades at 28 times the 85 cents per share that analysts expect the company to earn in fiscal 2007. Thanks to cost-cutting and business improvements, Ramey thinks Tyson will generate earnings that beat Wall Street expectations. He rates the stock a "buy" and has a 12-month price target of $28.