Smithfield Foods, Inc. F4Q08 (Qtr End 04/27/08) Earnings Call Transcript

Jun. 5.08 | About: Smithfield Foods (SFD)

Smithfield Foods, Inc. (NYSE:SFD)

Q4 2008 Earnings Call

June 5, 2008 9:00 am ET

Executives

Jerry Hostetter - IR

Larry Pope – President & CEO

Carey Dubois – VP & CFO

Richard Poulson – Executive VP

Joseph Luter - Chairman

Analysts

William Chappell - Suntrust Robinson Humphrey

Farha Aslam - Stephens, Inc.

Jonathan Feeney – Wachovia Capital Markets

Unidentified Analyst– Lehman Brothers

Timothy Ramey - D.A. Davidson & Co.

Kenneth Zaslow - BMO Capital Markets

Diane Geissler - Merrill Lynch

Christine McCracken - Cleveland Research Company

Operator

Welcome to the Smithfield Foods fourth quarter conference call. (Operator Instructions) At this time I would like to turn the conference over to Jerry Hostetter; please go ahead sir.

Jerry Hostetter

Good morning. Welcome to the conference call to discuss Smithfield Foods fiscal 2008 fourth quarter results. We’d like to caution you today 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 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.

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

Larry Pope

Thank you Jerry and good morning ladies and gentlemen and I’m pleased to report this morning that our fourth quarter income from continuing operations totaled $1.8 million or $0.01 per share compared with $51.8 million and $0.46 per share in the fourth quarter of last year. For the 12 months ending in April, we had $139.2 million or $1.04 a share compared with $211.9 million or $1.89 per share.

I hope you took note in reading the press release that there are a couple of things that need to be thought of as you look at these numbers. We do have a couple of one-time charges going through both directions. We did have an impairment related to a plant that we are in the process of closing as we speak which adversely impacted the pork results by $8 million and on the other side we had a $9.4 million gain in our European operations on the sale of a small portion of that business.

In addition there is a very favorable tax adjustment in the quarter as we adjusted our effective tax rate to the revised annual rate, Mr. Dubois will talk maybe more about that, and the favorable outcome of some tax positions that we had. Finally we have discontinued operations and you can see those numbers, I won’t review those for the sake of time, except to tell you that we have now reclassified our beef operations and cattle feeding operations into those numbers. As to that business, we do have a contract for sale of that business to JBS and so for accounting purposes that’s no longer reflected in the operating numbers. It’s being shown as discontinued operations.

The basic story for the quarter is that the hog production business was down sharply as a result of dramatically lower live hog prices and sharply increased raising costs. Those losses were offset in large measure by substantially better results in the pork operations; both fresh pork and processed meats. Unfortunately we were not able to recover all of the declines in the hog production side of the business back through pork pricing and pork margins and as a result the bottom line suffered.

I am very pleased on the fresh meat side of the business we had an outstanding quarter and had an outstanding year. This has been a very good fresh meat year for the company. This has been helped by some very strong export business. As many in the industry have been reporting upon, I can report to you today that our export business has been excellent. I know the numbers in the industry have been up very substantially, even very substantially the last three months. Our export business is actually better then the industries but we are benefiting very nicely from that. We have a very strong business. Many of you know that we’ve had some business in the Asian markets; some strong business over there and that has been very helpful to the business.

But as well we also have some strong business as a result of our two plants that are qualified to ship into Western Europe. We are shipping product on a regular basis into our Western European operations where the markets are favorable and as well we’ve got some sizable business in Australia. I can report to you that our export business this past year exceeded one billion pounds which is a mark for us and substantially above where we’ve been in the past and that has been very, very good for the fresh meat portion of the business.

Certainly cheap dollars have helped that process and these cheap proteins in the United States particularly pork have made our product very competitive in the other markets. On the slaughter levels we did kill at very high levels this year. The numbers reflect the PSS, Premium Standard Farms addition into the family as well as we ran our slaughter plants at higher levels this year reacting to the opportunities that were presented on the fresh meat side. So we did run more hours and more Saturdays then we have in the past and so we took that benefit to the bottom line and is showing up in the numbers.

The other positive in the pork section is the processed meats business. As I’ve spoken to you a number of times, that is part of a focused strategy we have to convert all of our available raw material that’s suitable for processed meats into processed and packaged meats. We have done what I believe is an excellent job in this company. We have accomplished in the past, I’ve told you that we are in fact a net buyer of hams and bellies on a regular basis. We have focused on improving our margins in this end of the business. We have focused on having a much more disciplined approach and we have focused on taking out costs out of our processed meats businesses and this impairment charge even this quarter is one more demonstration of the fact that we are looking very critically at our processed meats business and maximizing the utilization of the capacity that we have and idling those capacities or eliminating those capacities when they do not, we cannot fully utilize those if we are not operating them at the highest levels.

As we pointed out in the press release, some of the information relative to the margin improvements that we’ve seen in the packaged meats business of some 30% for this past quarter and even much higher numbers for the full year. As well we have very nice margin gains in a number of the very important categories that I know I seem like a broken record in talking to you again and again, about the advances that we’re making in the pre-cooked category from pre-cooked bacon to pre-cooked ribs, the smoked sausage, the dry sausage, our pre-cooked entrée business, all of those businesses are doing very well. The numbers that we are—our year-over-year volume gains there are very sizable.

All of those double-digits and many of those well into the double-digits. It certainly makes me feel good about the business as the business is migrating particularly in the bacon business, away from the raw business towards the pre-cooked business. Our pre-cooked bacon business is up very dramatically and now nearly one-third of all the bellies we process now go into pre-cooked bacon as this business is transitioning toward that end of the business. Its much more value-added, much higher margins for us, its where I believe we have very strong capacities and capabilities and that business is doing very well for the company. And it is falling to the bottom line.

The addition of the Armour-Eckrich business a little over a year ago and the addition of the Premium Standard Farms which did bring some pre-cooked bacon capacity and operations there, all of those have brought to us categories of processed meats that are where we want to focus and where we want to send our raw material and I think this focused effort has resulted in some sharply improved margins and they’re following through in this pork processing number which is $138 million for the quarter compared with $78 million last year in the fourth quarter or $60 million better and a 75% improvement and if you look at the year-to-date numbers, it’s a little over double what last year’s numbers were.

Yes it was a somewhat favorable raw material market that we were selling into so that certainly helped our margins. But I do believe that our focus on driving out costs and being disciplined in the way in which we go to market I think is having a very nice longer term benefit that will be continuing to show on this line. I guess the big negative for the quarter is clearly the hog production. Hog production for the quarter is showing $129 million operating loss compared with a $41 million profit in the fourth quarter of last year. Certainly that is a giant turnaround and the quarter was situation where we had started off the quarter with very low live hog prices and accelerating raising costs and I’d say that’s a terrible environment for us to be moving into.

As many of you who follow the company and the industry you know that the live hog market has turned around pretty dramatically since February and March and in fact the live hog market is well over $50 today. Unfortunately our raising costs continue to go up with the ever-increasing grain cost. From the operation side we have done—I’m very pleased with the improvements that have been made on the live production side of the business. Our [livability] numbers are sharply improved. Our feed performance feed conversion, or what we call feed performance, is up very nicely and those give us more then $20 million of improvements that we’ve made at the farm level.

Unfortunately we cannot offset these grain costs that even though as you know we take hedge positions that we don’t necessarily disclose so much to you, you know that that’s a regular part of our strategy to manage this end of the business. But as you know as we look forward grains continue to be very expensive well into the future and so as we look forward, and I’ll talk about that when I get there after Carey gives his update on financial, we are looking at a grain market that none of us has ever seen in the past. I think you all do know that we announced back in February that we were going to initiate a 4% to 5% reduction in our sow herds. We are in the process of doing that. We are committed to that and we are well on our way to doing that.

So I think there is liquidation, as many of you know, I think 10 out of the last 12 weeks the sow liquidation numbers have been well over 10% or double-digit numbers. I think that even given the return of the live hog market back into the $50s, I think people’s raising costs are now approaching $60 if they’re not already $60 and I can—if these grain markets stay anywhere near where they’re at, they are going to be $60 and better then $60 including ours and so even though the live hog market has recovered, no one is feeling like they can sit back and not focus on this end of the business. We are certainly not back where we need to be and these live hog markets are no where near where they need to be in order for this business to be profitable going forward.

The one comment I made toward the end of the press release that we are very bothered by is this ethanol situation in this country that is taking substantial portion of the grain production, corn production in particular, out of livestock feed and diverting that into fuel. This is having, we believe this is having a substantially adverse affect on our business. It’s going to cause food prices in this country to go up. It’s causing a strain on the American family and we are very bothered by this policy and to the extent that it can be reviewed and looked at, I think that’s one big positive down the road. There is a lot of attention now coming both in the United States and around the world, dealing with, focusing on this issue and attempting to get some of the leaders in Washington to pay more attention to this policy and to review this for changes.

I think that the law of [unattended] consequences has occurred here and where we thought we were doing something to lessen our dependence on foreign oil that may be somewhat true although I could debate that for most of the rest of the day; that will be minimal. What we are doing is having a ripple affect on food prices that some portions of the economy have already seen. In the protein sector they’ve not yet seen so much of that because of the strong supply levels that have been out there although these supplies are declining. With the sow liquidations that are going on, what’s going on in Canada, what’s beginning to happen on the white meat side of the business, I think that the protein pricing that we’re seeing is going to be passed through. We have to pass it through with these—we’re in a 1%, 2%, 3% business. Certainly we cannot begin to stand 60% and 70% increases in input costs without having to raise our prices dramatically.

Unfortunately this quarter we weren’t able to do it. We are raising prices as we go. The industry is raising prices but at the pace at which these cost increases are coming at us, it’s impossible for us to raise prices as fast as the costs are increasing. Although we are committed to that, I think the industry is committed to—as the market allows, we’re all focused on this. We’re all focused on being very efficient from our operations standpoint but this is an industry that’s already pretty efficient. There is not a lot of slack in this industry from any of the players. This is a mature business where all of us have our cost controls in place. We monitor costs every day. So it’s not like we could go in and cut $100 million of cost out of our operations. That’s simply not doable. So if this policy continues to be where it’s at, this has simply got to come through in increased pricing at the retail case.

On our international side, I won’t spend much time on that. Poland has done extremely well. I’m extremely pleased there. Our Western European operations, what we call Groupe Smithfield, had a very good year. Our Romanian meat processing operations are continuing to ramp up needing more volume. As you know we are vertically integrated in Romania. We did have a classical swine fever issue last summer which reduced the supply of the hogs from the farms to the plant and so we will continue to deal with that issue until we can get the farms back in balance and get the volume coming to the plant to be back to the levels that we need to be. But as far as the operation side, I’m satisfied there. Unfortunately the live production side of the business in Europe is even worse then the situation in the United States. They’re dealing with even higher cost grains in that part of the world and there has been severe outrage and liquidation occurring in the European markets on the live production side of the business and so it’s a worldwide issue. These grains are a worldwide issue that we’re all dealing with and it’s affecting our European operations every bit as much, and in fact more then it is our US operations.

With that I’ll turn it to Carey for the financial review and then I’ll give you some of my comments looking forward.

Carey Dubois

Thank you Larry and good morning everyone. I want to begin by pointing out two key items. First this quarter includes the Premium Standard Farm results whereas last year’s quarter did not. Going forward Premium Standard Farm’s results will appear in all numbers. This acquisition occurred in May, 2007. Second and as Larry noted, we stopped reporting the beef results under the beef segment and are now showing the results under discontinued operations. Both quarterly and full-year numbers in the press release were adjusted to reflect this change.

Moving on to the income statement, for the quarter, sales increased by 20% to $2.9 billion versus $2.4 billion for the same quarter last year. Sales were up across all of our business segments for a third consecutive quarter. Sales for the pork and hog production segments were up 19% and 42% respectively primarily from the Premium Standard Farms acquisition. The international segment had another strong quarter with sales climbing 59% due largely to strong volume increases and foreign translation impacts in Poland and Romania.

Selling, general and administrative expenses were up a modest 2% for the quarter. Increased expenses from Premium Standard Farms, compensation and benefits, and marketing activities were largely offset by positive foreign currency translation effects. Operating profit decreased to $29 million for the quarter versus $101 million last year. The decrease was attributed largely to an operating loss of $129 million in hog productions. Quarter-over-quarter results for this segment dropped by $170 million. Relatively low hog prices throughout most of the quarter and a continuing high grain cost environment was accountable for this swing in results.

Positive results in other segments partially offset this loss. For example, the pork segment was up 76% or $60 million due to the addition of Premium Standard Farms, continued low raw material costs, and further growth in exports. Further positive numbers came from the international segment which was up 425% or $25 million for the quarter. Adding back depreciation and amortization of $70 million plus impairment adjustments, our earnings before interest, taxes and depreciation and amortization were $107 million or 30% lower then the $154 million for the same quarter last year.

On a fiscal year basis, EBITDA was $672 million as compared to the $635 million for last year. Looking at our equity method investment, equity in income results increased by $13 million to $19 million for the quarter versus last year. Aggregate quarter-over-quarter contribution improvements of $20 million from Groupe Smithfield and Campofrio were partially offset by an $8 million drop in Butterball’s results due to the impact of higher grain costs.

Interest expense was up slightly by $4.5 million over the same quarter last year. Though debt levels increased $800 million throughout the year, a significant drop in our overall interest rate almost fully offset the impact of incremental interest expense from the higher debt level. The increase in debt resulted from the acquisition of Premium Standard Farms, investments in Eastern Europe, increases in working capital and foreign and currency translation effects.

There are two other points worth noting for the quarter before we get into the balance sheet items. First we had several one-time items for the quarter which in the aggregate were almost neutral to our results. A net gain of $9 million from rationalization activities in our Groupe Smithfield business was offset by an $8 million restructuring charge taken by the pork segment and the previously announced closing of an older plant in Kingston, North Carolina. Second $10 million of the income tax benefit resulted from favorable outcomes on the prior year’s federal and state income taxes. These benefits were realized as settlement items in the current quarter and resulted in a reduction to the annual effective tax rate of 34%.

Looking at our inter-quarter balance sheet and cash flow items, capital expenditures for the quarter were $116 million as compared to $69 million of depreciation. Within the quarter the overall debt increased by $277 million. Further working capital needs from higher raising costs and an increase in exports as well as the execution of the final stages of the planned investments in Eastern Europe accounted for most of this increase. Out debt to capitalization ratio was 56% and our current available liquidity is over $400 million.

I will now turn it back over to Larry for forward-looking comments.

Larry Pope

Thank you Carey, clearly looking forward into fiscal 2009 the big risk is in the hog production side of the business. We are all looking at $6 plus corn well into the future and we’re concerned about how we’re going to somehow pass that through in prices for the meat at the retail and food service case. Much of the grains, as you know, come into the operations over time through the feeding process so some of those grain costs are already imbedded in our operation and will take time even if the grain markets were to reverse.

As you know we routinely take commodity positions in the markets to protect us against some of the risk associated with this. We will continue to look at that very aggressively from our side to minimize the impact of this but I cannot give you any assurance today that we’re going to have profitable operations in the hog production side of this business in the near future. I certainly do believe that the liquidation that’s occurring will have its affect on the markets and I think live hog prices in this country have to go up or raising costs and grain costs in particular, have to come down.

One of those two have to happen. Liquidation is occurring as we speak although you know it takes time and I don’t think we’re going to see the real benefit of that until calendar 2009. We said that earlier. I continue to believe that these grain markets are elevated and we’re hopeful through some of the crop reports and if we have a good crop this year, that maybe these prices that the futures markets are reflecting are not reality here. I think the reality today is we have to consider they are going to be there. I wish I could tell you that there was some relief and that maybe there was going to be some changes occurring in Washington or some news that I knew that was going to change this but I can’t make that statement to you today. So that’s a reality of the business that we’re going to have to live with.

On the other side, the export markets continue to be extremely good. We have cheap dollars around the world. We have relatively cheap product particularly on a US dollar basis. The export markets are excellent. They’re open, in fact most of us are having—many of the people in the industry were having logistical problems getting the product to our customers. The orders are there and there are plenty of them so that’s helping to move this product out of the country. As you know we’ve had about a 10% increase in slaughter levels for the year. That product has moved out of the country. We have all got very active export programs and those export programs are still there. So that’s going to help to deal with some of this issue.

One other point looking forward I think is very positive, we haven’t made a big deal out of it, but we made some management changes inside this company beginning with the new fiscal year that I think are going to be very positive for us longer term. George Richter who was running the Farmland Foods operation has now moved to the corporate level responsible for all of our pork operations, reporting directly to myself. As well we have moved in a new Operating President of Farmland Foods which is Jim Sbarro, who was the Sales and Marketing VP. And as well we have moved Joe Luter IV from the President and Chief Operating Officer at Smithfield Packing Company to an Executive Vice President position at the corporate level focusing on the sales and marketing synergies and help manage our sales and marketing efforts on a combined basis. Tim Schellpeper who was the Vice President of Operations at Farmland Foods has moved in as the President of Smithfield Packing Company.

All of those are I believe are very strong moves. Each one of those is moving into a position that I think can improve the operating performance of the individual IOCs in terms of the IOC presidents but as well, we are going to manage our pork group in a much more cohesive way and a more synergistic thought process and I think that the addition of Joe Lute IV and George Richter are very positive moves. Joe was very strong on the sales and marketing side and George Richter is very strong on the management and operations side of the business and the combination of those two, I believe to be a very powerful management team.

We have been focusing, as I mentioned, a number of times on improving the efficiencies in our processed meats business; that has been a heavy focus here for the last two years. We are going to continue to focus there but we are as well turning our attention this coming year on the fresh meat side. There are some significant opportunities across our many fresh meat operations. We have done a detailed analysis and we’ve called in some outside help to help us with that and we have identified some very significant opportunities to improve our fresh meat results. The combination of those four people I just mentioned, particularly with George Richter and the two operating presidents plus Joe Sebring, who was running John Morrell, I believe that we will be making some very significant improvements on the fresh meat side of this business that will be falling to the bottom line in the pork segment going forward. I think these are very doable improvements and they will not take huge capital expenditures to accomplish that.

So as I look forward I think the basic business operations, what I call the things we can control, I could not be more pleased. I think we are doing what any good management team would do in this environment. We are tightening down our cost controls, we are looking for efficiencies and we have put in place some things over the last two years that are now beginning to hit the bottom line in a pretty significant way. Those are still in the implementation stage, some of that, so I think there’s still some more of that to come, and the focus on the fresh meat side, all of that I believe will help our pork segment and help offset what I see is the adverse impact of these grain costs coming through our hog production side.

I am very pleased on the production side, again I told you about the efficiencies we’ve driven out there even this past year. We are reducing our herds. We are taking out our older inefficient farms. We believe that this 4% or 5% reduction will have no impact on cost in our hog production operations. If anything its going to improve our cost structure there so it does not have an adverse overhead impact to us. So we are focusing on that side of the business as well trying to help with this over supply and at the same time help our cost structure.

So I look forward with a cautious note that I think from where we’ve done execution, I’m very satisfied. The processed meat strategy that we rolled out two years ago, we will continue to push that. We still have a ways to go there. So I think that’s still coming. Fresh meat is still coming. The management changes will help us and the only wildcard we’re playing with at this point--exports will probably be in our favor. The only wildcard is grain costs and that one we can all track and you can all see and our results will unfortunately or fortunately will go the direction of where those are.

With that being said, we will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of William Chappell - Suntrust Robinson Humphrey

William Chappell - Suntrust Robinson Humphrey

Talking about the sow liquidation and the recent run-up we’ve seen in hog prices, does that seem premature, is that all seasonal, how do you look at how hog prices should trend through the rest of the year?

Larry Pope

I guess I would tell you that I am a little surprised this hog market has run up and in fact it ran higher then it is today, it’s actually come off a little bit of its high. As you know the hog market trends up in the summer time anyway and so we were moving into the summer when the weights drop and the supply generally is a little bit less. I think there’s still going to be some hogs out there come the fall. I think that there’s going to be a fairly significant supply of those. I think we’re going to continue to have pretty high hog prices through the summer. I think we could have some fall off in this hog market come fall and we’ll have to see how that the fall hog run occurs but I think that could be some lower hog prices.

But then I think by January this thing becomes—this liquidation becomes real and the hog market then and the futures market even reflecting that, I think this hog market then is $60 and $70 I guess it could be as high as that. I predicted that the hog market was going to be $70 by next summer and there’s some indications there that it could be even sooner then that. But I think to answer your question, the summer I think will have some fairly high priced hogs. That’s very seasonal. I think we’ll have a fall hog run just like we’ve had in the past where I think you’ll see these prices fall back and then by January I think the full effect of this liquidation will start to show up in the higher prices.

William Chappell - Suntrust Robinson Humphrey

You might have disclosed, how much did currency help on the international operations both top and bottom line?

Larry Pope

Bill we’ve got your question, before we get off this call we’ll get the answer and come back to you before we finish the call.

Operator

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

Farha Aslam - Stephens, Inc.

I know you don’t comment on your hog positions, but could you share with us your parameters around hedging, how many hogs can you sell forward and kind of what percentage of your production can you hedge?

Larry Pope

Depending on how far you’re willing to go forward you can hedge a pretty substantial portion of that. There are open positions out there when you look at a whole year’s production and the contracts. Yes, you can get a very substantial portion.

Joseph Luter

You can hedge 100% if you want to.

Farha Aslam - Stephens, Inc.

On the turkey division, we’ve heard that you might be selling your facility out in Colorado, any thoughts of sales or reducing your [inaudible] placements to improve turkey profitability?

Larry Pope

At this point we have not done a lot of reductions in terms of placements there. We have looked at that operation you’re talking about. We do not have anything to report to you today and I would tell you that’s not new news. That is old news. We’ve been having discussions with a number of people so that’s one plant that’s not been running at anywhere near capacity and it’s a plant we’ve been looking at. But it’s not really related to the industry conditions and the situation today; it’s a discussion we’ve been having now ever since we acquired the Butterball business and so it’s not just—my point is it’s not related to the grain costs and the situation we’re in at all. We are looking today, we got an awful lot of use of the meat into the deli business and into the cooked product so we have not reduced our production but we are certainly talking about it.

Operator

Your next question comes from the line of Jonathan Feeney – Wachovia Capital Markets

Jonathan Feeney – Wachovia Capital Markets

You talked a little bit more today about the state of the corn markets then usual I guess and I know its an issue for everybody but I guess that combined with when you look at the spread between your reported raising costs and I guess would view as spot—buy it all today raising costs, that got a little bit closer sequentially, is it fair to say that you’re hedging a little bit less on the corn side and that you’re maybe a little bit more willing to take the view that corn [complex] is inflated right now then say three months ago?

Joseph Luter

Here again we’re not going to tell you what our exact hedging positions have been, but I can tell you they have been substantial and hopefully this corn had peaked. The bottom line is that when you take one-third of the US production and burn it up into ethanol in effect reduces supply in the United States by one-third, if you don’t expect to have a—I don’t call a ripple affect, I call it a tsunami affect, upon prices you don’t have any understanding at all about the law of supply and demand. Normally if you reduce a supply there’s some reduction in demand and this particular case the demand is increasing worldwide rather then going down so this is why you’ve got extreme effect and thank God we’ve had great crops for the last two or three years. We have not had a drought and production has been very good.

But if we should have a drought in one of the years going forward if we continue this ethanol program you could have a worldwide disaster and disaster means hunger and starvation in my mind. So I think that the government is going to have to look hard at this ethanol policy or you could have some very, very drastic consequences that would have severe political and economic and health negatives for years to come. I’m very concerned about what I consider this flawed policy of the United States. I know there was a big conference in Europe two days ago and I never thought I would get to the position of that the United Nations is right and our government is wrong. But I do believe that to be the case in this particular instance.

Jonathan Feeney – Wachovia Capital Markets

Do you think maybe others—I mean you’ve seen the industry change a lot as far as the competitor hog producers out there, do you think maybe other hog producers are hedging to an extent they never did in prior downturns? I guess before it used to be low hog prices that caused downturns, do you think increased hedging is maybe one of the reasons why you’re seeing close to record hog losses here without drastic supply reductions earlier?

Joseph Luter

I think there’s increased activity. I don’t think its commercial such as our sales doing the hedge and I think the financial markets have gotten involved to a much greater degree. I can tell you that we have hedged this past year very, very significantly and thank God that we did because it certainly has been a positive to our bottom line rather then going naked for the year. We do use hedging very, very aggressively to try to eliminate the possibility of a disaster which would be $7, $8 hog, corn prices and at a time when we haven’t had the chance to significantly reduce the herds. But hedging we feel is very, very valuable to us. It helps to eliminate an awful lot of risk. It doesn’t eliminate all of it obviously, our last year’s results is a good indication of that, but as I said earlier if we hadn’t of hedged at all and just went naked our losses would have been substantially higher.

Operator

Your next question comes from the line of Unidentified Analyst– Lehman Brothers

Unidentified Analyst– Lehman Brothers

You mentioned last quarter processed value-added meat margins were at least $0.10 or better, I know seasonally they come down in this quarter but would you say that they were still in the high single-digits or better?

Larry Pope

Yes I would, I would tell you that we had a very good processed meats quarter and you’re right, generally the third quarter which includes the holiday season is the quarter when our margins are very good. I would tell you that our margins for this quarter were very good again; extremely good. So no they did—I would tell you that they’re right at that $0.10 on top of that.

Unidentified Analyst– Lehman Brothers

What was the total consolidated debt of the company including the discontinued operations?

Carey Dubois

It was just under $3.9 billion.

Unidentified Analyst– Lehman Brothers

And was revolver availability on a committed basis?

Carey Dubois

We have a number--we have a revolver in a number of lines. As is stated we have in excess of $400 million of liquidity today.

Unidentified Analyst– Lehman Brothers

Is that committed and uncommitted or just committed?

Carey Dubois

Committed.

Unidentified Analyst– Lehman Brothers

And as far as the EBIT or the EBITDA of discontinued operations in the fourth quarter, would you happen to have a number? I’m just trying to apples to apples versus last year on a consolidated basis.

Larry Pope

Why don’t you call Carey offline.

Operator

Your next question comes from the line of Timothy Ramey - D.A. Davidson & Co.

Timothy Ramey - D.A. Davidson & Co.

Relative to the hedging was there any mark-to-market gain or loss in this quarter, can you comment on that? I know you’re not going to give us a number but was it positive or negative and was it substantial or unsubstantial?

Larry Pope

It was positive and its modest is what I’d tell you.

Timothy Ramey - D.A. Davidson & Co.

If we think about the European operations with the rebuilding of the herd in Romania, I’m sort of torn now, we want that to happen so that you can have capacity utilization but the margins are difficult. How should we be thinking about--?

Larry Pope

You’re having some of the same thoughts we are. We’ve got to get the operations back to a normal, at least the farms back to a normal operating level. We were planning on that plant moving up but today the losses at the farm level far exceed the opportunity at the plant level. So the rebuilding of the herds at this point, we were at 50,000 sows, we went down to 37,500 which is what we had to do as a result of that. We continued to be around that number and we are going to move the sow herds modestly up to about 40,000 as we can and as the markets dictate, we’ll go to 50,000. But we’re dealing with that same issue. We’ve got very expensive corn there and it simply does not justify moving these sow herds up to 50,000 at this point. We are buying for the plant. We’re buying hogs for the plant from outside of our own operations and in fact outside of the country. We’re very close to the Hungarian border so we can bring some hogs across the border from Hungary and process those. It’s not the optimal solution but it’s the best solution right now.

Operator

Your next question comes from the line of Kenneth Zaslow - BMO Capital Markets

Kenneth Zaslow - BMO Capital Markets

How much liquidation from the hog side would be required for you to get to a sustainable level of profitability? Are these cuts deep enough for you to eventually be returned to profitability; assuming current corn prices, assuming the current feed environment?

Larry Pope

Well I think we need to be approaching that 10% reduction across the total sow inventory in the United States. I don’t know whether you’re talking about us or you’re talking about the United States. Ours is 4% to 5%. Sow liquidation today is running better then 10% and I’m sure you already know that. I think that’s a giant start but killing 430,000 hogs in this country and its come down a little bit of late, but if we could get that daily kill down below 400,000 and the export markets continue to be good, I think a lot of hog prices will be substantially higher. The meat prices would be substantially higher and so whether that’s enough to move the hog market over $60 on a sustained basis and if grain prices stay where they’re at, the live hog market is going to need to be over $60 on a go-forward basis. I don’t whether that’ll do that.

Joseph Luter

It will get there, the only question is the timing. We’re going to have hog prices in my judgment in the high $60s for the foreseeable future here in just four or five or six months if you look at the futures market for next June on a [dressed] cost basis its right at $0.90 on a [dressed] cost. So bottom line is that this meat cost is going to go up, the hog numbers are going to come down and because the question is timing. But whether the timing happens in January of next year or September of next year we don’t know. But it will happen because the industry just cannot sustain itself in this current environment.

Kenneth Zaslow - BMO Capital Markets

And the Canadian and the Denmark liquidation is still happening pretty aggressively it seems like also from the data that I see? I don’t know if you could add some color to that?

Larry Pope

I really can’t add much more then you. I don’t have any more data then you’ve got but yes, I think it is.

Joseph Luter

I think it’s much more substantial then what’s taking place in the United States.

Kenneth Zaslow - BMO Capital Markets

In terms of your pork increase, can you identify how much was really from the improvement in the fresh pork business versus how much was really Smithfield-specific, and the sustainability of that? If I look at your year-over-year increase in pork, there’s a part of it that’s probably because of the pork packer margins have increased and then there’s a part of it that is because you have shifted to higher-end products and higher valued products and to me that seems to be more of a sustainable piece of the business so I’m just trying to figure out exactly how much of that business is sustainable and do you think—there’s a piece of that business that you continue into the future versus the fresh pork business can move all over the place.

Larry Pope

I think about two-thirds of that for this quarter, two-thirds of that improvement were in the fresh pork margins and one-third of it was in the processed meats margins.

Operator

Your next question comes from the line of Diane Geissler - Merrill Lynch

Diane Geissler - Merrill Lynch

Just thinking about your comments on ethanol and this is obviously been something that other companies have addressed in their conference calls; you’re the last meat packer to report so maybe you get the question because of your position in terms of the earnings calendar. But it strikes me as it doesn’t seem like Washington is budging on their policy on ethanol despite some of your commentary and some of your competitors’ commentary about the impact on grain. So is it fair to say that the rules of the game have changed and now we have to just adapt to the new rules and what is your outlook for how the little players out there are adapting to it because its just not only in pork but in poultry and beet, it just seems like its always some kind of the marginal player that delays the change within the industry. Can you talk about that a little bit?

Larry Pope

I hope to tell you that the—I do think the game has changed a bit. I do believe that we’re not going to return to $2 corn, now that part I do believe has changed. Even if the ethanol policy were completely reversed and eliminated, I’m not convinced that we would be back at $2 corn so I think we’re all going to have to adjust to higher priced grains. I think we could have a recession here and who knows what can happen as a result of all that. But I do think that has changed. Now the question is, is it $2 corn or $2.50 corn or is it $3 or $4 corn or is it $6 corn or God forbid some weather events and its $8 corn like we see in Eastern Europe. I think we have to adjust to an increased input cost and a grain cost which is going to result in higher priced meat. But meat in this country has been cheap. In many cases the raw material hasn’t gone up substantially in 30 years so we’ve got [sufficiencies] in these operations for 30 years. Food has been very cheap in the United States; that is going to change. Food prices are going to go up and meat prices are going to go up.

Now your question is how does this affect those two little guys; one is the guy raising the animal and the other guy is the person processing the animal. I don’t believe the losses that are occurring with these grains that are not being passed through in either live prices or meat prices, small guy I don’t know if they’ve got pockets deep enough to get through this to get to the other side. There’s clearly going to be the fallout from those guys who are already leveraged up or didn’t have much equity in the business, those guys I don’t think are going to make it particularly when you’ve got the banks out there that are not all that happy about lending more money to this industry. So I think those that go out will stay out. Its not that they’re going to take animals out of production and put them back at some later point. But I think that’s good, we need some contraction in this. The livability and the productivities that we’re all able to accomplish through our breeding operations continue to improve and so I think that’s a natural process.

And then on the processor side—if hog prices go up pretty dramatically and some of these smaller guys, we are not going to be able to get the prices through at the retail case fast enough then the margins on the processing side could be severely impacted. As I said here just a few weeks ago in our organization we were losing huge money in live production just six, seven weeks ago. That’s not the case today with live hog prices coming back. We’re not losing huge money, we’re losing money but not big money. And now the pressure comes in the meat processing side. That’s what should have happened to the model. Mr. Luter made the comment here a few minutes ago, this thing is going—the hog prices are going to go to $60. Hog prices are going to go to $70. When they do that the price at which we have to sell meat for to produce a profit at the meat processing plant is going to be a price our customers have never seen before. And the consumer has not seen before.

Now consumers have seen $60 hogs and consumers have seen $65 hogs but they’ve never seen that kind of—those kind of levels on any kind of a sustained basis. And so there are going to be price levels for the meat the consumers have never seen and there’s going to be lots of resistance from the retailers that I could through and talk about the food service side which I think are going to feel it even worse, but there’s going to be that price resistance as we try to push that through and that’s what Mr. Luter was talking about the delayed impact of this; that delay is there. But there’s no question that it has to go up, it has to go up substantially and those who don’t have the pockets to get through this are not going to survive and I think there could be some big numbers and periods of time either on the production side or the meat processing side, the numbers could get ugly, very ugly for a modest period of time and if you don’t have the capital to survive that, you won’t make.

Diane Geissler - Merrill Lynch

You had indicated that you thought on the seasonality with the fall hog run that you might see prices pull in a little bit here as we move into the fall, would it be a mistake for us to think that if you had that outlook you wouldn’t be already sold forward on your hog production for this fall?

Larry Pope

We’re not going to give you our positions but I would tell you obviously we have a view and then we aggressively hedged. You draw your own conclusions.

Operator

Your final question comes from the line of Christine McCracken - Cleveland Research Company

Christine McCracken - Cleveland Research Company

On liquidity, with the significant increase in grain costs that we’ve seen, don’t you think or do you believe that you’ll have sufficient liquidity to finance all your working capital needs?

Carey Dubois

It’s something that we do weekly. We actually look at our investments, our costs, our CapEx and our working capital needs monitoring this very closely and we continue to speak to our bankers and rating agencies routinely on this. So it’s something that we continue to monitor very closely and to the extent we feel that we need to further improve the balance sheet then we will take measures to do so.

Larry Pope

One of the things that we have done is secure additional working capital facilities out there to cover us for this because there’s no question that some of the lines of credit that we had established were not established when the balance sheet was not capitalized and thinking of $6 corns, but our banks have been very supportive of us.

Christine McCracken - Cleveland Research Company

As you look ahead at that liquidation it really needs to happen whether you [call it] 10%, 15%, to get hog prices higher if you look then at the processing industry and what that might mean in terms of securing hogs and the over capacity that might come as a result, how do you see this playing out? Is this—from your perspective you’re integrated, but several of your competitors or peers aren’t. I’m just wondering if you see a structural change in the industry as a result of this liquidation that has to happen.

Larry Pope

I think with the industry we’ve killed a lot of hogs this year, running longer hours and running Saturdays and so I think that you’ll see a reduction as this thing liquidates back, I think you’ll see fewer Saturdays and less hours and I think there has been some discussion along the way about building another processing plant by one person in the industry; that seems to be tabled for now, that’s for sure. I don’t know that I think a 10% reduction in this number is going to result in anybody leaving this industry or closing any operations as a result of that.

Joseph Luter

I don’t think so. I think what I believe, I believe that we’re going to continue to have inflation and I might even call it hyper inflation in regard to food prices. If this ethanol policy continues, we’re going to be taking not a third but about 40% of their corn crop into ethanol in the foreseeable future and when that happens in my opinion, you’re going to have a disaster on your hands in regard to food inflation.

Larry Pope

One of the things that you raised was whether we had liquidity, whether we were concerned about our liquidity, I want to remind you that we have a pending beef transaction that is scheduled for closing here, somewhere probably in our fiscal second quarter and that’s going to generate between $500 million and $600 million of cash, at least that on closing and could be significantly more then that depending on what we do with our cattle raising operations in connection with that. So there is, from our standpoint, there is substantial cash infusions coming in here in the relative near future.

Jerry Hostetter

Our time is up for today. We want to thank all of you for joining us and have a good day.

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