Smithfield Foods: Bringing Home the Bacon

| About: Smithfield Foods (SFD)

The largest pork producer reported second quarter earnings on Thursday, apparently easing investor concerns -- its shares shot through the roof, tacking on more than 20% to SFD’s decimated market cap. Although the company was able to increase revenues by 14% from $2.74 billion to $3.14 billion, its operating loss of $30 million was greater than expected. However, the market is more concerned with the future than the past, so it was eager to reward the shares based on management’s optimistic outlook. On Friday, the stock popped another 10% when DA Davidson & Co. upgraded its opinion on SFD from a neutral stance to a buy rating. The analyst declared, "the company looks sturdy, and a year from now, will be looking at earnings power which is not too different from historical levels".

Cost cutting efforts: The company’s SG&A costs plummeted $7 million from $217 million to $210 million, creating an improvement of 130 basis points, from 7.9% of sales to 6.6% of sales. SFD's gross margin cratered 300 basis points from 10.4 % to 7.4%, primarily attributable to a 65% increase in feed grain prices. Its interest expense for the quarter climbed 10% from $48.3 million to $52 million. The company expects feed costs to fall during its third and fourth quarters and plans to be profitable by the first quarter of 2010, as higher cost grain inventories are worked through.

Liquidity is golden: The company has over $900 million liquidity of which to draw on, partially due to its recent sale of its beef operations unit for $580 million. SFD does not anticipate covenant compliance issues for the remainder of its fiscal year.

Capacity reductions: The company intends to reduce its hog production 10% within the next six months, so pricing should begin to firm up industry-wide. SFD will also cut its capital expenditures by 50% as it attempts to get “lean and mean”. SFD stressed it is not interested in seeking acquisitions. Gross margins should start to expand as input costs decrease coupled with higher selling prices.

Equity ownership consolidations: The company owns equity stakes in Butterball LLC, Groupe Smithfield and Campofrio (OTC:CAOFF). These equity holdings contributed $21.9 million to second quarter results. Groupe Smithfield and Campofrio are slated to merge sometime in December, and SFD will own 37% ($130 million stake) of the new publicly traded entity, with a market value in excess of $350 million.

Bottom line: The shares are still cheap despite bouncing more than 50% from last month’s lows, as Wall Street in its infinite wisdom annihilated the shares beyond reason, providing a once in a lifetime buying opportunity. Seize it! The shorts might add even more fuel to the fire if they start to realize a potential squeeze could materialize.

Disclosure: Long SFD