Smithfield Seen Unlocking 23% Gain With Breakup: Real M&A

Smithfield Foods Inc. risks missing out on a 23 percent gain for shareholders by ignoring demands to sell its hog farms.

While Chief Executive Officer C. Larry Pope says selling the farms would be a mistake, Credit Suisse Group AG expects increasing pressure from investors for a breakup to enhance Smithfield’s focus on packaged meats. A split would lift its value to $32.45 a share from $26.43 yesterday, the average of six analyst estimates compiled by Bloomberg shows. Hormel Foods Corp., which sells pork while raising far fewer hogs, has a price-earnings ratio that’s 68 percent higher than Smithfield’s.

“It’s time for the management to return value to shareholders,” Ann Gurkin, a Richmond, Virginia-based analyst at Davenport & Co., said in a telephone interview. In a report this month arguing that a split was more likely, she gave a $48-a-share value for Smithfield following a breakup.

Smithfield should consider splitting into three businesses -- one selling pork and packaged meats, another that runs hog farms, and a third based outside the U.S. -- because the unprofitable hog-raising unit hurts returns, Continental Grain Co. said in a letter this month. The shareholder’s request came after Smithfield’s stock trailed Hormel and Tyson Foods Inc.’s in the prior year.

Stock Rallies

Continental Grain said in this month’s filing that its stake is down to 5.8 percent, a reduction from the 8.6 percent ownership reported in Smithfield’s proxy statement in August. The second-biggest shareholder sold 1.2 million shares on March 5 through March 7, according to Continental Grain’s filing.

Shares of Smithfield, whose brands include Eckrich sausage, surged 11 percent on March 7 after the Smithfield, Virginia-based company beat third-quarter earnings estimates and a breakup was brought up on a conference call with analysts. Following the close of trading, Continental Grain released its letter, fueling a 4.5 percent advance the next day.

Before the two-day rally, Smithfield shares had lagged behind rivals Hormel, Tyson, JBS SA and Hillshire Brands Co. since June 29, the first trading session after Hillshire completed its transformation to being almost entirely a packaged-meats company.

Lyndsey Estin, a spokeswoman for Smithfield who works at Kekst & Co. in New York, declined to comment on the company’s plans and referred back to a statement on March 8, when Smithfield said its board received a memo from Continental Grain and will review it with its financial and legal advisers.

Worst Drought

Higher feed costs have made it more difficult to make money raising hogs. Expenses have risen since 2006 and the worst U.S. drought since the 1930s pushed prices for the main components, corn and soybeans, to record highs last year.

Meanwhile, hog prices have slumped because of lower exports and concern that U.S. demand is weakening.

Davenport’s Gurkin sees more than a 50 percent chance that Smithfield, a supplier to Wal-Mart Stores Inc. and McDonald’s Corp., will have to work more “aggressively” to boost returns.

While Farha Aslam, a New York-based analyst for Stephens Inc., now recommends buying Smithfield shares because shareholders may succeed in spurring change at the company, she reduced her 2014 earnings estimate to $2.48 a share this month from $2.55 because of lower hog profitability.

“There’s tremendous volatility on the production side,” Peter Fleiss, a Boston-based analyst for shareholder Highfields Capital Management LP, said during Smithfield’s earnings conference call on March 7. “The usual investors who get involved in packaged meats just aren’t comfortable taking on that type of volatility.”

Being Patient

He asked Smithfield executives during the call how many more years “we have to hold on for the hog production ride” to pay off.

Pope responded to questions about the hog-raising business by saying “patient investors” will be “very pleased” because the unit helps increase relationships with major customers.

Smithfield, unlike competitors that don’t raise as many animals, can tailor conditions for hogs to meet customer demands, Pope said. In the U.S., Smithfield has been working since 2007 to convert sow housing to open pens from gestation crates, which retailers, grocery chains and restaurants are asking suppliers to phase out amid consumer backlash.

Broken up, Smithfield’s value would rise to $32.45 a share, according to the average of six analysts’ estimates compiled by Bloomberg. They range from $26 at KeyCorp to $48 at Davenport. The other forecasts are $29.67 at Miller Tabak & Co.; $30 at Stephens and JPMorgan Chase & Co., which called the figure its base-case scenario; and a minimum of $31 at Credit Suisse.

‘Golden Goose’

Today, Smithfield shares fell 1.5 percent to $26.03.

“Packaged meats is the golden goose,” Vicki Bryan, a New York-based analyst at Gimme Credit LLC, said in a phone interview. “Packaged meats is the most valuable and the hog production is the least desirable.”

Asian investors might be interested in Smithfield’s hog farms and processing plants that serve export markets, Continental Grain said in its letter. Continental Grain could seek to combine the hog business with the pork unit of Seaboard Corp., which has joint ventures with Continental Grain, Credit Suisse analyst Robert Moskow said in a March 12 report.

A representative of Continental Grain declined to comment.

Smithfield as a whole may attract meat companies that raise and process poultry and livestock, Bryan said. That includes Sao Paulo-based JBS SA, which bought Smithfield’s beef operations five years ago, she said. The unit included a ranching operation that was partly owned by Continental Grain.

Cargill Sale

Rosemary Geelan, a spokeswoman for JBS USA, declined to comment on whether the parent company would be interested in buying Smithfield assets.

Two years ago, Smithfield sold a 21,500-acre (87 square kilometers) hog production site in Texas to Minneapolis-based Cargill Inc., the third-largest U.S. meat processor, for $33 million. Mike Martin, a spokesman for Cargill, declined to comment on Smithfield.

While the packaged meat unit could attract competitors like Tyson and Hormel, any investor looking for a cheap asset may also be attracted, Gimme Credit’s Bryan said. The decision by Berkshire Hathaway Inc. and 3G Capital last month to buy H.J. Heinz Co., a ketchup and packaged food manufacturer, highlights the interest value investors may have in the industry, she said.

‘Exciting Time’

“I wouldn’t just look at major producers,” Bryan said. “There is a lot of embedded value in this sector that is brimming to be revealed. It’s an exciting time for food.”

Worth Sparkman, a spokesman for Springdale, Arkansas-based Tyson, and Rick Williamson of Austin, Minnesota-based Hormel declined to comment.

Smithfield started transforming itself into more of a consumer-meats company in 2009. Pope has been trying to increase profit per pound of pork that Smithfield processes by developing new dishes and boosting market share of brands such as Armour and John Morrell.

Even with greater pressure from investors, some analysts say they don’t expect Smithfield to break up. KeyCorp’s Akshay Jagdale and JPMorgan’s Ken Goldman said they don’t see a high likelihood of change. A transaction is “unlikely,” Tim Ramey, a Lake Oswego, Oregon-based analyst for D.A. Davidson & Co. who has a buy rating on the shares, said in a phone interview.

Still, the board and management should consider their options and explore whether the current company structure is best, Bryan Agbabian, a San Francisco-based sector head of agricultural equities for Smithfield shareholder Allianz Global Investors, said in a phone interview. In the short term, not owning farms would be better for the shares, while there could be a long-term advantage to retaining them, he said.

“If they were to break up, they would get more value,” Agbabian said. “These are questions the board and the officers of the company need to address, revisit.”

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