January 9, 2013

Smithfield Farms Is In the Process of Fattening up Profits Along with Its Hogs

by Alpha Now Research Team

Corn prices may remain at relatively high levels, but that doesn’t appear to be stopping Smithfield Farms from preparing to deliver another positive earnings surprise.

The pork production industry, along with many other meat processors, took a blow last year as corn and wheat prices skyrocketed during the summer’s devastating drought in the U.S. Midwest. The price of corn, for instance, one of the major sources of feed for hogs, hit a record high of $8.49 a bushel in August. While corn prices today hover closer to $6.88 a bushel on the Chicago board of trade, nearly 20% below those highs, that is still high, and some crop analysts already are concerned that even if rainfall returns to normal levels, it will take time for soil conditions to improve. But Smithfield Foods Inc. (SFD.N) seems well positioned to ride out at least part of this price shock, thanks to hedging strategies it put in place back in 2011 that is reducing the actual price that the company must pay to feed its hogs, helping it move closer to reporting better-than-expected earnings this winter.


Smithfield, the largest pork producer and processor in the country, already has reported $6.3 billion in sales in its first two quarters of its current fiscal year; in its fiscal third quarter, ending January 31, the company appears likely to report profits above the level that analysts are currently forecasting. That is due not only to the company’s ability to rein in costs but also to tighter pork supplies as many hog farmers have left the business amidst new, tighter regulations governing the welfare of the hogs being raised for slaughter. One of the factors that is making business more costly for many in the industry is the push to do away with individual gestation crates – metal enclosures in which sows are confined for much of their lives, as they produce their litters before being sent to the slaughterhouse. Described by some critics as confining the hogs to the equivalent of an economy airline seat for their lives, the pens help Smithfield and others run their businesses more cost effectively, but pressure from animal rights activists and a rebound in the company’s profits has caused Smithfield to commit to shift entirely to group pens by 2017. This will increase costs, but Smithfield may be better able to cope than some of its smaller competitors.

The company’s earnings have recently fared better than analysts had been expecting. For the quarter that ended October 28, Smithfield reported net income of 61 cents a share, better than the 45 cents a share than analysts had expected, although it didn’t measure up to year-earlier profits of 76 cents a share before charges. (The 2012 quarter included a one-time charge of $120.7 million related to the early paying down of some debt.) Analysts responded to that positive earnings surprise by raising their estimates for Smithfield’s estimates for the fiscal third quarter, a period that ends later this month. Only 30 days ago, the consensus forecast stood at 51 cents, but today for Smithfield to report a profit of 53 cents a share when it reports its fiscal third-quarter results on March 7.

The StarMine SmartEstimate stands higher still, at 54 cents a share, giving the company a Predicted Surprise of 2.5%. One analyst covering the company who has been awarded five stars by StarMine for his accuracy in predicting earnings has a Bold Estimate on the fiscal third-quarter earnings that is higher still, at 65 cents a share. Bold Estimates that are significantly above or below the consensus are worth heeding, given that they are made by analysts known for their prowess in correctly predicting earnings.


Smithfield has said that it expects increasing the range and sales of its packaged meats products will contribute to strong revenues and earnings in fiscal 2013. The company also has moved to address its balance sheet by refinancing the costly debt it had to issue to keep itself afloat during the economic crisis of 2008 and has taken full advantage of the current low interest rates. Last August, Smithfield used the proceeds of a $1 billion issue of 10-year bonds with a 6.625% coupon to redeem debt with higher coupons and to shore up its balance sheet with more cash. Currently, the company has $2.35 billion in total debt ($500 million of which is short term debt), down from $4.01 billion it had on its books as of July 2008, just before the financial crisis triggered another crisis in liquidity and made borrowing exceptionally costly and difficult. The reduction in both the absolute debt levels at Smithfield and the lower interest rates owing on the remainder together mean that the interest expense burden on the company will continue to ease, enabling more of the company’s revenues to flow to its bottom line in coming quarters.

As Thomson Reuters analyst John Kozey pointed out recently, Smithfield’s stock has been volatile of late and ended 2012 in the red. But in that analysis, he identified the company as one whose fundamentals appear to be more robust, and which offers a number of encouraging signals, ranging from a buyback offer to a rising price to cash flow ratio.

SmartEstimates: Thomson Reuters StarMine Professional quantitatively analyzes the earnings estimate accuracy of sell-side analysts and uses this information to create proprietary SmartEstimates®.SmartEstimates help you better predict future earnings and analyst revisions with estimates that place more weight on recent forecasts by top-rated analysts.
Predicted Surprise %: The Predicted Surprise% is the percentage difference between the SmartEstimate and the I/B/E/S consensus estimate. When SmartEstimates diverge significantly from consensus, it serves as a leading indicator of the direction of future revisions and/or surprises. In aggregate, this indicator gets earnings surprises directionally correct 70% of the time.

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