Pork producer Smithfield Foods
To the casual observer, Smithfield is a mishmash of variables. From prices on raw materials such as live hogs and grain to the retail prices for its meat products, there is a lot to consider. But this isn't a witch's brew.
The company recently added cattle feeding (beef is 16% of sales) to its business model. The goal is to produce profits in different economic conditions through vertical integration. High live cattle prices, which usually result in poor retail margins, will benefit the feeding business -- and vice-versa. In the countercyclical world of live versus processed meat, Smithfield's business model is aimed at dampening earnings volatility.
The countercyclical nature of the business is crystal clear in this quarter's pork results (75% of total sales). Hog production produced a profit of $3.4 million last year. Near-record live hog prices for this time of year produced a $98.2 million profit -- almost a 30-fold increase in profits! At retail, higher hog prices pressured retail pork profits, which fell from $42.5 million to $39.9 million.
Smithfield also knows how to manage assets. In 2003, it sold Schneider, one of Canada's largest food processing companies, for $378 million (nine times EBITDA). Then it acquired the sizable pork operations of bankrupt farmers co-operative Farmland for six times EBITDA. Farmland, which had $75 million in EBITDA in the year prior to the acquisition, earned $104 million in EBITDA during its first year with Smithfield.
Smithfield is hardly a perfect investment. Its 3.2% operating margin this quarter trails those at pork-fed competitor Hormel Foods
Also detracting from Smithfield's luster is nearly $1.9 billion in net debt (total debt minus cash). The saving grace is that Smithfield is selling for 13 times this year's estimated earnings. So, while the company is pigging out at profit's trough, the stock is reasonably priced for a company expected to grow earnings at low double-digit rates.
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Fool contributor W.D. Crotty does not own stock in any of the companies mentioned.
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