Smithfield Foods' (SFD) CEO Ken Sullivan on Q1 2016 Results - Earnings Call Transcript

| About: Smithfield Foods (SFD)

Smithfield Foods Inc. (NYSE:SFD)

Q1 2016 Earnings Conference Call

April 28, 2016 6:30 AM ET


Keira Lombardo – Senior Vice President of Corporate Affairs

Ken Sullivan – President and Chief Executive Officer

Glenn Nunziata – Chief Financial Officer


Bryan Hunt – Wells Fargo Securities

Carla Casella – JPMorgan

Hale Holden – Barclays


Ladies and gentlemen, thank you for standing by. Welcome to the Smithfield Foods 2016 First Quarter Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Keira Lombardo. Please go ahead.

Keira Lombardo

Good morning and thank you for joining us today for Smithfield Foods' conference call for the first quarter of 2016. Joining me on our call today is Ken Sullivan, President and Chief Executive Officer; and Glenn Nunziata, Chief Financial Officer. We would like to caution you that in today's call there may be forward-looking statements within the meaning of Federal Securities Laws. In light of the risks and uncertainties involved, we encourage you to read the forward-looking information section of the Company's 10-K for calendar year 2015. You can access the 10-K on our website at

I'll now turn the call over to Ken. Ken?

Ken Sullivan

Good morning, everybody. First, I want to apologize for the time of this call. 6:30 on a Thursday morning isn't exactly prime time for a quarterly earnings call. I get that. Obviously, we don't ordinarily hold our calls at this time of the morning and I'll spare you all the reasons we're conducting the call at this hour. Sufficed to say, we're an international company and among other reasons, we're coordinating this call with other parts of our organization that are in different time zones around the world.

Personally, I'm still trying to figure out which time zone I'm in. I've spent the better part of the last month on the road, including several days visiting our operations in Poland and Romania. I'm back in the US now. Glenn, on the other hand, who joins me on this call is I think still outside of the country.

We're going to keep this call short and crisp this morning. Notwithstanding the early hour, we're on a tight timeline today with a number of us having planes to catch and places to be. Plus, we just had a call less than 30 days ago, in which we talked expansively on the state of our one Smithfield Union. We're not going to repeat ourselves here this morning. I think that call is still out there and available for replay. In any event, let's get to it.

I have to say, when I learned the time of this call, I was afraid everybody would assume we chose the wee hours of the morning to report because we have disappointing results to report. Let me immediately dispense with that notion. Our first quarter results are strong. In fact, the 10-Q we filed this morning contains record operating profits for the first quarter.

As always, all the numbers you need can be found in that filing. If you didn't have an opportunity to download it yet, Glenn will provide a comprehensive run down of the numbers in a few minutes. Before he does that, I will recap at a very high level operating profits in each of the segments.

Total U.S. GAAP operating profits totaled $210 million for the quarter. That's against $188 million in the prior year. That represents a record first quarter for our Company. Here's the quick rundown. Packaged meats profits totaled $207 million versus $173 million a year ago. Fresh meat profits totaled $100 million versus $33 million a year ago. International division profits totaled $14 million versus $16 million a year ago. That's impacted by approximately $2 million in FX translation losses.

Hog production division losses totaled $84 million versus $6 million in losses a year ago. Add it all up, deduct the corporate segment and you'll get to $210 million in total operating profits. What makes this result particularly encouraging is the fact that we actually lost $83.5 million in our live production segment, yet still managed to record a record quarter nonetheless. How did we manage it? Clearly, our packaged meats business again led the way with stellar 12% operating margins.

Our investments in our brands are paying off, both customers and consumers. The list of highlights is long, but let me provide a few to give you a sense of the forward momentum we've generated. Our Smithfield bacon volume is up 36% and is now the number two bacon brand internationally, up from number four. Of course, Smithfield is the number one bacon seller when you add up all our brands.

Smithfield bacon has also achieved its highest ACV to date at 60%. That's 15 points versus a year ago, 15% point increase versus a year ago. That's a major part of our effort to achieve national distribution with Smithfield bacon. Eckrich smoked sausage has achieved record high distribution at nearly 79% ACV and an all-time high market share of 15%. Eckrich deli grew 15% in volume versus a year ago with a 7% increase in ACV distribution from 24% to 31%.

Nathan's is the number one national brand in premium hot dogs with a market share of 39%, nearly nine market share points ahead of our leading competitor in that space. Kretschmar recorded positive volume growth in 34 of the 35 last month, including this quarter -- the three in this quarter. And to cap it all off, Smithfield Foods is now the second largest deli manufacturer in the US. Our One Smithfield changes continue to pay dividends in the packaged meats end of the business and our momentum is palpable.

Turning to fresh pork, a couple of highlights here. Our operating margins in fresh pork were particularly strong at 9%. In fact, fresh pork had their second best quarter in our history. Smithfield marinated fresh pork achieved a number one dollar and volume share of the category with over a 30% share, driving both distribution and velocity gains versus a year ago. Expanded -- we expanded our Smithfield prime footprint by securing new distribution with a large customer in the Northeast and we secured huge wins on our Smithfield branded fresh pork ribs for this summer with several large customers.

In the international segment, international margins were relatively flat year-over-year, but our packaged meats volumes were up 5%, including 9% in hot dogs. The number of our volumes continue to increase in the international segment with the hogs processed up 13% up in Poland and 16% in Romania. That's overall a 14$ increase in our total European operations. The number of hogs we raised is up 18% year-over-year and as I mentioned at the outset, our operating profit includes a negative FX impact of nearly $2 million in the quarter. Once you normalize for that, we're relatively flat against a year ago, the story being of course lower hog prices in the European region, which leads me to our performance in our U.S. domestic hog production segment. We lost $83.5 million in that end of the business. That continues to be a cyclical business for us and while the results are disappointing, I'm particularly pleased that we have offset those losses with really what I'd characterize as excellent performance in other areas of the business.

So I promised at the outset we'd keep this call crisp and short. Those are the highlights for the quarter. I'd turn it over to Glenn so that he can run down the numbers and then we can take questions and save the time for Q&A. Glenn?

Glenn Nunziata

Thank you, Ken, and good morning to everybody on the call. Thanks for dialing in to hear our interim report for the first quarter. And as Ken mentioned, the details of our Q1 2016 financials are available on our form 10-Q, which was filed earlier this morning.

Right now, though, I'm going to focus on some key highlights and then we're going to open the line for questions. Keep in mind please that all comparisons in my remarks are to the same period last year and for any WH Group analysts on the call, please note that our results are going to be presented on a US GAAP basis. Therefore, the results and the presentation of those results may differ from WH Group's IFRS presentation.

Okay, let's dive into the numbers. Our first quarter sales totaled $3.3 billion compared to last year's $3.6 billion. Sales dollars decreased across the segments with the exception of our packaged meats segment. Volumes increased across the packaged meats and the international segments while volumes decreased for fresh pork and hog production. Every segment of our business experienced lower price levels with the exception of packaged meats. Prices for packaged meats remained relatively unchanged.

In addition, the strong U.S. dollar affected the measurement of our sales and the international segment. Currency negatively affected sales by approximately $30 million to that segment. On a consolidated basis, operating profit totaled $210.1 million compared to last year's $188.2 million. That's an increase of $21.9 million. The gains in fresh pork and packaged meats were slightly offset by the decrease in hog production segment. But I'll cover the segment details here in a moment.

Pretax profits were $178.1 million in the current quarter and that compares to $140.7 million last year. Net income totaled $121 million versus the $97 million we posted in the prior year. From a consolidated results perspective, we continue to post some solid earnings. As Ken mentioned, our management team is executing under One Smithfield. We're operating as a consolidated, streamlined organization and we continue to focus on our competitive cost and aligning our Company and our personnel to better serve our customers and our consumer needs.

Let me turn to segment performance quickly. Our packaged meat segment had another solid quarter. Ken mentioned earlier operating profits totaled $207.1 million and that's up 20% from last year. And volume is up slightly year-over-year. Fresh pork had another strong quarter. Q1 operating profits at $99.9 million and that compares to $33.2 million in 2015. The story behind fresh pork for Q1 was lower raw material costs. Hog prices dropped while meat prices remained relatively steady. In hog production, our Q1 results reflected an $83.5 million loss and that compares to a $6.4 million loss last year. The decrease from the prior year is primarily due to some favorable hedging results experienced in 2015.

Looking at international, Q1 operating profits totaled $14.2 million compared to $15.9 million in the previous year. Operating profit was negatively impacted by foreign exchange rates, just like sales were. On a constant currency basis, operating profit was flat.

Moving down the P&L, our Q1 interest expense was $32 million. That compares to $34.7 million in the previous year. The decrease reflects our continued debt reduction efforts and our Q1 EBITDA was approximately $268.7 million, and that's up 9.1% from the prior year. We continue to demonstrate a healthy balance sheet. Our net debt to EBITDA ratio has remained at around two times. Our net debt to capital ratio is approximately 30% and we're covering our interest expense eight times.

At the end of the quarter, outstanding gross debt was $2.3 billion. We have nearly $1.6 billion of global liquidity, including cash on hand, and we have no meaningful debt maturities during 2016. I'd also like to point out that these leverage ratios and liquidity levels at quarter end include the effects of a couple of significant events during the quarter. One was a $125 million voluntary contribution to our pension plans and a $74 million dividend we made to our parent company. We expect additional dividends during 2016 to aggregate at approximately $325 million. Simply put, our liquidity continues to be a non-issue.

Just a few more items here. Capital expenditures totaled $76.8 million for the quarter and our capital budget for the full year is expected to land on $350 million. Our depreciation and amortization expense was $58.6 million for the quarter.

We've received some questions in the past from some of you about restricted payment baskets so I wanted to touch on that for a second, and although these limits very based on which underlying debt instrument we're speaking about, I can tell you that our most restrictive basket at quarter end was approximately $645 million.

And finally, there are no debt covenant issues. And this concludes my recap of Q1 2016. Keira?

Keira Lombardo

Thanks, Glenn. Operator, we'll now open the line for questions please. Thank you.

Question-and-Answer Session


Thank you. [Operator Instructions] And one moment please for your first question. Your first question comes from the line of Brian Hunt from Wells Fargo. Please go ahead.

Bryan Hunt

Good early morning to all of you and thank you for your time.

Ken Sullivan

Bryan, I need to congratulate you -- you're here in the US -- for you to get on this call at this hour, I appreciate your attentiveness.

Bryan Hunt

No problem. It was the smell of bacon that woke me up. I was wondering, one, can you first of all comment kind of on your market share gains on ribs and I think you also called out marinated product. And kind of where you stand on an ACV basis with these new distribution packs that you got for the year.

Ken Sullivan

Yes, sure. I'm not going to comment specifically on our ACV points on anything in particular, Bryan, because it's a little bit difficult to navigate. You've got to understand what particular product category we're talking about. If you're talking about Smithfield Prime, I think I articulated what that was in the comments. But here's the idea is that your question is really relating to part of our fresh meat operations, if you're talking about Smithfield Prime. And the bottom line is with all these share and distribution gains, it ultimately comes back to some of the changes we made last year as part of One Smithfield where we consolidated all our sales functions and combined all our sales functions.

We've now done that with our marketing efforts as well. And ultimately, it's really translating into these shared distribution gains. I think our strategy in that regard, our tactical day-to-day strategy in regard to how we're approaching the market and our sales efforts I think are, again, linked back to the One Smithfield consolidation and ultimately, we're seeing the benefit of it.

Bryan Hunt

Great. My next question is if I look at the competing proteins, whether it's cage-free eggs or grass-fed beef, and I know you all have -- you're the leader in (inaudible) free and the gestation crates, you guys led the way. Can you talk about kind of the freeform movement and what you all are doing -- all natural movement -- and what you all are doing to kind of capture some of that wave with new products introductions, and maybe what percent of your total packaged meat business may be in line with that trend?

Ken Sullivan

Sure, so it's a small percentage. Ours is no different than any other really competitor out there. These remain a little bit of a niche market. Having said that, there's no denying that there's some increases in these segments of the business, whether it's all natural, organic, et cetera, et cetera, ABF, cage free, et cetera.

There's no denying that there's a consumer interest in this and ultimately, Brian, we follow what the consumer wants, what our customers want, consumers want, we'll follow. And we've, I believe, led the way, at least in the pork industry, relative certainly to our initiative to convert all our sow farms to group housing where we'll be complete with that effort, which has cost us over a $350 million over a ten-year period. We'll be complete with that at the end of 2017. I think I've talked before about a number of our customers have commitments to provide or sell or purchase, rather, group house pork or purchase pork, sorry, from only suppliers that can provide the group housing seal of approval, if you will.

We're going to be well positioned for that. I would tell you beyond that, we certainly are paying attention to these trends. We have an innovation department, if you will, a chief innovation officer. One of their key foundations or platforms for innovation is the health and wellness, all of which fall into the categories that you're talking about.

So I would tell you, Brian, we're playing in that space. We'll continue to play in that space. We're looking at some programs right now, as we speak, with regard to antibiotics and trying to figure out exactly how we can service that market and do it in a way in which both our customers and consumers want, and do it in a way that's cost efficient ultimately for them so that we don't have to charge a huge premium.

Bryan Hunt

And my last question is, if I look at working capital investment this year in Q1, and I know you usually have a Q1 swing, is much greater than a year ago. I was wondering, I mean can you discuss what happened during the period? Is it a timing issue or is there some other event that's taking place within your working capital that should be noted? Thanks.

Ken Sullivan

Glenn, you want to handle that one?

Glenn Nunziata

Sure, Brian. You're right. You mentioned timing. We had a good chunk of farmer payments go out in our normal procurement patterns in early January and then we -- again, we funded our pension plan, which took $125 million of cash away as well. And then we also had a tax payment where last year we had a tax refund. So right there is a big chunk of the change of working capital swings.

Bryan Hunt

Great. I'll hand it off to somebody and stop at Starbucks or get you some coffee. Thanks.

Glenn Nunziata

They serve bacon on their sandwiches.


Your next question comes from the line of Carla Casella from JPMorgan. Please go ahead.

Carla Casella

Good morning. I had a question on the dividend. First of all, I missed the total amount you expect to finish. Was it [300 or 350?]

Glenn Nunziata

The total dividend this year is expected to be [400] with [72] or so already paid in the first quarter.

Carla Casella

Okay, great. And then industry wide in pork on the processing side, there's some capacity plan to come on, on over the next few years. I'm wondering if you -- what you think of the kind of competitive openings environment on the pork processing side as we move forward? Do you think we could see some of the older legacy plants shut down industry wide? Or are we going to see a big onslaught of capacity?

Ken Sullivan

Carla, this is Ken. I guess how would I characterize my reaction to it? It's really more surprise than anything else. I'm surprised that not necessarily at one plant or two plants, but there are four, five plants that people have talked about, some larger, some smaller of course, and I think ultimately it's going to come down to what it seems like it always has in the US pork industry for the last 15 years or more, which is exports. If we're going to produce more pork, ultimately, unless Americans are going to consume more pork, we're going to have to sell that pork in channels outside of the US.

It's fine. I mean the export channel is a channel not dissimilar to any other, whether it's retail or food service. It's just another channel. We're just going to have to expand the sales in that end of the business and I would tell you, I think US pork exporters as a general proposition are doing that. I think exports are up, I believe, in 2016. I know ours are significantly up and so I think ultimately we're going to have to do that. Will that lead to somehow some of the older plants going sort of shutting the doors or shutting down the kill -- that's possible. I think it could be some real battles going on here as you look into 2017. So we'll have to see.

Carla Casella

Okay, great. Okay, great. And then when you look at exports, have -- what are your biggest export markets today and has that changed over the last -- or do you see that changing in 2016?

Ken Sullivan

The biggest export markets, not just for us but for US pork is always China, Mexico, Japan. And I think that continues into this year. Obviously, with our -- with being a wholly owned subsidiary of the WH Group, one of the benefits of that is that we've been able to develop repeatable export programs into the China marketplace and I'm really happy with the partnership that we have with our sister company, Shuanghui Development in mainland China, to ship more US pork into mainland China. We're continuing to improve that or increase that each year. The transaction or the merger occurred in September of 2013 and in each successive year, we've shipped more pork products.

I think it's important to note a lot of these pork products are offal, meaning they're variety meats that US consumers don't tend to eat, but they provide us with a great market outside of the US and we have continued to increase that as well as some muscle meat shipments outside.

So it remains the big three, Mexico, Japan, and China.

Carla Casella

Okay, great. And then when we look at Europe, can you just talk about the dynamics in that market are kind of newer to me. I guess to you to a little bit, but what's going on in terms of market by market there? And are you seeing any stabilization in some of the markets that had been, I guess, economically or pressured by other reasons?

Ken Sullivan

Yes, I would tell you, we've been involved in Europe now for more than 15 years and our investments there started, candidly, slowly. But I'm very happy with where they are now. As I said at the outset of the call, I just spent some time there and really I think we've got some very strong growth opportunities in that area of the world, in particular where we're located, which is sort of Central or Eastern Europe, in Poland and Romania. It's not dissimilar to the Midwest of the US, which is to say that's where the grains are grown.

And so our operations there, I think, are very well suited from a standpoint of if you look at all the market fundamentals that you'd want to raise pork products. We have in the areas where we're located. And I think if you look at the demographics in Central Europe, I think they're short pork in Central Europe. Western Europe is mostly long pork. There's a number of factors at play in sort of the broader EU pork complex, including the idea that in Poland today, we've got some export limitations due to some African Swine Fever limitations. Poland's been -- has an African Swine Fever designation, and so exports from Poland are limited. And so we are working with the proper authorities to try and get those barriers removed because we don't have African Swine Fever in our operations. I think once we're able to do that and open up the export markets, I think it'll translate into real advantages for us in that part of the world.

The bottom line, I think, with -- in that end of the world is it's a huge growth opportunity for us and we're going to be looking aggressively at that over the next few years.

Carla Casella

Great. Thank you so much.


Your next question comes from the line of Hale Holden from Barclays. Please go ahead.

Hale Holden

Good morning. Thanks for taking the call. It's been a while since I've heard you talk about Europe. So I was just -- in terms of growth, is that -- are you thinking sort of M&A inorganic growth or vertical growth in terms of more packaged brands? Just --

Ken Sullivan

Yes, Hale, I think we don't take anything off the table there. I think it can be both. Certainly, we have organic growth plans there but we've also looked at the landscape in terms of who the competition is and what the opportunities are. And there are some opportunities there for us and we're actively having that discussion about what our longer-term strategy is for Europe.

And so I mentioned that, again, I was just there. My intention is to go back again in June and we're having collectively discussions at the WH Group level as well in terms of where our investments should ultimately be over the next three to five years.

So I think that, as I said, that Central European sector or swatch represents a real opportunity for us.

Hale Holden

Great. Thank you and thank you for all the detail on the RP baskets. Can you just remind us what further cash pension payments you were planning to make this year?

Glenn Nunziata

Hey, Hale. This is Glenn. The answer is none so we -- through the voluntary contributions we've made over the last few years, we're sort of ahead of our funding schedule, our required funding schedule. So that $125 million will keep us in a position of not having to fund for quite some time. So you should expect that there will be no, as of right now, we're not expecting to pay any further contributions in 2016.

Hale Holden

Got it. And then last question I had is -- I can see all the sort of the forward commodity curves. But is there anything that you guys are thinking about or looking at sort of medium term in terms of grain pricing or input pricing that's sort of different from what the market's suggesting?

Ken Sullivan

I don't think it's necessarily anything different than what the markets are suggesting. I think you know as a matter of routine, we are -- have hedge instruments in place. That's no different for 2016. We've got various strategies from futures to collars to try and lock down or mitigate the risk of input prices getting away from us.

And so I'm pretty satisfied with where we are in regard to that right now. Same thing on the lean hog side. We look at those markets and we're looking for opportunities there. And if you -- I think you do follow these markets, you know that you too suggests there's some profits in the live side. It's a little bit slow in evolving but I think there are some profits in Q2, certainly Q3. Q4 on the other hand, remains a question mark and is still in the red at this point.

Hale Holden

Great. Thank you very much. I appreciate the time.

Keira Lombardo

Operator, we're going to end the call here please. Can you please provide the replay information? Thank you.


Thank you. Ladies and gentlemen, this conference will be available for replay after 9:00 a.m. Eastern Time today through May 12th. You may access the AT&T Teleconference Replay System at any time by dialing 1-800-475-6701 and entering the access code 391721. International participants dial 320-365-3844. Those numbers once again are 1-800-475-6701 or 320-365-3844 with the access code 391721. That does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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