Smithfield Foods, Inc. — Fiscal 2013 Third-Quarter 10-Q
Reporting period: Three and nine months ended January 27, 2013; comparatives are the periods ended January 29, 2012. Smithfield produces and processes pork and packaged meats, reporting through Pork, Hog Production, International and Corporate segments. Figures below are in millions of dollars unless otherwise indicated.
Financial performance
| Metric | Third quarter 2013 | Third quarter 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Sales | $3,583.3 | $3,478.3 | $9,900.4 | $9,885.1 |
| Gross profit / margin | $328.8 / 9.2% | $379.8 / 10.9% | $1,038.3 / 10.5% | $1,206.5 / 12.2% |
| Operating profit | $136.3 | $170.5 | $446.4 | $568.4 |
| Income before taxes | $95.7 | $123.6 | $201.1 | $421.6 |
| Net income | $81.5 | $79.0 | $154.1 | $281.8 |
| Diluted EPS | $0.58 | $0.49 | $1.03 | $1.72 |
Quarterly sales rose 3%, but gross profit fell 13% and operating profit fell 20%, mainly from higher hog feed costs and lower U.S. fresh-meat values. Nine-month sales were essentially flat; operating profit fell 21% and net income fell 45%. Nine-month results include a $120.7 million debt-extinguishment loss, versus $12.2 million in the prior period. The quarterly effective tax rate was 15% versus 36%; the nine-month rate was 23% versus 33%, reflecting earnings mix and reinstated tax credits.
Segments and material comparisons
- Pork: Third-quarter operating profit was $179.9, down $16.0. Fresh pork profit declined to $7 per head from $11; packaged meats profit increased to $125.9, with a $0.15-per-pound margin. For nine months, segment profit was $492.8 versus $503.8; packaged-meats margin improved to $0.17 per pound from $0.14.
- Hog Production: Third-quarter operating loss was $64.5 versus $6.6; nine-month loss was $74.0 versus profit of $127.0. Feed-driven raising costs averaged $67.98 per hundredweight in the quarter, up 7%, while live hog prices averaged $59.96, down 2%. Nine-month operating results included derivative gains of $66.3 versus $33.4 in the prior year.
- International: Third-quarter operating profit was $43.7 versus $6.2; nine-month profit was $100.4 versus $23.5. Comparisons benefited from the prior-year $38.7 share of Campofrío Food Group (CFG) restructuring charges. Romanian results also benefited from EU export approval and higher government subsidies.
- Corporate: Operating loss was $22.8 for the quarter and $72.8 for nine months, improving from $25.0 and $85.9, respectively.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $55.0, down from $210.7. Investing cash use was $217.5, including $194.9 of capital expenditures and $23.1 for the American Skin acquisition. Financing cash use was $26.4; the company repurchased $386.4 of shares.
- Cash declined $185.7 from the fiscal-year opening balance to $138.6. Management reported total liquidity of approximately $1.2 billion: $138.6 cash plus $1.1 billion of available credit capacity.
- Balance-sheet debt and capital lease obligations were $2,363.5 ($511.1 current and $1,852.4 long-term), compared with $1,964.4 at April 29, 2012. The filing’s fair-value note separately reports carrying value of long-term debt, including current maturities, of $2,337.2; the text does not reconcile this difference.
- The company issued $1.0 billion of 6.625% notes due 2022 and used proceeds to repurchase notes due 2013 and 2014, recognizing the $120.7 extinguishment loss. It also extended its $200.0 Rabobank term loan maturity to May 2018. Subsequent to quarter-end, it expanded the Inventory Revolver commitment to $1.025 billion and entered a $200.0 million term loan due February 2014.
- Working-capital pressure included inventories rising $318.3 to $2,390.7, mainly from a larger hog population and higher grain/feed inventories and prices. Current liabilities rose to $1,515.6 from $1,136.3; cash was below current liabilities.
Outlook, risks and unusual items
- Management expected fresh-pork operating margins of $3–$7 per head in fourth-quarter fiscal 2013 and fiscal 2014; packaged-meats margins at the high end of $0.12–$0.17 per pound, with fiscal 2013 volume growth of at least 2%–3%; and fiscal 2013 hog-production losses in the mid-single-digit range per head. International operating profit was expected near the high end of a $50–$125 range for fiscal 2013 and 2014. These outlooks are subject to volatile commodity markets.
- Management planned annual capital expenditures of $300–$350 over the next several years; $80–$100 was anticipated for the remainder of fiscal 2013. It also described a proposed 50/50 sausage and sow-processing joint venture, expected to close in fiscal Q4 subject to customary conditions and anticipated to be immediately accretive.
- Smithfield said it was monitoring potential USDA inspector furloughs related to sequestration and cautioned that effects on operations could be material. Key operating exposures include hog, grain and other input prices, weather, disease, regulation, foreign exchange, interest rates, and hedging and credit risks.
- The carrying value of the 37% CFG investment was $389.0. Management concluded it was not impaired, but estimated fair value had declined 10%–20% over 21 months and the risk of impairment had increased; further deterioration could result in an income charge.
- The company completed a global settlement of substantially all Missouri nuisance litigation; settlement payments affected operating cash flow. An Iowa environmental enforcement matter concerning wastewater effluent limits at the Denison facility could result in penalties, which management did not expect to be material. The filing reported no material contingencies expected to affect fair presentation.
Investor verification priorities
- Track whether feed costs moderate and whether Hog Production returns to profitability, including the scale and timing of derivative gains or losses.
- Verify delivery of forecast fresh-pork and packaged-meats margins and volume growth amid commodity and consumer-demand volatility.
- Monitor cash generation, working-capital needs, upcoming debt maturities, borrowing-base availability and compliance with debt covenants, including the minimum 1.75-to-1 interest coverage covenant.
- Review the assumptions supporting CFG’s valuation and impairment conclusion, given the narrowing fair-value cushion.
- Confirm capital-spending, share-repurchase and proposed joint-venture plans remain consistent with liquidity needs; monitor potential USDA inspection disruptions and the Denison regulatory matter.