Smithfield Foods, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2012, the three months ended July 31, 2011; comparison is the three months ended August 1, 2010. Smithfield is a global hog producer and pork processor, with Pork, Hog Production, International and Corporate reportable segments. Results exclude the turkey and Butterball businesses sold in December 2010.
Financial results
| Metric | Q1 FY2012 | Q1 FY2011 |
|---|---|---|
| Sales | $3,094.2 million | $2,901.3 million |
| Gross profit | $407.1 million | $367.7 million |
| Operating profit | $173.2 million | $177.6 million |
| Net income | $82.1 million | $76.3 million |
| Diluted EPS | $0.49 | $0.46 |
| Interest expense | $48.1 million | $68.6 million |
| Operating cash flow | $(64.2) million | $102.7 million |
| Capital expenditures | $62.9 million | $30.8 million |
Sales rose 7% and gross profit rose 11%; gross margin was approximately 13% in both periods. Operating profit fell about 2%, while net income increased about 8%, supported in part by lower interest expense. Q1 results included a $39.0 million charge for Missouri nuisance litigation, $4.3 million of accelerated depreciation for idled Missouri farm assets, and a $1.2 million debt-extinguishment loss. The effective tax rate was 34%, versus 30%.
Segments and drivers
- Pork: Operating profit increased to $136.7 million from $113.3 million. Packaged meats profit reached a record first-quarter level, supported by pricing discipline and pass-through of higher input costs; fresh pork profit declined to $35.4 million from $46.0 million.
- Hog Production: Operating profit was $69.7 million versus $63.8 million, including the litigation charge. Live hog prices rose 19%, while domestic raising costs rose 15% to $62.88 per hundredweight. Derivative gains were $30.0 million, compared with $4.6 million a year earlier.
- International: Operating profit was zero versus $24.5 million, as higher raw-material costs and weak demand pressured results. Sales rose 19%, including a $37.8 million foreign-currency translation benefit.
- Corporate: Operating loss widened to $33.2 million from $25.2 million, including $5.7 million of fees related to a potential CFG acquisition that was abandoned in June.
Cash, debt and liquidity
Cash and equivalents fell to $149.9 million from $374.7 million at May 1, 2011. The $224.8 million decline reflected operating, investing and financing outflows. Operating cash use included $108.2 million of pension contributions, including a voluntary $100.0 million contribution, and higher working-capital needs. The company expected total fiscal 2012 employer pension contributions of approximately $140 million.
At July 31, 2011, current and long-term debt and capital lease obligations totaled approximately $2.063 billion, compared with $2.122 billion at May 1. Management reported net debt to total capitalization of 35% and a goal of approximately 40% or lower, with a 50% ceiling. Reported liquidity was approximately $1.2 billion, including cash and available capacity under credit facilities. The company said it had no substantial debt maturities until fiscal 2014.
In June, Smithfield replaced its $1.0 billion asset-based revolver with a $925 million inventory revolver (expandable to $1.2 billion) and a $275 million receivables securitization facility; it also extended its $200 million Rabobank term loan to June 2016. The inventory revolver has financial covenants and may mature early in March 2014 if specified 2014-note debt conditions are met. The company redeemed its remaining $77.8 million of 7% notes in July. After quarter-end, it redeemed $13.1 million of 10% secured notes for $14.7 million, with a $1.6 million loss expected in Q2.
Outlook, risks and notable matters
- Management expected fresh pork margins to remain strong, with margins at the high end of its normalized $3–$7 per head range for the balance of fiscal 2012. Packaged meats were expected to remain solidly profitable, with margins averaging $0.10–$0.15 per pound; the company targeted 3% full-year volume growth across its twelve core retail brands.
- Smithfield expected domestic hog production to be modestly profitable in fiscal 2012. Higher feed costs were expected to push raising costs into the mid-to-upper $60s per hundredweight; favorable grain hedges were expected to mitigate some cost risk. The cost-savings initiative was projected to reduce annual base raising costs by about $2 per hundredweight, or $90 million, by fiscal 2014.
- International outlook was mixed: management expected Polish and Mexican operations to contribute positively, Romanian meat operations not to be profitable, and CFG to remain a positive contributor despite European recessionary pressure.
- Missouri nuisance litigation remains uncertain. The company increased its accrual by $39.0 million after progress in settlement talks, but no global settlement had been signed and the company could not estimate maximum exposure or possible losses beyond accrued amounts. A separate $11.1 million jury judgment was affirmed and was to be paid; another trial was postponed. Management said it would seek insurance recovery and did not expect payments to materially harm overall liquidity.
- CFG shares fell after quarter-end, creating a potential impairment indicator; management considered the decline temporary and recorded no impairment as of the filing. Commodity, currency and interest-rate exposure, derivatives and related margin deposits can affect earnings and liquidity. Management cautioned that volatile markets make forecasts difficult.
Important facts for investors to verify
- Progress and ultimate cost of the Missouri litigation settlement, including any insurance recoveries and adequacy of the accrual.
- Whether pork and packaged-meats margins meet management’s stated ranges, and how higher grain and hog prices affect production costs.
- Liquidity and covenant headroom under the new facilities, including the inventory revolver’s conditional early-maturity provision.
- CFG’s market value and whether the post-quarter share-price decline becomes an other-than-temporary impairment.
- Cash requirements from pension contributions, capital spending, debt repayment and the $150 million share-repurchase authorization; $65.1 million had been repurchased through September 7, 2011.