Smithfield Foods, Inc. — Form 10-Q Summary
Business context and period. Smithfield is a global hog producer and pork processor, selling fresh and packaged meats domestically and internationally. This unaudited report covers the three months ended August 1, 2010, the first quarter of fiscal 2011; comparisons are with the three months ended August 2, 2009. The company reports Pork, International, Hog Production, Other and Corporate segments. It moved certain European and Mexican hog-production operations into International and restated prior-period segment data.
Financial performance
| Metric | Q1 FY2011 | Q1 FY2010 |
|---|---|---|
| Sales | $2,901.3 million | $2,715.3 million |
| Gross profit / margin | $367.7 million / 12.7% | $98.7 million / 3.6% |
| Operating profit (loss) | $177.6 million | $(74.8) million |
| Net income (loss) | $76.3 million | $(107.7) million |
| Diluted EPS | $0.46 | $(0.75) |
| Operating cash flow | $102.7 million | $66.5 million |
| Capital expenditures | $30.8 million | $30.4 million |
Sales rose 7%, while gross profit increased substantially and the company returned to profitability. The improvement mainly reflected better hog-production economics and higher fresh-pork prices, alongside $34.1 million of prior-year hog-farm impairment charges. SG&A increased 9% to $201.0 million; interest expense increased 13% to $68.6 million. Mark-to-market derivative gains were $38.6 million, versus $5.9 million a year earlier.
Segments: Pork operating profit was $113.3 million, up 12%; fresh pork improved, while packaged-meat profit fell to $67.3 million from $106.0 million as raw-material costs outpaced price recovery. Hog Production earned $63.8 million versus a $180.2 million loss, aided by higher hog prices, lower raising costs and $11.3 million of breeding-stock sale gains; the prior-year segment included the $34.1 million impairment. International profit was $24.5 million versus $25.4 million, including lower Romanian subsidies. Other earned $1.2 million versus a $4.6 million loss; Corporate operating loss widened to $25.2 million from $16.4 million.
Balance sheet, debt and liquidity
At August 1, 2010, cash and equivalents were $542.4 million; current assets were $3,274.2 million and current liabilities $1,105.6 million. Total assets were $7,596.4 million and total equity $2,801.5 million. Balance-sheet borrowings and capital-lease obligations totaled approximately $2,977.5 million, plus $33.6 million of notes payable; the comparable combined amount at May 2, 2010 was approximately $3,008.1 million.
Management reported liquidity of approximately $1.3 billion: $542.4 million cash, $758.8 million available under the $1.0 billion ABL facility, and $40.4 million available under international lines. Operating cash flow was positive; cash increased $91.2 million to $542.4 million. The company said cash flows and facility availability should cover working capital and obligations for at least 12 months. Capital spending is expected to be below depreciation in fiscal 2011.
Changes, outlook and risks
- Market conditions and outlook: Management described commodity markets as highly volatile. It was optimistic about Pork for the balance of fiscal 2011, citing lower expected slaughter and low freezer stocks; export demand was expected to remain solid. Packaged meats were expected to remain profitable, with margins expected to average above $0.10 per pound despite higher live-hog costs.
- Hog Production: Management expected domestic raising costs to remain in the mid-$50s per hundredweight during fiscal 2011 and estimated the multi-year cost-savings initiative could eventually reduce base costs by about $2 per hundredweight, with full benefits expected by fiscal 2014. Estimated remaining initiative expenses were $33.9 million; management did not expect significant benefit in fiscal 2011.
- Debt restrictions: The company did not meet the notes’ 2.0-to-1.0 interest-coverage incurrence test at quarter-end. This is not a maintenance covenant or default, but restricts certain additional borrowing, dividends, share repurchases and investments. Management said the restriction was not expected to materially harm liquidity. The ABL fixed-charge covenant applies if borrowing availability falls below specified thresholds.
- Subsequent debt repurchase: Through September 8, 2010, the company repurchased senior notes due August 2011 for $71.3 million. It expected a $1.9 million loss and approximately $2.8 million interest savings through maturity.
- Butterball: Smithfield activated the joint venture buy/sell process after offering about $200 million for its partner’s 51% interest and related turkey assets. If Smithfield buys, it would also assume or retire about $240 million of Butterball debt as of August 1; the outcome could change the segment and financing needs.
- Contingencies and other risks: A Missouri nuisance-litigation jury verdict of $11.05 million was on appeal; other proceedings remained pending. A September 2010 consent-judgment extension required farm changes, manure-scraping technology and a $1.0 million voluntary payment; the company did not expect it to materially increase its prior $41 million compliance-cost estimate. The timing and amount of final insurance recovery for the 2009 plant fire remained unknown, although management expected coverage to fully cover costs and losses. Other stated risks include commodity and feed-price volatility, livestock disease, food safety, interest and foreign-exchange exposure, debt, proposed GIPSA rules, and regulation affecting livestock ownership and production.
Important facts for investors to verify
- How much of the earnings recovery reflects sustainable operating performance versus commodity movements, derivative gains and one-time breeding-stock gains.
- Whether higher hog prices and feed costs change fresh-pork and packaged-meat margins, and whether the stated outlook is achieved.
- Progress, timing and total cost of the hog-production savings initiative and related capital projects.
- The Butterball buy/sell outcome, financing plan and effect on debt, liquidity and reported results.
- Debt-covenant headroom, refinancing or repayment plans for upcoming maturities, and ABL borrowing-base availability.
- Developments in Missouri litigation, environmental compliance costs, insurance settlement and proposed GIPSA regulation.