Smithfield Foods is confident its fresh pork business will deliver profitable results this year, even as it is squeezed between depressed consumer sentiment and the need to raise retail prices.
The US company booked expectation-beating second-quarter earnings yesterday (6 December), as it side-stepped some of the most extreme affects of the “turmoil” in the protein markets. However, Smithfield said it was “disappointed” by the performance of its fresh pork unit.
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Speaking to analysts during a conference call, chief executive Larry Pope said fresh pork results had been hit by higher pricing, higher levels of supply and a weak consumer environment.
“The influence of high-priced product, combined with 2-3% more meat to sell and sluggish retail demand all adversely affected our sales margins,” Pope revealed.
Significantly, Smithfield said it had been forced to increase retail prices at a time when consumer incomes are under pressure in the US. In response to this consumers reduced consumption levels, Pope observed.
“Higher priced meat, and not just pork, beef and chicken included, have certainly had some sticker shock to consumers as they are walking in the grocery store… I think everyone is concerned about the price increases that they are having to force through the retail channels. When paychecks aren’t growing [consumers] can’t afford to buy the same level when the price is changing so much.”
Exports of fresh pork products were also down in the period, as some of the company’s production facilities were delisted in some export markets, notably China. However, Pope said the issues impacting exports have been resolved and shipments have resumed.
“While I am not nearly satisfied with this quester’s results, I am not really worried about fresh pork and fully expect fresh pork profitability to be fine for the year,” Pope said.
BB&T Capital Markets analysts concurred Smithfield’s pork unit should be able to overcome these short-term stumbling blocks. Significantly, BB&T suggested mithfield’s fresh pork exports would benefit in the mid- to long-term from rising global demand for protein.
“Global supply reductions should lead to stronger demand for US pork, which should benefit Smithfield’s business broadly,” they added.
More broadly, Pope said Smithfield booked “strong” second-quarter results. While the company did feel the negative impact of rising grain costs, Pope said its hedging strategy had provided a degree of stability.
“On the operating side, our results reflected the ongoing turmoil in all protein and grain based businesses today: high volatility and increasing cost of production primarily tied to higher grain costs,” Pope said.
According to Pope, three months ago the price of corn was under US$6 a bushel and a record crop was expected. “Our hedging positions didn’t look so good then,” he conceded. Today, crop estimates have been reduced by a third due to poor weather conditions and drought in the US. Corn and soybean prices have hit “record highs”, Pope said. “Suddenly our hedge positions make us look like we were geniuses.”
Pope said Smithfield’s hegding policies are designed to provide some insulation against the volatility in the commodities markets.
“This uncertainty around hog production is why we changed our hedging philosophy and practices a few years ago. We can’t predict the future. We hedge to control costs danmanage our hog production margins.”
As a consequence, the group was able to book a first-quarter profit in its hog unit and Pope said he expects the business to break-even or report a “small loss” for the full year.
Smithfield is therefore developing its strategy to control costs and margins in hog production, while simultaneously focusing on developing revenues from its value-added offering.
To this end, Pope said he was “especially pleased” with packaged meat results. To drive growth of its packaged meat division, Smithfield has increased its marketing investment by “double-digits” and is expanding its value-added offering into new categories. The company was bullish on its investment in opening a new “state-of-the-art” hotdog facility. Meanwhile, Pope said Smithfield has developed a “significant” new product pipeline, pointing to the Farmland Oven Perfect range that the company is preparing to launch.
As a result of these efforts, Smithfield was able to grow its branded sales by 7% in the quarter, with total packaged sales up 4%.
“Our strategy [is] to control costs and margins in the volatile parts of the business, like hog production, to reduce their adverse impact on the business, and then stay focused on the meats business to drive more stable and increased earnings. [This is] primarily tied to packaged meats. I wish I could tell you we have eliminated volatility in the business: that is simply not true. I do however think we are continuing to make progress in muting a significant part of it,” Pope said.
