It's flu season again—bad news for Smithfield Foods (SFD), the world's largest producer of pork. Six months ago, fears that the H1N1 strain might have originated at one of Smithfield's joint-venture facilities in northern Mexico put the company into crisis mode. Eventually the Mexican government determined there was no connection to the Smithfield (Va.) company's farms, but critical global markets for its products remained closed. And the Oct. 19 announcement that a Minnesota pig was the first in the country to have contracted the H1N1 virus, first called swine flu after early genetic tests suggested a link to pigs, could set off false fears of a link to human illness.
Those concerns come at a particularly vulnerable time for Smithfield. The company had record sales last year of $12.5 billion. But a substantial overabundance of pigs across the U.S. and rising corn prices have put Smithfield and its rivals in a position where they lose an average of nearly $23 on every hog sold to be butchered. The result: a $190 million loss in the year ended May 2009—Smithfield's first in 37 years. It lost a further $108 million last quarter.
CEO C. Larry Pope has taken steps to minimize the damage. He cut his own sow herd 13% over the past year, a big move for a company that controls almost a third of the U.S. market. He did an expensive restructuring of $1 billion in debt and sold $850 million worth of high-interest notes earlier this year after the company was in violation of its loan covenants. Not everyone has cheered all his moves: Two board members, themselves sizable stockholders, quit in protest when he issued $300 million in new equity.
Now Pope is trying to ramp up overseas sales, which account for 9% of revenue. That strategy is complicated by China's having cut off imports of U.S. pork products. While the ban is officially in response to flu concerns, Pope argues that the true motivation is political, a desire to protect China's domestic farmers.
Smithfield already operates throughout much of Europe, which consumes more pork than the U.S. But the big prize is China, which devours about half the world's supply. Smithfield's mainland sales picked up in the first half of 2008 when disease and natural disasters hurt domestic Chinese hog production. To help build market share, Pope sold a 5% stake in Smithfield to Chinese agribusiness giant COFCO in July 2008 and put its chairman, Gaoning Ning, on his board. Since 2002 he has also run a joint venture in China called Maverick Food. "Five or 10 years from today, you'll look back and think. 'That was a smart move,'" says Pope. Having traveled to China, he has found the process of relationship building to be slower than he'd like.
FATTENING MARGINSBack home, Pope is trying to rely increasingly on more profitable processed-pork products, which make up 45% of sales. He is reducing Smithfield's portfolio from more than 100 brands to a core group of key names, focusing on such brands as Armour and John Morrell. He has also closed five plants and pushed salespeople to get more of Smithfield's smoked bacon, ham, and baby back ribs into retailers such as Wal-Mart Stores (WMT) and restaurants like McDonald's (MCD) and Applebee's (DIN). Instead of selling processed pork almost at cost to move product, Pope has also insisted on the simple goal of getting 10 cents of profit per pound. His slogan, "It's time for the dime," now adorns managers' desks and many line workers' hard hats. "Our industry doesn't have a lot of Harvard people," he explains. "You've got to keep the message simple and deliverable."
On that level, at least, the simplicity is working. Last quarter, Smithfield exceeded its goal, making 16 cents per pound on processed pork. But the broader issues of oversupply and flu fears remain.
At the processing plant near Smithfield headquarters, everyone is working flat out. Employees stand bundled up in sweatshirts under their white coats to combat the 45F temperature as they sort hams, bacon, pigs' knuckles, and scraps for hot dogs. Floor-to-ceiling ovens smoke the hams, while bacon is crisped in another room for McDonald's Angus Bacon & Cheese burgers. Technicians monitor the ovens on laptop computers, occasionally leaving their stations to go eyeball the meat. As assistant plant manager Marvin Peterson explains: Any digression "costs us money."