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Smithfield in Neutral Lane

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We reaffirm our Neutral recommendation on Smithfield Foods Inc following mixed fourth quarter results.

Why the Reiteration?

Smithfield reported its fourth quarter results on Jun 14, 2013. Its revenues increased 3.0% year over year, driven by the strong momentum in the packaged meat business. Revenues also exceeded the Zacks Consensus Estimate. However, earnings missed the same and lagged the prior-year earnings figure due to weak margins in the hog production business and decline in pork exports.

The continued rise in grain costs after the 2012 draught resulted in a sluggish hog production business. Pork exports also declined due to a fall in shipments to China and Russia. The requirement of a new ractopamine (animal drug) certification in China slowed down the exports, which picked up later in mid-March. Exports in Japan suffered due to depreciation of yen against dollar.

The company’s operating margin declined during the quarter due to higher raising costs, which impacted both the hog production business and the international segment.

Of late, Smithfield has struggled with rising grain costs and a weak hog production business. Smithfield thus agreed to sell itself to Hongkong-based meat processor Shuanghui in May-end. Following the closure of the deal, Smithfield will not trade publicly. Smithfield turned out to be an attractive prospect for Shuanghui, given the former’s solid management team and strong product portfolio that strongly focuses on maintaining food quality standards. The deal is likely to benefit Smithfield as it can leverage Shuanghui's solid distribution network in China to expand the presence of its brands. We believe that Smithfield and Shuanghui together will be able to fulfill the growing appetite of China for pork.

The deal is expected to be complete by the end of second quarter of fiscal 2014 but is yet to receive shareholder and regulatory approval. U.S regulators remain concerned about the food supply chain as they do not find Shuanghui’s food safety practices in China acceptable.

Smithfield holds a Zacks Rank #3 (Hold). Other meat producers Pilgrim’s Pride Corp (PPC - Free Report) and Tyson Foods Inc (TSN - Free Report) , both hold a Zacks Rank #1 (Strong Buy). Another food company, Dole Food Company also holds a Zacks Rank #1.

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