Smithfield Foods, Inc. — Form 10-Q Summary
Reporting period: Third quarter and first nine months of fiscal 2012, ended January 29, 2012. Comparisons are with the periods ended January 30, 2011. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and financial performance
Smithfield is a hog producer and pork processor with Pork, Hog Production, International and Corporate segments. The former turkey and Butterball operations were sold in December 2010 and appear in prior-period results.
| Metric | Q3 FY2012 | Q3 FY2011 | Nine months FY2012 | Nine months FY2011 |
|---|---|---|---|---|
| Sales | $3,478.3 | $3,186.2 | $9,885.1 | $9,086.3 |
| Gross profit | $379.8 | $457.2 | $1,206.5 | $1,257.6 |
| Gross margin | 11% | 14% | 12% | 14% |
| Operating profit | $170.5 | $372.7 | $568.4 | $828.4 |
| Net income | $79.0 | $202.6 | $281.8 | $422.6 |
| Diluted earnings per share | $0.49 | $1.21 | $1.72 | $2.53 |
| Interest expense | $42.3 | $60.3 | $134.6 | $194.4 |
Quarterly sales rose 9%, but gross profit fell 17% and net income fell 61%. For the first nine months, sales rose 9%, while gross profit declined 4% and net income declined 33%. Higher hog and feed costs pressured margins; lower interest expense partly offset the operating deterioration.
- Cash flow: Nine-month operating cash flow was $210.7, down from $390.6. Capital expenditures were $199.0, versus $112.1; investing cash flow was negative $189.2, compared with positive $280.6 in the prior period, which included Butterball-sale and insurance proceeds. Financing cash flow was negative $227.9. Cash fell $211.1 to $163.6.
- Debt and liquidity: Balance-sheet long-term debt and capital lease obligations, including current maturities, totaled $1,978.4 at January 29, 2012, versus $2,122.3 at May 1, 2011. Management reported net debt to total capitalization of 34%. Cash of $163.6 plus $1,076.9 of available credit facilities provided approximately $1.2 billion of liquidity. No substantial debt obligations were due until fiscal 2014, according to management.
- Other financial items: The effective tax rate was 36% for the quarter and 33% for nine months, compared with 32% and 31%. A $10.6 release of uncertain-tax-position reserves reduced nine-month tax expense. Pension contributions were $132.1, including a voluntary $100.0 contribution. The company repurchased 5.5 million shares for $110.6 during the nine months.
Material changes and segment results
- Pork: Q3 operating profit fell to $195.9 from $254.8. Fresh pork profit fell to $78.5 from $130.3 as hog prices increased 23% and selling prices did not fully offset raw-material costs. Packaged-meats profit was $117.4 versus $124.5. Nine-month segment profit was $503.8 versus $557.0.
- Hog Production: Q3 operating loss was $6.6 versus $2.3; nine-month profit was $127.0 versus $139.8. Higher feed costs offset higher live-hog prices. Domestic raising costs averaged $63.73 per hundredweight for nine months, up from $53.18.
- International: Q3 operating profit was $6.2 versus $34.5; nine-month profit was $23.5 versus $103.1. The current quarter included Smithfield’s $38.7 share of Campofrío Food Group (CFG) restructuring charges. Foreign exchange translation reduced Q3 segment sales by approximately $33.5.
- Corporate: Q3 operating loss was $25.0, compared with profit of $86.2 in the prior year. The prior period included a $120.6 insurance-recovery gain related to the Cudahy plant fire. Nine-month corporate results also included $6.4 in professional fees for a proposed CFG acquisition that was abandoned.
Outlook, commentary and risks
- Management expected fresh-pork margins to move toward historical operating profit of $4–$7 per head for the rest of fiscal 2012, then improve in fiscal 2013. It cited healthy export demand and tighter protein supplies, while warning that weaker exports could pressure margins.
- Management expected packaged meats to remain profitable through fiscal 2012 and fiscal 2013, with operating margins averaging $0.10–$0.15 per pound. It reported core-brand retail volume growth of 2% for the first nine months.
- For Hog Production, management expected full-year fiscal 2012 margins at the low end of its normalized $10–$15 per-head range. It forecast domestic raising costs in the mid-$60s per hundredweight in Q4 and low-$60s in fiscal 2013. Some production was hedged against commodity-price movements.
- International results were expected to improve in parts of the business, while CFG’s multi-year manufacturing consolidation plan was expected to support longer-term performance. These forecasts are subject to volatile commodities, economic conditions and execution risks.
- Restructuring and investment: The Portsmouth, Virginia plant was to close as production moved to an expanded Kinston, North Carolina facility. The expansion was estimated at $85, with completion expected by fiscal 2013; approximately $68 of related capital spending remained. Accelerated depreciation and other related charges were recorded. Certain Missouri farm assets were permanently idled, with accelerated depreciation charges also recorded.
- Litigation: Smithfield increased its Missouri nuisance-litigation accrual by $39.0 in Q1 and said a global settlement was probable, but no agreement had been reached. It could not estimate maximum exposure or additional possible loss; payments could reduce cash flow. The company intended to seek insurance recovery.
- Other risks: Commodity, interest-rate and currency exposure is managed partly through derivatives; market movements can affect earnings and require collateral. Cash on deposit with brokers was $40.8 at quarter-end. Smithfield also guaranteed certain joint-venture debt and leases. CFG’s quoted share price indicated a possible impairment, but management concluded its investment’s fair value exceeded carrying value and recorded no impairment.
Important facts for investors to verify
- Whether fresh-pork pricing and packaged-meats margins can offset elevated livestock and feed costs, and whether the stated segment outlook is achieved.
- Progress and total cost of the Kinston expansion, Portsmouth closure and Missouri farm changes, including remaining capital expenditures and future charges.
- Outcome of Missouri nuisance-suit settlement negotiations, adequacy of the recorded accrual and timing or amount of any insurance recoveries.
- CFG’s operating recovery and valuation assumptions, including whether future results or market conditions require an investment impairment.
- Liquidity and covenant headroom under the credit facilities, cash requirements from debt maturities, derivative collateral and pension funding.