High on the Hog - The Spear Report Recommends Smithfield Foods

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While doughnut-maker Krispy Kreme, and other high-carb food producers such as American Italian Pasta Company and Interstate Bakeries have seen their share prices drop precipitously in recent months, meat and poultry producers like Smithfield Foods and Tyson have seen their shares hit 12-month or all-time highs recently. Technically, Smithfield Foods (SFD) is a chart of beauty and we recommend it right here. Smithfield Foods (SFD) PE 33, market cap $3.2 billion.

The US food market is undergoing sharp changes. On the one hand, the rise of interest in "natural" foods has thrust companies like Whole Foods and Wild Oats to the forefront, while forcing more mainstream markets to continually expand their natural foods and organic foods segments. But this growing market is still in its infancy, and the US diet is still dominated by "meat and potatoes" consumers.

Change is also occurring within that mainstream market, however, due to the Atkins diet and the dozens of high-protein, low-carb spin-offs. While doughnut-maker Krispy Kreme, and other high-carb food producers such as American Italian Pasta Company and Interstate Bakeries have seen their share prices drop precipitously in recent months, meat and poultry producers like Smithfield and Tyson have seen their shares hit 12-month or all-time highs recently.

Smithfield Foods is a producer and distributor of fresh beef, pork and processed meat products domestically, as well as in 25 foreign markets including Mexico, Poland, France, Japan, China and South Korea. The company specializes in pork and through its pork division, Smithfield manufactures a variety of processed meats, including smoked and boiled hams, bacon, sausage, hot dogs (pork, beef and chicken), deli and luncheon meats and specialty products, such as pepperoni and dry meat products. But that's not half the story. When it comes to pork, this company goes whole hog.

With annualized sales of $9 billion, Smithfield Foods is the leading processor and marketer of fresh pork and processed meats in the United States, as well as the largest producer of hogs. It all started in 1990, when Smithfield Foods flew 2,000 sows specially bred by Britain's National Pig Development Company (NPD) to the United States. With exclusive U.S. rights to their genetic lines, Smithfield envisioned a herd that produced meat significantly leaner than any other commercially raised hogs.

Six years later, Smithfield Foods launched Smithfield Lean Generation Pork (tm), the first fresh pork to be certified by the American Heart Association for its low fat, sodium, and cholesterol content. In fiscal 2001, this product's sales volume topped 100 million pounds. "Lean Generation is an outstanding example of why we began vertically integrating this company," says Smithfield Foods Chairman, President and Chief Executive Officer Joseph W. Luter, III. "It has allowed us to develop consistent, branded products that are truly different from anything else in the marketplace. As a result, we can command a premium for fresh pork, something that has historically been thought of as a commodity item." Today, Smithfield Foods produces 12 million hogs and processes 20 million annually, making it the world's largest vertically integrated pork processor.

That is what distinguishes the company from the rest of the pack and has enabled the stock to set new all-time highs recently. Through its hog-raising and pork-processing subsidiaries, the company can exercise complete control over its products. Vertical integration increases operational efficiencies, enables enhanced safety and accountability standards and also reduces earnings volatility. Furthermore, it allows Smithfield to customize its products for the global market. In Japan, for instance, Smithfield's largest export market, the company's fresh pork sales through Sumitomo Corporation of America have climbed steadily as the company has been able to design its pork products specifically for the Japanese market. The Japanese are very particular about the way their pork looks and prefer more marbling and a pinker color than the U.S. consumer desires. Smithfield was able to identify the correct hog genetics to produce this meat to meet their exact specifications.

Smithfield is highly conscious about food safety and their vertical integration gives them a valuable competitive advantage in this area. The company tracks data on each hog they raise, including their genetic makeup, nutritional and medical regimens and when and where they were processed. While a pig disease similar to Mad Cow does exist and seems to be spreading, it is less dangerous to humans and in any case, any such event would affect Smithfield less than other pork-packers because of its careful tracking of its livestock.

Vertical integration also offers Wall Street a built in hedge on earnings volatility. By being both supplier and processor the company has smoothed out some of the peaks and valleys in their earnings and it makes the company more profitable than many of its competitors. For the 40 weeks ended 2/1/04, revenues rose 25% to $6.75 billion, while net income from continuing operations recovered to $91 million, up from $7.7 million, despite lowered revenues and margins in the beef segment due to the Mad Cow scare.

Technically, SFD is a chart of beauty. The stock broke to new all-time highs on Thursday (May 27)and we recommend it right here.

About Profiled Stocks in The Spear Report (http://www.spearreport.com)

Every Friday, we deliver to our members our Buy List (the very best candidates for purchase that week,) and we do something more. We profile two, three or even four stocks, in-depth, and include recommendations on when to buy these companies, and why.

Of the 145 companies we've profiled in our editorial from January 1, 2003 through March 18, 2004 the average return per company since the date profiled is 33.6%! Overall, 115 stocks (79% accuracy!!) are higher today than the day they were profiled. Their average gain is +45.6%! Thirty stocks are lower than the day they were profiled. Their average loss is -12.5%. Amazing performance.

To learn more go to http://www.spearreport.com

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Kathy Butler
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