How This $7.1 Billion Multinational Uses Small-Town Farms as a Shield From Millions in Fines

The business of hog farming is by nature dirty, but there is something wrong when a multinational mega-corporation is able to avoid fines by pinning Clean Water Act violations on small-town farmers.

Jan 28, 2014 at 2:21PM

Thirty-five years ago hog farming was a pretty simple business. Most operations held less than 100 hogs; the biggest held upwards of 3,000 hogs at any given time. The business was profitable, it created jobs, and it was sustainable. 

Then the business model began to change. Beginning in the 1980s, executives from global corporations like Smithfield Foods would approach these farmers with a proposition...

Spending (borrowed) money to make money

Pig

Source: The Pug Father

These executives offered the small-town farmer a contract to raise hogs owned by Smithfield. The contracts were generous, oftentimes worth six or seven digits in annual revenue.

There was a catch.

To achieve scale, Smithfield needed the farmer to raise 10,000, 15,000, or more hogs at a time. With contract in hand, small-town farmers across the U.S. approached banks to mortgage the farm and build new infrastructure to attempt to support the massive influx. This was their opportunity to enter the big time.

Upfits were complete, the new hogs were delivered, and seemingly overnight the operation was transformed into a massive factory-style facility, the type that dominates the industry today.

According to the North Carolina Department of Agriculture and Consumer Services, in 1986 over 87% of North Carolina's 15,000 hog farms held fewer than 100 hogs and pigs. Only 800 operations held more than 500 hogs.

By 2000 the total number of North Carolina hog farms had decreased to just under 4,000 operations. Of those, 1,500 operations held over 1,000 hogs each and controlled over 99% of the statewide hog inventory. The factory-style farm had become the industry standard.

Unintended consequences for the small farmer

A critical aspect of the hog business is management of all the waste. A typical hog will produce about four gallons of waste per day; this kind of volume on a 15,000-hog farm is incredible.

To deal with this volume of waste, hog operations typically use a "lagoon and spray" method. They construct giant, open-air lagoons that can hold tens of millions of gallons of hog waste. These lagoons are typically lined with a thin clay barrier. Unfortunately, clay is porous. It doesn't prevent the waste from leaching into the ground, but it does slow down the dissipation into the environment.

G

Hog barns and lagoon in Trenton, N.C. Source: Waterkeeper Alliance

As the lagoon fills, the facilities use spray systems to distribute the waste over neighboring fields, either grass or crops -- corn, soybeans, wheat, or another. In theory, the hog waste is absorbed as fertilizer and safely disseminated into the environment.

But that theory doesn't always work out in practice -- 10,000+ hogs producing four gallons of waste per day can fill a lagoon faster than the spraying system can responsibly distribute the existing waste. The farm operations are forced to spray onto fields already saturated, leading to pools of waste that can run off onto neighboring properties -- forests, wetlands, neighborhoods, rivers, and so on.

Worse yet is when these lagoons burst. Whether the result of a hurricane's rains, a flood, or even faulty construction, a burst lagoon means millions of gallons of waste spill into the environment, polluting the communities, water supply, and wildlife for miles downstream.

Examples abound

Floyd

Flooding in the aftermath of Hurrican Floyd, 1999. Source: Wikimedia.org

In 1995, a North Carolina farm working under a contract with a Smithfield Foods subsidiary, spilled over 25 million gallons of hog waste into the Neuse River, a major waterway in central and eastern North Carolina. 

In 1999, Hurricane Floyd burst at least five hog lagoons and flooded at least 47 others in North Carolina.

In 2011, a factory hog farm in Illinois spilled 200,000 gallons of hog waste into the water system. The pollution from that spill caused a massive 100,000+ fish kill.

To see a slide show of the hog waste disposal process, click here.

The small business heads to court, the multinational yawns

Any discharge of hog waste into “waters of the United States” is a violation of the Clean Water Act. Under the law, violations are the responsibility of the owners and operators of the hog facility, that is, the local farmer. The mega-corporation -- in this case, Smithfield Foods -- is protected by an indemnity clause in its contract with the local farmer.

The local farmer agrees to house the hogs, which are owned by Smithfield, feed them food provided by Smithfield, give veterinary care and an antibiotic regimen as prescribed by Smithfield, and otherwise raise the hogs to exacting standardized specifications set by Smithfield.

Smithfield though is contractually held harmless for any on-site violations.

The local farmer is stuck between a rock and a hard place

Pigs

Source: WikiMedia.org

Earlier this month, nonprofit watchdog groups The Waterkeeper Alliance and the Neuse Riverkeeper Foundation jointly filed a Notice of Intent to sue a hog facility based in Trenton, N.C. The facility is under contract with Murphy Brown, LLC, a subsidiary of Smithfield.

Facing a lawsuit and likely a hefty fine with expensive cleanup costs, why wouldn't the local farmer sue the global corporation to revoke the indemnity clause as unconscionable? It was the corporation's idea to house such an incredible volume of hogs on the property, and the hogs were raised to the corporation's precise standards and procedures.

It seems plausible that the indemnity clause is lopsided at best and extremely unfair at worst. And yet the farmers do not sue.

The reason, unfortunately, is dollars and cents. If the local farmer breaks off its relationship with Smithfield or another global player, the revenue from that contract stops. Without that income, the farmer can no longer afford the mortgage on the property. From there it's a short time before the bank is foreclosing.

Economically, these farmers are stuck between a rock and a hard place. If they turn down the contract initially, they don't have the scale to compete on price against the factory farm competition. If they accept the contract, they can achieve scale but they are left high and dry in the event of a regulatory or statutory violation.

By contracting locally, companies like Smithfield distribute their regulatory and environmental risks across a huge network of distinct small-town farms. There are over 4,000 hog operations in North Carolina today, with approximately 90% of them contracted or owned by Smithfield. A Clean Water Act lawsuit against one of these farms is hardly a blip on Smithfield's radar screen; they have thousands of other farms under contract operating business as ususal.

Its a complex problem and it requires a complex solution

Hog farming is big business in North Carolina and other states, and there is no simple fix. According to the National Pork Producers Council, the North Carolina pork industry supports nearly 25,000 jobs and contributes nearly $1.5 billion to the state's gross domestic product. North Carolina is second only to Iowa in pork production nationally.

With such a large economic impact and so many jobs at stake, local politicians are hard pressed to act decisively. 

Simultaneously, the current system is structured to benefit the global companies, giving them little incentive to support change. In its 2013 annual report, Smithfield reported sales exceeding $13 billion and operating profits exceeding $500 million. The company has been profitable for nine of the past 10 years, generating aggregate operating profits in excess of $4 billion. 

Shuanghui Logo

Shuanghui International acquired Smithfield Foods in Sept. 2013. Source: Smithfield Foods Investor Relations

Smithfield, as a result of its scale and financial success, was acquired in 2013 by Hong Kong-based Shuanghui International Holdings Ltd., in a multi-billion dollar deal that made Shuanghui the largest pork producer in the world.

The industry today stands at a crossroads: continue down the same path defined by an oligarchy of faraway global corporations' drive for profits, or reform the system to protect the long-term sustainability of the small farm, the environment, and the local communities that rely on the industry.

Discover how to profit from analysis like this

As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas with sound fundamental analysis, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love. 

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers