SFD Smithfield Foods, Inc.

Meat producer Smithfield Foods Inc (SFD) posted earnings of 27 cents per share in the first quarter of fiscal 2014, missing the Zacks Consensus Estimate of 38 cents by 28.9%. The results also lagged the prior-year earnings of 40 cents by 32.5% due to a weak operating environment in fresh pork and the international business.

The company’s earnings from fresh pork suffered on account of seasonal weakness. Higher raising costs in the hog production businesses in Eastern Europe and Mexico dented the profits of the international segment. Pork exports also continued to decline in the first quarter due to lower shipments to key export markets, namely Japan, China and Russia.

During the quarter, total sales increased 10.0% year over year to $3.4 billion, driven by strong momentum in the packaged meat business. The company also witnessed improved volumes as well as increased market share across its product portfolio and in its core brands like Smithfield, Armour, Kretschmar, Curly's, Margherita and Carando in the first quarter. Total sales also beat the Zacks Consensus Estimate of $3.2 billion.

Operating profit declined 26.2% to $97.3 million during the quarter due to weak margins at the pork and international segments. Operating margin declined 100 basis points to 3%. Weak pork and international segment margins overshadowed the strong margin of the hog production segment.

Category Details

Pork: The Pork segment mainly consists of three wholly-owned U.S. fresh pork and packaged meat subsidiaries. Sales in the Pork segment increased 9.6% to $2.85 billion compared with the previous-year period.

Fresh Pork: Sales of fresh pork increased 8.1% to $1.36 billion. However, operating margin declinedto negative 3% compared with a negative 1% in the prior-year quarter as the company was not able to pass on the higher hog costs to its customers. Exports were also sluggish due to seasonal weakness in the first quarter.

Packaged Meat: Sales of the packaged meat business increased 11.1% to $1.49 billion. Segment sales were driven by solid volume growth across a number of key product categories and core brands. The segment also witnessed improved market share in cooked dinner sausage, dry sausage and marinated pork. The company also expanded distribution in its Eckrich cooked dinner sausage, Gwaltney hot dogs, Smithfield bacon, Curly's BBQ, Armour dry sausage, Armour portable lunches and Smithfield and Farmland marinated pork.

Segment’s operating margin declined 300 basis points on a year-over-year basis to 7% due to higher raw material costs.

Hog Production: Hog Production sales increased 19.7% year over year to $872.4 million in the first quarter of fiscal 2014 due to higher hog prices. The company's risk management strategy also helped mitigate losses in the quarter. The segment’s operating margins were also strong and increased to 8% compared to a margin of 3% in the prior-year quarter. Higher hog prices were able to more than offset the higher raising costs in the quarter.

International Segment: The segment reported an 8.4% increase in sales to $376.0 million in the reported quarter, despite higher raw material costs and macro-economic headwinds. However, segment operating margin declined 400 basis points to 1% in the quarter due to higher feed costs in the company's hog production operations.

Smithfield-Shuanghui Merger Update

On Sep 6, the Committee on Foreign Investment in the United States (CFIUS) approved the proposed merger deal of Smithfield with Hongkong-based Shuanghui International Holdings Limited. Smithfield and Shuanghui also announced that the parties have received governmental merger clearance in Ukraine.

The CFIUS is in charge of reviewing foreign acquisitions made by U.S. companies for potential national security concerns. The 30-day review period starts from the time a potential acquisition is reported. Following the end of the 30-day period, CFIUS can exercise its option to extend the term to a maximum of another 45 days.

Per the deal signed on May 30, Shuanghui will acquire all of the outstanding shares of Smithfield for $34.00 per share, totaling $7.1 billion, including Smithfield’s debt. The deal will open the doors for Smithfield to expand its footprint in China taking advantage of Shuanghui's solid distribution network.

As far as Shuanghui is concerned, it will be able to meet the growing demand for pork in its domestic market by gaining control of Smithfield’s brands such as Smithfield, Armour and Farmland.

Shuanghui has arranged for the finances for the merger and the deal is still expected to close in the second half of 2013. However, the transaction is yet to receive shareholder approval.

Smithfield's shareholders are scheduled to vote on the transaction at a special shareholders meeting to be held on Sep 24, 2013. However, one of the largest shareholders of Smithfield, Starboard Value LP, with beneficial ownership of approximately 5.7%, is planning to vote against the deal as it is seeking other offers that would provide greater value to Smithfield’s shareholders.

Starboard has sent a letter to Smithfield’s board stating that it has received written interest from other parties to buy Smithfield's assets at a higher value. Starboard had also sent a letter to Smithfield's board of directors in June stating that it will be in the best interest of the shareholders if Smithfield sells off its various divisions like pork, hog production and international business individually rather than divesting the whole business all at once. Starboard also stated that the estimated value of the company is $9 billion – $10.8 billion or $44 – $55 per share, which is much higher than the deal price of $34 per share.

Smithfield holds a Zacks Rank #2 (Buy). Meat producers like Pilgrim’s Pride Corp (PPC) with a Zacks Rank #1 (Strong Buy) and Tyson Food Inc (TSN) with a Zacks Rank #2 (Buy) are better placed and are worth considering. Another food company Dole Food Co Inc (DOLE) with a Zacks Rank #2 can also be considered.

 
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