More on Pork, China and Smithfield Foods

I had a post last weekend about Smithfield Food's (SFD) entry into China. Motley Fool followed up Friday with an article with some additional details:

Smithfield's team speculated that China's hog market could be slashed by a whopping 20% due to disease. Given the country's problems, China could become an enormous market for Smithfield to tap.

After the conference call, Smithfield announced an official agreement with an "undisclosed" trading company to deliver 60 million pounds of Paylean-free pork to China through year-end. Sixty million pounds sure sounds like a lot of meat, but compared to the meat processor's typical yearly production, the number is fairly modest. However, management did indicate that more agreements could develop a long-term relationship with the unknown company.

So just how important is the 60-million-pound contract to Smithfield? Well, in 2006, the company sold 3.1 billion pounds of fresh pork products. The contract represents just 1.9% of that.

The deal might be modest now, but it indicates that Smithfield has a foot in the doorway of the hugely important Chinese market.

There is the possibility China may not become a significant importer from the protein king, and you wouldn't -- and shouldn't -- base your valuation solely on a chance that the country will drive significant growth for Smithfield.

Its (China's) industrialization has farmers dropping their pitchforks and abandoning their livestock for big city manufacturing jobs. And while the country has a large agriculture market, a lack of farmers cannot keep up with the demand of a rapidly growing population.

So this article picked up many of the themes I outlined the week before; but the point about a large percentage of population moving from rural to urban areas is also a good one, and bodes well for food importers in the long run. This specific play is especially interesting, simply because pork is a popular food in China.

Again, this is a very long term play and the stock is not going to spike due to financial results in the near term due to this China play (it could spike from contracts like it did last week). But definitely one to watch for continued progress into China.

As an aside, an astute reader emailed me with a small cap play on the pork growth story in China. It is an over-the-counter stock but apparently with plans to move to a major listing (application sent into NASDAQ July 19th). Stock name: Zhongpin (ZHNP) - the reader notified me of this stock @ $9.25, so let's keep a long term eye out on this one as well although it's a bit speculative at this point.

The financial results for ZHNP in its last earnings report are pretty outstanding:

Revenues doubled to $64 million

Gross profit +73% to $8.2 million

Net income (not quite as impressive) +23% to $0.23/share

This is more of a consolidation and aggregration play of the local Chinese pork market by an emerging local player vs. the SFD play which is new market entry of an established player. But again, we see this price inflation in China - pork prices for this company rose 37% year over year (it appears food prices worldwide are really shooting up.)

Gross margins dropped simply because inputs (cost of hogs themselves) are rising even faster. Part of this attributed to disease in the local herd in China. This is a very thinly traded stock not appropriate at this time for the basis of the Marketocracy fund (nor available to it, due to the exchange it trades on) but is another data point/source of info for this play into pork.

No positions in fund or personal account.

Comments

[hpski]

SFD's treatment of its animals, not to mention contracted farmers, has been dismal. The company's environmental impact is a legacy of well placed political donations & lobbying efforts designed to circumnavigate federal & local clean water regs. Of course their web site tells a charming story of their respect for the environment, which has more holes in it than Sonny Corleone at a toll plaza. Loss of animals from disease is usually due to extremely inhumane, cramped living conditions, expediting microbial transfer and random mutations, leading to more resistant strains. Add antibiotics to this, and you have the classic arms race, creating "superbugs". The last thing I would ever ingest would be something that says "Smithfield" on it - yeah, the pork may be tasty, but it's also a witches brew of hormones & antibiotics, not to mention the factory farm induced psychosis of the deceased pig. I agree that the China connection will have little impact on SFD's bottom line - however, when the dems take the WH in 08', SFD may have to invest more in its infrastructure to ameliorate the above ongoing situation, possibly reducing its margins.

[semuren]

Just a quick comment on the implication that there is some sort of shortage in agricultural labor in China due to rural urban migration. The fact is that there is still a large surplus rural labor pool. If and when the household registration system that classifies rural and urban as almost different types of citizens is substantially reformed things might change more dramatically, but I would not count on rural labor shortages in China any time soon. What is more, much of the rural to urban migration is seasonal or temporary, based around agricultural cycles.

[TraderMark]

thanks semuren. Part of this is a pure economic theory play - from much of what I read in general most of China is not very fertile ground vs say parts of Russia or the American Midwest - hence the movement of goods from 1 country to another makes sense if trade barriers fall - i.e. we (America Midwest) provide what we specialize at (grain/wheat etc from fertile grounds) and export, whereas Chinese move from inefficient rural farming to more efficient (for them) items such as manufacturing. Sort of a big picture idea.