Smithfield Foods (SFD)

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Approximately 52% of Smithfield's profits come from processed meats sold under one of Smithfield Foods' private brand names, a percentage that the firm hopes to increase in the future.^[1] These products are sold at higher margins, even in times of rising commodity prices - whereas fresh meat is sold to butchers, who then mark up the product to earn a profit. Processing the meat itself allows the company to earn maximum profit from each sale and to pass a higher percentage of input costs onto consumers.

By vertically integrating its hog production and processed pork segments, Smithfield is insulated from the hog commodity market. It is not, however, insulated from feedstuff commodity prices, like grain, since 60-65% of the cost of raising hogs is feedstock prices.^[2] Corn makes up 85% of a pig's diet, and demand for corn, spurred by ethanol production as well as an expanding global population, has led corn prices to rise nearly 60% in 2007 and early 2008.^[3] Increased commodities prices depress margins as Smithfield Foods is unable to completely pass on feed prices to consumers.

[edit] Company Overview

Smithfield Foods operates in four segments: pork (its largest segment), international, hog production, and other (turkey production). Until March 2008, when it was sold to Brazil's JBS S.A. (SAO:JBSS3), Smithfield Foods also had a beef segment.^[4]

[edit] Pork

The pork segment consists of fresh pork and packaged meat. Smithfield is shifting strategy towards its packaged meat business, due to the higher margins of private labels. Meat is sold under Smithfield, Farmland, John Morrell, Gwaltney, Great, Cumberland Gap, Armour, Eckrich, Margherita, LunchMakers, and Dinner Bell, among others. The pork segment procures about 52% of hogs from the hog production segment and the rest from the hog spot market.

[edit] Hog Production

The hog production segment consists of raising and selling hogs. It has approximately 900,000 sows producing 14 million market hogs annually, making it the largest producer of hogs in the world. By integrating this segment with the processed pork segment, Smithfield Foods hopes to use economies of scale to decrease the hog cost for each.

[edit] International

The international segment consists of several international meat processing operations. Smithfield has controlling interests in processing plants in Poland, Romania, and the United Kingdom, and smaller interests in plants in Western Europe, Mexico, and China.

[edit] Other

The other segment consists of turkey production relating to the 49% stake that Smithfield Foods owns in the Butterball company.

[edit] Beef (Discontinued Operation)

Smithfield Foods sold its beef segment in early 2008 for $565 million. This sale has improved Smithfield Foods' margin because the beef segment only earned $5.7 million on $2574.7 million in sales. Additionally, the sale decreased Smithfield Foods' leverage, as the company used the proceeds of the sale to pay off long term debt and therefore decrease its debt to equity ratio.

[edit] Financials

As of fiscal 2007, Smithfield Foods had $2.8 billion dollars of long-term debt on a $7 billion balance sheet. Cash reserves are $57.8 million, as Smithfield has spent most of retained earnings on growth through acquisitions.^[5] However, the $565 million sale of Smithfield Foods' beef division should provide the company with necessary liquidity. The chart to the left illustrates revenue and operating income from 2005 to 2007. While revenue increased, operating income remained largely the same due to rising commodity prices. The graph on the right illustrates Smithfield Foods' sales by operating segment.

[edit] Key Trends, Risks, and Forces

• Rising Feedstuff Prices Cut Smithfield Foods' Margins as Corn Is 85% of a Pig's Diet: Smithfield Foods is heavily dependent on favorable pricing of feedstuff, such as corn prices and soybeans, as well as hog and cattle prices. Corn prices have risen sharply since the beginning of 2007, as ethanol producers have increased their demand for the commodity (rising oil prices, in turn, have increased demand for ethanol). Smithfield Foods engages in various hedging activities to "lock in" to current prices and protect itself from price increases. It does this by buying forward grain contracts at current prices. This means the company is protected in the case of raising prices, but is also liable in the case of falling prices because it will continue to pay the contracted rate. Any long-term, significant increase in feedstuff prices has the potential to seriously depress margins and reduce profitability. Though hog prices have steadily declined, Smithfield Foods is insulated from price increases by supplying its processed pork segment with lower priced hogs from its hog production segment.

• Smithfield Foods Has Significant Exposure to Several Customers: In 2007, Smithfield's top ten customers, including McDonald's (MCD) , Subway, and Wal-Mart Stores (WMT), represented 26% of net sales.^[6] However, Smithfield does not have long-term sales agreements with any customers and does not, therefore, have a guaranteed source of revenue. The loss of one of these top customers would have a significant impact on Smithfield's balance sheet.

• Smithfield's Transition towards Value-Added Meats Will Increase Margins: Smithfield Foods is looking to increase revenue from processed meats (currently just over half of revenues). These products carry a higher margin than fresh pork, because they are sold one step closer to the consumer on the supply chain - to stores, rather than to butchers who then mark up the meat once again before selling to stores. Rising commodity prices factor into the price that consumers must pay for their pork, but these input costs cannot be passed on in their entirety. By eliminating an extra step in the sales process, Smithfield can pass a higher percentage of production costs onto the consumer as well. As of 2007, Smithfield Foods sold 2.9 billion pounds of processed meat versus 3.1 billion pounds of fresh pork.^[7]

[edit] Competition

Smithfield Foods is currently the world leader in hog production and has 25% of the market share in United States pork. ^[8]

^[9]

[edit] References

1. ↑ [1]SFD 2007 10-K, Item 1, pg.9
2. ↑ Morningstar Analyst Note 8-23-07
3. ↑ [2] National Corn Growers Association Futures Quotes
4. ↑ [3]"Meat producers' shares rise on Smithfield Foods sale of beef unit to JBS S.A." CNN Money Online
5. ↑ [4] SFD 2007 10-K, Item 1a, pg.18
6. ↑ [5] SFD 2007 10-K, Item 1a, pg.20
7. ↑ [6]SFD 2007 10-K, Item 1, pg.4
8. ↑ Morningstar Analyst Note 4-3-2008
9. ↑ [7]Wikinvest, Tyson Foods