Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Jerry Hostetter – IR

Larry Pope – President & CEO

Carey Dubois - CFO

Analysts

Eric Katzman – Deutsche Banc

Diane Geissler - Merrill Lynch

Kenneth Zaslow - BMO Capital Markets

Robert Moscow - Credit Suisse

Christine McCracken - Cleveland Research Company

Pablo Zuanic - JP Morgan

Jonathan Feeney - Wachovia Capital Markets

Farha Aslam - Stephens, Inc.

Timothy Ramey - D.A. Davidson & Co.

Smithfield Foods Inc. (SFD) F3Q08 Earnings Call February 28, 2008 9:00 AM ET

Operator

Ladies and gentlemen thank you for standing by and welcome to the Smithfield Foods third quarter conference call. (Operator Instructions) As a reminder we are recording today’s call for replay. It will be available from 11 am Eastern today and will run for two weeks through midnight March 13th. To access the replay dial 1-800-475-6701 and then you’ll be prompted for an access code. The access code is 912061. I’d now like to turn the conference over to our host, Mr. Jerry Hostetter. Please go ahead sir.

Jerry Hostetter

Good morning and welcome to the conference call to discuss Smithfield Foods fiscal third quarter results. We’d like to caution you today that in today’s call there may be forward-looking statements within the meaning of the Federal Securities Laws. In light of the risks and uncertainties involved, we encourage you to read the forward-looking information section of the Smithfield Foods Form 10-K for fiscal year 2007. You can access the 10-K and our press release on our website at www.smithfieldfoods.com.

I would like to cover one administrative detail as we get started; we would like to provide the opportunity to as many analysts as possible to ask questions. As a courtesy we request that you ask only one follow-up question so that everyone can participate and we thank you for that.

With us today are Carey Dubois, Chief Financial Officer and Larry Pope, President and Chief Executive Officer. This is Jerry Hostetter, Head of Investor Relations. Larry Pope will begin our presentation with a review of operations, Larry.

Larry Pope

Thank you very much Jerry and good morning ladies and gentlemen. I’m pleased to report this morning our third fiscal quarter results. Income from continuing operations of $59.1 million or $0.44 a share compared with $62.1 million or $0.55 in the same quarter last year. On a year to date basis we’re at a $139.8 million compared with $148.4 million and $1.04 versus $1.33. I hope you recognize in the numbers that we have substantially increased numbers of shares outstanding as a result of the Premium Standard Farms acquisition we did this past May and the PSF results are clearly included in these results for these three quarters.

On an overall basis I am pleased with the results for this quarter. The pork segment of our business is clearly the outstanding leader here; that segment of the business is up more than 100% in fact 125% year over year. That number is a very strong number for us. I think the vast majority of people who cover the company are well aware that this was a very strong quarter for fresh pork. We benefited as much as others did in the industry from top quality live hog prices and that certainly improved the cut out numbers on the fresh pork side of this business. We as well were in a position that we ran our plants, well essentially every Saturday this fall, and in fact we ran the plants one Sunday due to the very strong margins and the very strong business we had. Many of you know that we had an order for China that we were filling at that period of time and we simply didn’t have the capacity on our six day and we had to use some weekend and took an unusual step of actually running the plants on Sunday.

So that part was extremely good. Beyond that the export business for the industry and Smithfield in particular has also been extremely good for us. That has also helped the fresh pork margins for everyone in the industry and ourselves in particular. The industry for the last couple of months is up 14%; our exports are up 42%. For the January through December period the industry is up 4%, we’re up 16%. Certainly the fact that we’ve got a very cheap US dollar has accrued to our benefit and that continues to help us with our export markets.

I know that so many people think that our business has largely been the result of some of the business of recent that we have alluded to in the Chinese market, but I assure you our export business goes far beyond just the Chinese market. Our business in Japan and Russia and in the EU which we are uniquely in a position to export to, those numbers are very solid for Smithfield. The industry as well has got nice numbers but our numbers are extremely good numbers. And so that has certainly helped to fuel these earnings in spite of the fact that we have record kill levels this fall. The industry was able to absorb those record kills and so this meat, both in the United States and outside the meat and propelled us to very strong results on the fresh meat side of the business.

As a touch for just a minute while I’m in the fresh meat side of this, I made the comment in our last call that I would be travelling in the very near future into China and look at the Chinese market. I did that towards the end of January and spent about 10 days in China in a number of provinces meeting with a number of government officials as well as our good customer and I can report to you this morning that we were very well received and had a very cordial trip in that country. Both at the governmental level, the very senior governmental level, at the local province level and I was in a number of provinces where I was meeting with provincial leaders, and as well with the government and then finally, importantly the inspection service, what is known as the AQFIQ, we have very strong and very good relations with that organization, our government agency. And they have been extremely supportive of Smithfield and I can report to you that that was a very good trip for us. I think it’s very good for us long term. We are going to follow that up over the next two quarters and sending a team into China, visiting, following up on my visits and we are going to give this what I call a deep study. With the size of that market that it is with 50% of all the pork in the world being consumed in China and growing rapidly and two-thirds of their protein diet is pork. It’s the product of choice. It’s a market that we have not paid much attention to in the past but a market that we need to pay attention to going forward. And so I can’t tell you much beyond that which way we’re going to go, except to tell you that I am very pleased with the trip and I’m very pleased with the way we were treated while we were in that country and it all went extremely well. I’m just going to pass that on to you while I’m in the export and the fresh meat side of the business.

Clearly offset to the fresh meat business was the raising business. We’ve gone from the situation where the hog production business has been carrying us for the last couple of years to now that with substantially higher raising costs, live production is not profitable. And so the meat processing business has responded in the opposite side and have helped to offset those losses on the production side, but we are in an environment where raising hogs is not profitable. It is not the result of the production operations; circle virus is well under control in our farms. [Hers] which many of you know is a standing problem in the industry. We refer to it as hot and cold and it is cool at this point. It has calmed down fairly substantially for us and so we’re getting good numbers in terms of production numbers. It’s an overall issue associated with largely, essentially grain costs and those costs are now reflecting through our raising costs as is very prominent to everyone else and I don’t need to explain that very much to all of you on the telephone.

On the beef side of the business, I would tell you it’s not good but our numbers still I think stack up very favorably with those others in the industry. We have in the past been plagued with some fairly significant losses on the cattle-raising side. I told you several months ago that we had dealt with most of that and that would be getting behind us as took some of that higher feeder cattle and could raise that out and completed that process and we are replacing those, back filling those with lower priced feeder cattle. And so we are always having much better beef processing numbers but they were being offset by cattle losses. That part is, neither is particularly great, but from my standpoint in a very adverse environment we continue to deliver something on the beef side of the business. I am not at all satisfied with that. You shouldn’t take that as a satisfaction. It’s the fact that it’s a very tough environment out there and has been now for some four years. But we continue to compare favorably and I’m at least satisfied we’re doing as well as we can in this market.

Internationally it’s a mixed bag. Poland continues to perform well for us particularly in the packaged meats business there. That business has grown very substantially and that business is very solid even in spite of high live hog prices, its still a good market for us. Our Romanian processing plant is breaking even. So even as again we deal with some of these issues over there, we’re still breaking even so it is not dragging us down. The offset to that is Western Europe. We have hit a bump in the road there with our group Smithfield operations. They are feeling some of the pricing pressures of competition and that we are not doing as well in our French and Western European operations as we were a year ago. We’re still profitable but not doing, not certainly at the levels we were some 12 months ago.

I want to turn for a minute and talk about the packaged meats business. That’s one of the shining stars that I continue to talk about every quarter and our packaged meats business this past quarter was again a very, very good quarter for us. We had a very good ham holiday season. The company had both increased margins and increased volumes. We did have cheaper raw material and that worked to our benefit. I would pass that through but as well we have got a very strong focus in this company on that end of the business so many of you who talk to me along the way knows this was a big focus of mine. We’ve got a giant packaged meats business that I think has a lot of imbedded potential and opportunity here. We are just starting to really mind this in a big way. We are heavily focused on that end of the business and I can tell you as I made reference to in the press release, a number of the categories we continue to focus on again and again and again, the convenience oriented products are up significantly for us. Our precooked bacon business is up well over double-digits for the quarter. Our precooked sausage business is up substantially. Our precooked rib business is up very nicely. Our spiral ham business is up. All of those businesses are up very nicely and they’re getting a double kiss here in that many of those categories are the same categories we acquired when we purchased the [RM Records] business a little over a year ago. And I know there’s been speculation out there that Smithfield made a mistake in buying the [RM Records] business that that’s been “a disaster for those guys and they’re having to wrestle with that.” As we’ve continued to point out to you that we’ve rationalized plant. I can report to you today that the [RM Records] acquisition has been a very good one for this company and it has been accretive from the day we purchased it. Yes, we continue to rationalize plants and we rationalized another plant just this past January in Austin, Texas. It was a cooking plant. It was under utilized and we reallocated and relocated the product to other plants reducing our plant operating cost, rationalizing capacity which we are continuing to focus on in this company. But you should not take from that that this has not been a good acquisition for us. It’s all essentially convenience-oriented products for this company and the fact that that combined with the other businesses we’ve had in place, this portion of our business is, I will not tell you it’s hitting on all cylinders but I will tell you the engine is firing very well.

Even in spite of the fact that we are all facing increased cost pressures in all areas of the operations, I know that the protein side from live hogs to cattle to poultry; all of those we’re feeling the lower prices. As I look at virtually every other cost that impacts this company and I get a report on that every week, I would say virtually 100% of everything else affecting this company has gone up. So there is imbedded food inflation at least from my perspective, there is imbedded food inflation in this country that is going to have to be passed on. To date it has not been but I would suggest to you that I believe that there are price increases and these costs are going to have to be translated into higher food costs. And I think that is coming to all of us.

The big issue is clearly the fact that we’ve got a lot of protein in this country. And I’m worried about that. But before I give you too much more on that I want to at least turn this over to Carey and let him give you some financial numbers and then I’ll come back and speak about where I think we’re going from there.

Carey Dubois

Thank you Larry and good morning everyone. Before I begin with the financial highlights, it’s worth noting the only remaining macro difference in the quarter versus last year was the acquisition of Premium Standard Farms in May, 2007 and the inclusion of their results.

Beginning with the income statement, sales for the quarter increased by 16% to $3.8 billion versus $3.3 billion for the second quarter last year. For a second consecutive quarter sales were up across all of our business segments. The pork segment and hog production segment sales were up 13% and 30% respectively primarily from the Premium Standard Farms acquisition.

International segment sales were up over 50% due largely to strong volume increases in Poland and Romania, as we continue to build out there fresh and packaged meat platforms and also to foreign currency translation affects.

Selling, general and administrative expenses were up $60 million quarter over quarter. The increased expenses were largely attributed to the addition of Premium Standard Farms, foreign currency and inflation affects and increases in the variable compensation expenses.

Operating profit increased by 34% to $166 million versus $124 million a year ago. This increase was driven largely by improved earnings of $122 million or 122% in pork, due to the addition of Premium Standard Farms, lower raw material costs, growth in our export business and extension in our packaged meat markets. Seventy percent of these gains were offset by an 85% drop in hog production results which were adversely impacted by higher grain costs.

Other noteworthy quarter over quarter changes were seen in the [D] segment results which realized an increase of $11 million from positive results from both our processing and cattle feeding operations and two, from our Butterball operations which experienced a drop of $8 million from the impact of higher grain costs. Adding back depreciation and amortization of $67 million plus [interment] adjustments our earnings before interest, taxes and depreciation and amortization were $236 million or 29% higher versus $183 million for the same quarter last year.

On a trailing 12 month basis EBITDA was $773 million as compared to $613 million for last year. Equity and income results fell by $12 million to $15 million for the quarter versus last. The majority of this decline was attributed to two factors. First we experienced a drop of $5 million of Groupe Smithfield due to a slight decline in sales volume and to a decrease in margins from the competitive price pressures for certain categories within our French and Dutch markets. Second we had an $8 million decline in our Butterball operation results due to higher grain costs.

Interest expense was up $19 million over the same quarter last year driven largely by an overall increase of $600 million in debt over the past year. This increase resulted from the acquisition of Premium Standard Farms, investments in Eastern Europe and increases in working capital.

For the quarter you will notice that we increased the affective tax rate. We felt this was necessary due primarily to a change in performance outlook in Eastern Europe for the year. Our Eastern European business is subject to relatively lower tax rates versus the US. As such periods of good performance in that region tend to reduce the company’s overall affective tax rate. With the continued pressure on the result of our farming operations in Poland and Romania, we believe that we will have little if any favorable benefit from these lower tax rate jurisdictions in this fiscal year.

Accordingly we elected to increase the overall affective tax rate for the quarter which also required a true up for the first and second fiscal quarters as well. We believe this adjustment negatively impacted net income by $0.06 per diluted share based on previously anticipated tax rates.

Our final income statement item is a $4.5 million charge taken for our discontinued operations. These charges came largely from the sale of our biodiesel facility in Texas which is currently under contract for sale. These charges impacted net income by $0.03 per share.

Looking at intra quarter balance sheet and cash flow statement items, capital expenditures for the quarter were $120 million as compared to $65 million of depreciation. The overall debt level within the quarter decreased by $69 million. Seasonal working capital reductions accounted for this drop. Our debt to total capitalization ratio was 55% and our current available liquidity stands at over $450 million.

With that I will turn it back over to Larry.

Larry Pope

Thank you very much Carey. Looking forward I know the question on everyone’s mind as they look at this business and the protein business in general is these sharply higher grain costs. We are all seeing the same numbers and we’re all concerned about the same issue. I am convinced this issue will work its way through. As I made the comment earlier we have really not had much food inflation and food costs have not gone up at this point. I know a number of us in the industry are talking about the fact that we cannot take these kinds of cost increases without raising our prices. The ability to raise prices is obviously subject to competitive pressure and we’ve all got competitive pressures at this point.

There is a lot of protein in the market. Whether that be poultry or that be red meat, there is a lot of protein out there in the market. I sincerely believe this problem will get solved. I don’t think it can get solved by us wishing it away and I don’t think we can sit here and wait and hoping the other guy will do something. And in fact, that’s not the position Smithfield is taking. We are doing something. I’m sure all of you saw last week that we made an announcement that we are reducing our sow herds between 4% and 5% affective immediately. That will take several quarters to get that fully implemented but we are committed to taking out sow production out of Smithfield’s approximately 1 million US sows; taking 40,000 to 50,000 sows out of production. We will either be abandoning those operations or converting those finishing operations and that’s going to happen.

As well I’m sure a number of you just saw this week that Canada has announced a support program towards the reduction of 150,000 sows in Canada. The combination of that plus the announcement we had last week would total as much as 200,000 sows and would be somewhere in the neighborhood of 4 million plus total market animals being reduced from the market and that’s just the two of us. I wish I could sit here today and tell you that I saw a similar support program from the US government for farmers in the United States but routinely the US government has not gotten involved in helping farmers through these tough times. Sometimes we certainly question that other governments come to the aid of their farmers on this side of the business. I think on the live production side there’s never been much support for this part of the business and the Canadian government sees that as an area they need to help these farmers through.

I have not seen, I would acknowledge to you only anecdotally through conversation. I know a number of people are telling us they are reducing their sow herds but the proof will be in the pudding when we see the sow liquidation numbers increase substantially. We’ve seen some ups and downs and more ups in fact [of even] but we haven’t seen the pig go to slaughter numbers that we expect will occur along the way here. But I do believe this problem will get solved. This situation can not continue like it is. It will be challenging for us. Even given that as you look in to the futures markets, into the summer months at least, even with the higher raising costs it is still going to be somewhat profitable through the summer. And that is traditionally a very profitable time for raising hogs as those who follow the market know very clearly, and even as you look into the fall the futures markets are certainly well above where we’ve seen and traditionally see in the fall period of the year. So the markets due anticipate that there is going to be some correction in terms of number of animals coming to market and I believe that those markets are probably reflective of what’s going on with smaller farmers out there. And I think over time, and I’d certainly look 15 months out or 16, 17 months out and say this situation will solve itself in that kind of timetable. Between now and then it’s probably a little less clear and we’ve said that many times. It’s hard to project a quarter out here. It’s much easier to project a little farther out.

What I can tell you is that from a company standpoint I think we are very solid from an operation side of this business. I think we are focusing this business on managing our production costs very tightly. We are focusing on our plant operating efficiencies and capacity levels and we are looking at the operations that are not contributing to the bottom line of this company very critically. We have been regularly rationalizing capacity out of the business as this equipment becomes much more efficient and faster. The footprint that needs to be in place is substantially smaller and we are shutting operations as opposed to out there chasing business in an effort to fill these plants up. I have said many times I would much rather be a smaller more profitable company than a larger less profitable company and I think that’s imbedded in this organization and cultural thinking at this point.

As I’ve said in my earlier comments the convenience product side of this business continues to be a very strong and growing part of this business. The margins there are substantially better than the commodity, unbranded product label or commodity cut business. We are focusing on arbitraging what I call raw material opportunities in this company. We’re in a position to ration raw materials and in fact are a buyer of most of the time on many of the raw materials we need in this operation so we are arbitraging to the best opportunity and that means cooked product.

Brand development continues to be an area of focus in this company and I think that we are beginning to look at maximizing how this business can take this vertically integrated model that has been built up in this company for more than 20 years and take that vertically integrated model and get the most out of it. And the opportunities that we’re seeing to move product into Western Europe, the ability to sell product into the Chinese market, the ability to produce products for the Russian markets and Japanese customers, all give us very nice opportunities for margin improvements and those are being reflected in these operating profits that you’re seeing in the pork segment. You can tell from my comments that I am extremely bullish on that part of the business. Raw material costs have helped us, there’s no question about that. But beyond that our focus on that I believe as well as helping us and we’re continuing to deliver these profits in spite of $100 oil that’s out there as well as virtually every other ingredient that goes into our products from the packaging to the boxes to the seasonings and the operation of the trucks to the maintenance, the parts, there are cost increases as many of you heard from many of your other companies that you follow. Those are imbedded costs and we’re having to accomplish those through improved efficiencies and I’m proud to say we’re paying attention to those and we’re reacting to those.

With that being said, I will open this up to questions and Jerry I’ll turn it back to you.

Jerry Hostetter

Operator we’ll be glad to take the first question please.

Question-and-Answer Session

Operator

Your first question comes from Eric Katzman - Deutsche Banc

Eric Katzman – Deutsche Banc

Hi good morning everybody. Congratulations on getting to a successful quarter in a tough period. I guess Larry my first question is in the press release you kind of noted that calling out that the fourth quarter might be a bit more of a challenge in hog production, is that just a function of your hedges or just the market being a bit worse, maybe you could comment a little bit shorter term.

Larry Pope

Well as I look out there Eric there’s no question that the near term outlook for hog prices in our fourth quarter of which we’re now one month into it as I guess this week, hog prices today I guess the live hog market is $43 this morning and clearly with raising costs into the $50s, I guess I wouldn’t say into the $50s, right at $50 that at least the first month of the fiscal quarter it’s not going to be, it’s going to be ugly on the live production side and I think that we can see this all the way, I think there’s going to be some improvement. I’m trying to be careful here and I think it is going to be an improving situation as we go through the quarter. But I think it’s going to be a rough quarter for live production and I think this fourth quarter if we do have increasing raising cost here, I think I’ve explained and I think Carey’s attempted to a couple of times, to explain to you that we went to this mark-to-market accounting I guess it was in the third quarter of last year, so we’ve been only a year so as we have hedges in place we have to mark-to-market those hedges. So in affect the grain cost that you actually see, that we actually see in our raising costs are the cash prices we pay plus the profit or loss change in the hedging position since the last time you measured them. So with these grain cost have gone up, we pick up the hedge benefit early on and in fact you don’t see that benefit. It’s a struggle we deal with all the time. It doesn’t necessarily get matched with a quarter to which these hedges were put in place. That’s the reality of mark-to-market accounting. So I think, I know that’s a very long winded discussion to say I think we’re going to have relatively cheap hogs this quarter and we’ve got a situation of continuing to have increasing raising costs. It’s just that simple.

Eric Katzman – Deutsche Banc

Okay and then just as one more follow-up and then I’ll pass it on per Jerry’s instructions, the comments about China longer term sounded very interesting, I’m sure it seems like an interesting opportunity to you in an area that you haven’t necessarily focused on, does that mean, I mean CapEx has been running well ahead of the D&A, should we in our models think about that the bias on CapEx is now up given the potential for you to put money into that market?

Larry Pope

That’s going to take me a minute to explain that one. Let’s start by saying that we have been spending CapEx for several years now in Eastern Europe in a big, big way and Carey pointed that out that even the CapEx this quarter was double depreciation and that’s largely the impact of our continuing to build out the live production operations in Eastern Europe. We have slowed that down pretty significantly and so that the CapEx commitment to Eastern Europe is going to fall off here relatively quickly here. And so that will be coming back the other direction and from an investment standpoint in China we are just starting the process here. Those people have been very cordial to us and I thank them for that. They were more than gracious to me and I would say thank you and I did say thank you to the Chinese government. But that’s going to take some time to work through. It’s a process where we’re new; we would be new to that country. It’s a new process for them. They’re in small rural farming development. They’ve got to adjust. We’ve got to adjust so I don’t see any huge CapEx coming at us in that country for some period of time here if we make that decision. And we have not made that decision. We’ve only made the decision to give this a good strong look over the next three to four months. That’s what we’ve committed to do and so I don’t think that you should yet make that decision. At this point if I were you to have a bias, my bias would be that CapEx would be trending down not trending up. And as we make our decisions on China we’ll report back to you and then I would tell you to change your bias but for now I would tell you to hold your bias toward the downward side as you see the giant CapEx we’ve been making to Eastern Europe begin to trend down.

Eric Katzman – Deutsche Banc

Okay, thank you.

Operator

Your next question comes from Diane Geissler - Merrill Lynch

Diane Geissler - Merrill Lynch

Good morning, congratulations on your quarter in a tough environment. Question on you talked a little bit about the hedging on the grain side, I’m looking at the hog piece and what you called out as a live market hog price, and if I look at that in comparison to the revenue you booked it suggests that you actually experienced something a little bit higher in terms of the prices realized on your hogs. I’m not sure if I’m doing the math right, but was there some forward sales of hogs earlier, say last fall that you saw the market coming down and you went ahead and took some coverage?

Larry Pope

Diane, I guess I’ll answer that question simply and easily; you probably won’t like the answer. You know we’re very careful with our hedging position. I think Smithfield has been very successful and I give a lot of that credit to Joe Luter, that’s what he spends a lot of his involvement with the company doing, Mr. Luter does an excellent job in that end of the business and my compliments to him. His experience there, the last 30 years have been invaluable to this organization and we do routinely put hedges on, take hedges off. We do it with hogs, we do it with grains. We do it with cattle as far as that goes. And so I guess what you’re gleaning, I’m not sure, I guess you’re looking at that paragraph relative to hog production operations and trying to glean, trying to do some calculation of the sales number relative to something else. I’m not sure but…

Diane Geissler - Merrill Lynch

Where you mention that live hog market prices averaged $37 per hundredweight. Your revenue line would suggest that you realized, I guess my question is is that a cash market price or is that your price?

Larry Pope

Well the other side of what you’re seeing, the other thing you’re seeing on that revenue line has got all kinds of things in that in terms of selling out, selling live stock outside and I don’t know that you can do that direct, Carey you may have a better input, I don’t know if you can do that direct math or not at all. I wouldn’t tell you that’s necessarily a good proxy for the math. But I would tell you we, I’m not going to tell you that we don’t routinely have, put hedges on and take hedges off in all of those categories so it’s an important part of this business, I will tell you that.

Diane Geissler - Merrill Lynch

Okay. Appreciate that and then just on the current market environment with where grain is and hogs, can you give us an idea about versus your raising costs today where a break even on hogs prices would have to be? Where would hog prices have to be in order for you to break even?

Larry Pope

I think that we’re going to be in a raising environment in the fourth quarter. We said this quarter our raising costs were $49, they continue to go up. I’m telling you that our raising costs in the fourth quarter Diane are going to be over $50 and more like $51. I haven’t seen the final numbers, some of that could depend on where we have to end up buying grain during the quarter but they could, I don’t think they’re going to be above $52 but they could be, they’re going to be about $50, I’ll tell you that. If I had to pick a number now, I would tell you by fourth quarter raising costs are going to be $51. If I had to pick a number, but I’m not.

Diane Geissler - Merrill Lynch

All right, I appreciate that, thank you very much.

Operator

Your next question comes from Kenneth Zaslow - BMO Capital Markets

Kenneth Zaslow - BMO Capital Markets

Good morning everyone. Larry did I hear you correctly when you said that this quarter obviously would be bad but there’ll be profitability over the summer if you just use the futures and even the current feed environment? Is that what I heard?

Larry Pope

You did hear me say that.

Kenneth Zaslow - BMO Capital Markets

Great, that was just a point of clarification. The same thing is there’s been a lot of rumors about the possibility, and you guys have been pretty forthcoming about what you guys would do with different acquisitions and divestitures, your beef operation, there’s been rumors of interested parties in your beef operation. Can you give us…?

[ audio cut out for 7 seconds ]

Larry Pope

…our beef operations to we’re buying everybody else’s beef operation and I’ve heard we’re building a new plant; we’re not building a new plant. So if you’re not being rumored you’re not of substance. I think that, I’ve said a number of times that I didn’t like the structure that we were in and I thought we were, our plants are on the edges of the United States or relative outside of the close proximity to the feed lot so I said we’re not positioned correctly. I don’t feel any rush to do anything. We’re still doing well. I think that it’s options that we are all studying. I think most everyone in this industry is studying the options of how to turn this beef business around and exports would help, opening these export markets would help. At this point I guess I’m not going to make any more comments than that. Certainly I’m not going to comment on some silly rumor but when we have something to report to you I will be forthcoming with that as soon as we can.

Kenneth Zaslow - BMO Capital Markets

Great, I appreciate it.

Operator

Your next question comes from Robert Moscow - Credit Suisse

Robert Moscow - Credit Suisse

I’m just doing my math here on what break even would be given where the futures are for corn and soybean meal and I’m looking at a minimum $5.30 corn at the end of the year and maybe $340 of soybean meal and I’ve got to me honest with you, at those levels it looks like break even could be like $0.60 a pound. Am I doing the math correctly or and you’re talking more like 51, I know that’s near term but if you look out in the market longer term do you think it could get that high?

Larry Pope

Well Rob there’s no question as you look at those grain, the corn costs as you go farther out and meal as you go farther out, costs, my numbers don’t look quite as high as that but I do understand how you do that math and you’re right I said $51 for the current quarter and that’s a process of evolving. Remember hogs eat their entire life cycle so it’s a growing situation but if we do continue to have corn at this $5 and a half, and we continue to have this meal up here at $3.50 we’re going to have some high price hog raising. There is no question about that. I think, again I might question whether it gets to $60 but I get into the upper 50s, I’ll tell you that. Because that’s why I tell you. This thing has got to be, we’ve got a lot of protein out there so the big issue today is there’s a protein. There’s a lot of competitive pressure from other proteins, and our own protein. We killed 108 million hogs last year; a record. And that’s up 4 million from the year before. Now we’re taking between what Canada’s offering and what Smithfield is doing, that’s a reduction of 4 million hogs a year, that’s the reduction. It’s probably not enough and if I were a farmer today, if you look at this hog corn ratio you don’t have to be a rocket scientist to say when this hog corn ratio is below 10 and I think its seven and a half, I mean God knows if I were a farmer I’d sell my corn. Why risk raising the hogs. They may get [pers], they may die, they may have another issue. Why not just sell the corn, put the money in the bank and more importantly put it in your gas tank and not be in the hog business. So I think that, Joe Luter has used the comment for a number of years, the cure for low prices is low prices. And I think everyone is feeling this enormous pressure out here and everyone should do the same math you’re doing Rob and I think something’s got to happen.

Robert Moscow

I’ll ask my follow-up, you set a goal for $0.10 a pound for value added in terms of profitability, how do you think you did in the quarter against that goal and then another follow-up also, when you start slaughtering all these sows, you’re going to create a lot of meat for sausage, is there a threat that you end up excess supplies of sausage during that time period and would that hurt your value added margins?

Larry Pope

I don’t know which one of those questions to answer, let me say that the third quarter was a very good quarter. We got our $0.10 in the third quarter, how about that Rob? Now we got above our $0.10 in the third quarter. That’s a good quarter for us. I expect that to be the best quarter. I told you we had a great ham season this fall and it’s also cheap raw materials but, and so we’re doing high plus, our packaged meats business and I’m not using processed meats anymore, I’m using the word packaged meats. Now your question about sows going to market. There’s actually been a backup in the sow slaughter operations and if you track the markets you’ll see the sow market dropped dramatically here a few weeks back. It’s recovered as those have caught back up. It’s relatively from a big standpoint, it’s relatively [inaudible] it comes out as sow meat and trimmings and such into the marketplace. That kind of volume it’s just sow. That kind of volume is not going to really impact this market. I wouldn’t worry about that.

Robert Moscow - Credit Suisse

Okay great, thank you.

Operator

Your next question comes from Christine McCracken - Cleveland Research Company

Christine McCracken - Cleveland Research Company

Just on these pork inventories, they were up pretty significantly in this last report, drove the hog market lower, what do you think is behind that?

Larry Pope

Well Christine, a fair amount of that if you look is the inventory of hams in the freezer. And I can’t tell you that we’re not a substantial part of that. I would tell you that this product, many of us have been putting product away for the export markets. They’re showing up in those freezer inventories and so I think what you’re seeing the impact of the export business as it goes through the freezers. I would tell you that you certainly on the good portion of this and I’m looking at the breakdown as I speak to you right now, from our standpoint it’s all sold. And so I’m not worried about those freezer inventories at all. In our case, it’s 40% increase in frozen inventory and when you’re selling these frozen boneless hams to Russia, that product has got to go through the freezer and so that’s just the process. I understand the numbers you’re looking at and I saw the same numbers you did and said Jimmy the breakdown of what’s in there, and what portion is our dollars so, I think the industry is seeing a nice pickup in exports. It’s helping all of us and it’s almost, I’ll say it’s all, most of it’s sold in the frozen basis and that’s what’s happened, it’s going through the freezers.

Christine McCracken - Cleveland Research Company

Pork bellies were up a lot too, is that weaker food service, can you comment on what you see?

Larry Pope

That’s the impact of $0.75 bellies when bellies are generally well over $1.00 to $1.25 and we’re going to have $57 hogs this summer. We’re going to have some high priced bellies this summer so some of, I won’t comment on our position except to say some people in the industry thought it might make sense to put bellies in the freezer at $0.75 and pull them back out this summer.

Christine McCracken - Cleveland Research Company

Okay and then just a follow-up on the production cut you announced obviously a good proactive measure there to cut and do your part in terms of liquidating the herd, but we haven’t seen maybe the same kind of announcement besides from a small California operation by Hormel to take production out, what do you think it’s going to take? Is it a timing issue or is it that the markets over summer are just like you say break even or so, is that keeping people in the US from liquidating maybe at the rate that we’d expect of them if the prospects from much higher feed costs?

Larry Pope

Christine I’ve heard that some producers out there have bought some of their corn ahead on the futures market into the summer and so some of those producers have hedged that portion of the business and maybe they aren’t feeling the pinch yet. And if you look at this $57 market this summer, some would say well even with these costs mine are going to be close to that but I’ll still be okay. I think even the run up here we’ve had in the last seven days, these market shocks, the conversation that we have in the industry is this is going to shock even this week. And I think our announcement probably got people to thinking. I think this Canadian announcement this week has people thinking. Have I got any hard information I can tell you today? I can only give you the Hormel is what 9,000 I think which is not going to change the world either. But I think that now people are, the rumors, the comments have always been in the past, why don’t those big guys do something about it. They always want us to reduce our herds, why don’t they do something. Well the fact of the matter is the big guy did do something. The big guy came out first and said I’m going to reduce our herd and that’s a publically traded company. Another one, Hormel, a publically traded company came out and said I’m going to do something about this. The Canadian government has come out and said we need to do something about this. So I think that that’s given some, at least puts some people to start thinking much more than they were thinking before and even this week, these shocks to this market has got people one, scared of it and number two if they’ve got the opportunity between hogs and grain, they’ve got to make one more decision and say why raise the pig if I can sell the grain. I know that’s not a very good answer for you. To me it’s as plain as day to me, but I’ll agree with you, I haven’t quite seen the numbers yet.

Christine McCracken - Cleveland Research Company

Thank you.

Operator

Your next question comes from Pablo Zuanic - JP Morgan

Pablo Zuanic - JP Morgan

Larry I just want to go through a thought process, are you giving guidance for whole production earnings in the summer? I guess you know obviously if you are fully hedged in hogs and you’re making use of those above average hog futures, and you’re fully hedged in grains, I agree. But in an earlier question you said that you didn’t know what your raising cost was going to be for the April quarter because you still had to buy the grain, I’m surprised. I always thought you were about nine months hedged. And related to that, your raising costs have been $49 for three quarters in a row, so I guess my question is when I look at demand and supply on the hog side going around 4% in support, I [inaudible] for seasonality I don’t see a pull on hog prices. And then on the raising costs I agree with the assessment that you could get up to 59, so and then you also said that the sow slaughter numbers, the [inaudible] would take 15, 17 months to really make an affect. So hog futures in the summer are high not because of sow slaughter call backs, I would say because people are speculating on China. So net, I’m just trying to get a sense of for you to go out and say that you want to make money in hogs in the summer, you have to be hedged already on hogs and grains otherwise I would argue that spot prices of course in the summer would probably come down from where futures imply and your raising costs are going to go up. Can you comment on that?

Larry Pope

Well I think Pablo what you’re trying to do and I’m not going to agree with that is to tell me what my hedge position is for the summer. I’ll tell you again that we routinely take advantage of these markets when we think they make sense for us on both sides of this thing. And the $59 raising cost that you just calculated is if that corn state of these very elevated levels for a year, remember that you’ve got a feeding process here that you’ve got to go through. Through the sow, through the baby pigs and into the finished weights and you know that by the summer those costs will not be $59 I don’t believe for anybody at the industry. So I believe that $57 for the summer, if the futures are right, $57 for the summer will probably yield some profit. I don’t think it’s customarily the kind of margins that we’re used to seeing when hogs are $57 and not even the kind of margins that we’re used to seeing in the summer time. But I think today you could lock this thing down and put yourself into a profit situation. I think, you did the math Pablo so you agree with that. I think part of the route that gets much more problematic is finally you made the comment that I hedge generally nine months out, I thought I explained a few minutes ago the fact that the mark-to-market accounting for this says that you take the profit earlier. You don’t take it in the summer you take it; we’ve made this comment in other quarters that this profit does not get reflected. It’s just like marketable securities, every day to market and so if the grains go up you pick those profits up in the quarter in which they are reflected in the market not the period in which you eat the grain. I know that was a complicated answer.

Pablo Zuanic - JP Morgan

No that’s fine thank you and then just a follow-up on the pork processing side, obviously very very strong numbers even compared to the quarter before. I realize that January is probably the most favorable seasonably speaking for pork processing. But I’m just trying to get a sense was the big delta there on the fresh side or on the packaged food side. Obviously both benefited but I’ve always thought there is more stickiness on packaged food and out cut outs. So with $37 hogs the bulk of that delta in terms of earnings has to be coming on the packaged meats side. Can you walk us through that?

Larry Pope

Pablo I would tell you for the quarter that the big improvement over the same quarter last year, the 99.6 to the 221.5, I would tell you a good portion of that came on the fresh meat side of the business. We got it on both sides. So let’s be very clear. We got it on both sides. But the fresh meat business was very good for the quarter and we had more hogs. We had the Premium Standard Farms volume in there which increased the volume about, I think our volume increased 35% a couple of things, we had the PSF addition to the organization, those two plants and we ran the plant every Saturday and we ran a Sunday so in good cut outs we took advantage of running these plants over 100% of capacity. And so we got nice pickups on the fresh meat side. This export business has been very good to us in many countries because of the cheap US dollar. My gosh, what the euro went to 151 today, that cheap US dollar is helping these exports and helping the margins on these exports. So fresh pork I will tell you, that more than 50% of this came from fresh pork but packaged meats was also very good.

Pablo Zuanic - JP Morgan

Thank you.

Operator

Your next question comes from Jonathan Feeney - Wachovia Capital Markets

Jonathan Feeney - Wachovia Capital Markets

Larry I keep thinking about how different this Q3 is compared with what had previously been the worst quarter for hog production which was the Jan. ’03 quarter, more importantly kind of what that means for your P&L when hog prices start to inevitably reflect these high grain prices whenever that is. So correct me if anything is wrong, but by my calculations you’re quarterly loss per headed hogs is actually roughly comparable to what it was in the last trough five years ago. You had a little higher [inaudible] because you’re killing about a million more hogs with the premium per quarter, with the premium debt. But I really want to get at is the huge difference is in pork where you’ve almost triple or $150 million more profitability than you had back then. So I want to know about how much of that difference do you think is the packaged meats [inaudible] where you’re almost billable and you largely bought that from ConAgra Sara Lee versus just kind of get lucky on fresh pork margins or I don’t know if you view it as lucky or whatnot, but driven by export [inaudible] and how much of that pork profitability which is [inaudible] do you think can stick around when we eventually see higher hog markets?

Larry Pope

Well I guess I would tell you that we’ve been, I’ll try not to say we got lucky either. It was a very good fresh meat environment. Exports have been very good. I know I’ve said this 14 times now and so that’s helped that fresh meat complex and this rapid decline in hog prices, very sharply last fall puts good margins, I mean we saw margins and January in fresh pork like we’ve really never seen. I will tell you unfortunately in February they’ve fallen off quite a bit so but one of the big pushes here is this packaged meats business and we have been now in this for several years. I’ve been talking about it for now every single quarter. That is a much more stabilizing and a growing piece of this business. Now we will have to see. This is going, we’re going into a new world here. We’ve never been into a paradigm of north of $55 raising costs which is going to translate into meat prices that we’ve never really seen before on a longer term basis. We’ve seen $60 hogs before. All of us in this industry have seen $60 hogs. We survived in $60 hog environments. We’re going to have to, if these grains are going to stay where they’re at, if this government policy is going to stay where it’s at, we’re going to have to see meat at levels that we only saw when hogs saw those summer time $60 prices. Americans can pay it and I’ve made the comment a number of times, if this is what this government has decided higher food costs, which would have to go up maybe 15% or 20%, at least in the protein side of the business, if that has to go up, and that’s the cost of becoming more independent from foreign oil, I guess that’s the price Americans are willing to pay. But Americans have paid it before so it’s not like we’re going to be selling $3 and $4 gasoline. They’ve seen these prices before and the consumer and consume it. The other side of that is we have put enormous effort on this packaged meats side of the business. The convenience products are growing very nicely. They’re nice margins. Standing margins are very good in that. We are rationalizing out capacity getting our cost under, well under control and utilizing our plants more efficiently from the utilization. That’s a very substantial part of what you’re seeing as you see this pork segment continue to be a very good contributor to the bottom line.

Jonathan Feeney - Wachovia Capital Markets

And when you say very substantial Larry, sorry to be nitpicker, would you say more than half of that sort of $150 million [inaudible] from the last trough which the fresh pork margin, [inaudible]

Larry Pope

No I was just saying one half of that is the packaged meats market.

Jonathan Feeney - Wachovia Capital Markets

Okay. Thanks so much.

Operator

Your next question comes from Farha Aslam - Stephens, Inc.

Farha Aslam - Stephens, Inc.

On the beef numbers your quarter to quarter numbers have varied pretty significantly in terms of profitability, if we have to kind of think of that business going forward, what would you think a good range would for us to think about that?

Larry Pope

That’s a wonderful question. I wish I knew what the beef business was going to do going forward. I would yield more to the Tyson people who have more experience and are much bigger than this. This business has had some seasonal pretty good periods here even in the last 12 months. I think this business can continue to be cloudy and crummy until these export markets open up because the cattle side of the business, the beef side of the business, is feeling the impact of this grain just like the pork side is. So beef prices have got to go up too and so beef has got to go through the price adjustment as we’ve all got to go through and so I think beef could continue to be tough for a good while Farha.

Farha Aslam - Stephens, Inc.

So tough is kind of current possibility around $12 million or more like $3 million?

Larry Pope

I was going to say I don’t see us necessarily going into a loss situation but I was going to say that zero to $15 million range.

Farha Aslam - Stephens, Inc.

Okay and my follow-up would be on the European meat side are you seeing any [inaudible] in the competition or should we anticipate that competitive activity going forward?

Larry Pope

It’s tough. As I’ve said a number of times France may be the toughest market in the world to do business in and that’s more than 50% of our business in Western Europe is in France and that’s a very tough market. I think that that’s, we’ve got, we have got to make some tougher decisions in that market in terms of our plant operations. It’s been good for the last 12 months. The merger of this whole Groupe Smithfield deal has been very good for Smithfield because we were not doing well at all. We’re still making decent money in that market. Not making what I think we should be making. I think it will continue for some time there Farha. I do think it will. I think our earnings will still, we’ll still have earnings, I just think they won’t be where they were 12 months ago.

Farha Aslam - Stephens, Inc.

Thanks for the color.

Jerry Hostetter

Operator, we’ve got time for one last question please.

Operator

Thank you and your final question comes from Timothy Ramey - D.A. Davidson & Co.

Timothy Ramey - D.A. Davidson & Co.

Are you willing to say what the net impact of mark-to-market hedges was in the 3Q just looking at both hogs and grain and anything else that you hedged?

Larry Pope

Tim I don’t want to go there on that. You can make your own calculations. I think there’s some, if you look at the hog production costs and such and look at the hog production paragraph or such and you’ll have some information in the 10-Q, but I do not want to get into a discussion of mark-to-market. Tim there’s more to it than even just the hedge position. We take forward grain positions on a cash basis with farmers and so it’s a complicated question. Even mark-to-market only answers one piece of it so I think our quote I’ve said to you guys is judge us on the numbers, the good and the bad and I won’t use mark-to-market as a crutch and I won’t use it as a benefit. Judge us by the numbers.

Timothy Ramey - D.A. Davidson & Co.

And just a follow-up on the Romania/China comments, I think it was three years ago at Cagney I thought yours was maybe one of the most visionary presentations talking about Romania. A lot of that still remains a vision for Smithfield not a reality and so when you’re starting to at least consider putting assets on the ground in China, does the Romania experience color your view or inform your view in any way?

Larry Pope

Well I guess we had, Romania let’s be clear, I’m very pleased the fact that we’ve had the bump that we’ve had here from a manufacturing and processing side, I’ve been very pleased with that side of the business. The fact that we’ve gone in and starting in a very significant length to convert that from a carcass market to a cut market and we’re delivering fresh product into the marketplace. That’s been, we’re doing a very good job there Tim and I think Romania continues to have the promise we thought it did. The issue is that it’s got classical swine fever. We were going at a very fast pace there to get those farms in and I think we did what we could do from a security standpoint and a bio security standpoint. We have gone back and said we need to do more. That’s a country we need to be more. And that’s, if you want to talk about China. That’s why I made the comment a few minutes ago about the CapEx. China is going to be a deliberative process. We’re going to go in there and look at that with our eyes open having been to Poland, Mexico and Romania. We have a lot of background now in terms of doing business outside of the United States. And we’re going to look at that market smartly and hopefully if it makes sense to be there, we’ll be there but we’re going to be there on the basis that if sustainable long term, and it is Tim. For those on this call who’ve been there, you know I don’t need to say much to you for those who haven’t been there, it is eye opening just from the time you come in for approach on landing you say, my goodness gracious, this world has really changed. Those folks like the product that we produce so you’re going to a place that enjoys the product and you’re going to a very cooperative government. The government is part of industry. They’re not anti industry, they’re part of industry. And so they’re your friend and many countries, including the United States sometimes, the government is not friend. It’s almost your enemy. In China the government is your partner and your friend. So it can be, you have to do it smartly and we’re going to do it smartly and today I’m not, I don’t have enough information to tell you that it makes sense to be there but I have enough information to tell you that we are looking whether it makes sense to be there and I think we have a lot of background, now knowledge, that can make us make much better decisions there and understand what the realities are of doing business in that country.

Timothy Ramey - D.A. Davidson & Co.

Thank you.

Jerry Hostetter

Thank you for your time and interest today. I’m sorry there were several analysts in the queue that we did not get to but we’re out of time. Thanks very much.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Smithfield Foods Inc. F3Q08 (Qtr End 01/31/08) Earnings Call Transcript
This Transcript
All Transcripts