Smithfield Foods Inc. (SFD) posted better-than-expected adjusted earnings (excluding early debt extinguishment charges) of 61 cents per share in the second quarter of fiscal 2013, much ahead of the Zacks Consensus Estimate of 44 cents. However, the results lagged the prior-year earnings of 76 cents per share by 19.7% due to sluggish sales and weak margins in hog production business.
During the quarter, total sales slipped 2.6% year over year to $3.23 billion. The decline was due to soft sales in all the categories, lower meat and hog prices, which offset higher volumes. Total sales also lagged the Zacks Consensus Estimate of $3.30 billion.
Operating profit declined 20.6% to $178.3 million during the quarter due to rising costs and lower sales. Operating margin declined 100 basis points to 6%. Weak hog production margins overshadowed the improved margins of fresh pork, packaged meat and international segments.
Segment and Margin Details
Pork:Sales in the Pork segment declined 1.9% to $2.72 billion compared with the previous year period. While sales of fresh pork slipped 4.3% to $1.24 billion, sales of packaged meat increased marginally to $1.484 billion compared with $1.482 billion in the prior-year period.
However, operating margin in the pork segment increased 100 basis points to 7% on the back of robust 8% fresh pork margins and improved packaged meat margins of 7%. Widespread domestic demand as well as continued strong export demand for pork improved fresh pork margins in the second quarter, following a disappointing first quarter. Packaged meats margins improved on the back of lower raw material costs, improved product mix and higher strategic investment in advertising.
Hog Production:Hog Production plummeted 6.5% year over year to $734.0 million in the second quarter of fiscal 2013. The segment’s operating margins were also disappointing at negative 4% compared to positive margins of 8% in the prior-year quarter. Higher raising costs and lower live hog prices were the key reasons for the decline, which offset the improved operating efficiencies from hog production cost saving initiatives.
International Segment: The segment reported a decline of 8.3% to $358.6 million in the reported quarter. However, operating margins more than doubled to 11% compared with 4% in the prior-year quarter led by strong results in the company's Eastern European hog production operations and significant improvement in average selling prices in Romania.
Other Financial Details
Smithfield repurchased high interest bearing debt in the quarter, which was refinanced with a new debt at a much lower interest rate and a longer maturity, thus reducing interest expense by 6% in the second quarter of fiscal 2013. This reflects the company’s successful efforts in reducing leverage.
During the quarter, Smithfield repurchased 3.4 million shares worth $67 million and 8.2 million shares subsequent to quarter end for $174 million.
Smithfield continues to expect packaged meat margins to improve in the third quarter, driven by product mix and increased marketing of its core brands. For fiscal 2013, the company expects packaged meats margins at the high end of the normalized range with 2–3% volume growth.
Further, decline in global pork production and higher pork prices, especially in EU, are expected to push up demand for pork in the US in fiscal 2013.
The company expects hog prices to normalize in the coming quarter, making the Hog Production segment profitable. Moreover, the company’s risk management strategy will help in limiting the rising grain cost impact.
In the International segment, both hog production and meat processing businesses are expected to improve in Poland and Romania.
We have a Neutral recommendation on Smithfield over the long term. Both Smithfield and its peer Tyson Foods Inc. (TSN) hold a Zacks #2 Rank (short-term ‘Buy’ rating) given their bright prospects.