Smithfield Foods, Inc. (SFD) Earnings Call Transcript & Summary

Perfect. Well, good afternoon, and thanks for joining us just after lunch. So next on the stage, we have Smithfield Foods, a leading packaged meats company and the largest pork processor in the United States with a very large integrated operation. With us today are Shane Smith, President and CEO; as well as Mark Hall, the company's CFO. Well, Shane, first of all, great to have you here for first conversation in a couple of years after you re-IPOed earlier last year. And good to have you back. And maybe just to begin with, I'll hand it over to you for just some general opening remarks and then we go into questions as it relates to the recent announcement.

Yes. Well, thanks, Ben, and thank you all for being here. I was wondering what it would look like if we schedule this over lunch. So I think I now have my answer. But it is great to be here, Ben. This has been a great conference. So a little bit about Smithfield. For those of you who don't know us very well, we've been in business actually last week was our 90th anniversary. So we've been in business for a long time. But I would tell you, we are a very different company today than we have ever been in our history. What we've been -- what we have built pre coming back to the U.S. IPO market was a much more durable earnings model. and it's really been built around 3 priorities: so grow our packaged meats business, improve whole hog utilization in our fresh pork business and then rightsize our high production segment. And so we've been executing on those 3 strategies for a number of years now. In the second quarter and first half of the year was really a good example of how that strategy is working for us. We did deliver record-setting second quarter and first half operating profit, and that was despite a consumer environment that, quite frankly, remains very challenged. and commodity markets on the input side of our business that have remained much more or become much more volatile. Earlier this week, I'm sure you saw, we did announce that our upstream segments, particularly in our fresh pork business have been unfavorably impacted by some of those market pressures I was just talking about. The USDA pork cutout, particularly the HAM prime within that cut out, has declined significantly since we gave that outlook back in early August. That's resulted in an overall lower outlook for that part of our business. And to a lesser extent, we did lower our Q3 outlook for hog production. Hog prices have come down in correlation to the cutout that we were just talking about. And so while we're seeing pressure in these 2 parts of our business, we are still extremely encouraged by the momentum that we're continuing to see in our packaged meats business. We are expanding our distribution. We've gained share in key categories. We're seeing returns on innovation across our portfolio. And we're also attracting younger consumers. And so we're seeing a younger consumer base buying our product. And so we're really excited about how the business is continuing to evolve. And most importantly, I would tell you what's different today than at any other time in our history is the strength of our balance sheet. We have an extremely strong balance sheet and that gives us a lot of financial flexibility as we continue to think about growth and continue to think about investing for the long-term health of the business as well as creating value for our shareholders. So overall, while the operating environment is very dynamic been, we feel really good about where we're positioned in this environment and on our ability to execute. So we can open up to questions if you have them.

Well, maybe just picking up on that and some of the details you've explained. So how was that change over the last 4 weeks? Because you obviously had earnings just about 4 weeks ago, reiterated guidance there but made some adjustments to guidance but nothing of that magnitude. You did the pre-announcement with more details on Q3. So maybe what were the drivers of those changes? And how should we think about the path forward.

Yes. I would say, again, I would lead off with the guidance, we reaffirmed our packaged meats go. So we're still really excited and see a lot of momentum carrying into the second half of the year for our packaged meats business. The call down was really isolated to the commodity inputs on the fresh work and hard production side of the business. So first, 1 of the main things that changed since our August report is in the USDA cutout. So that cutout declined a lot further than our expectations, and it really compressed the overall industry spread. Specifically, again, inside of that cut out, when you look at the HAM component of the cutout, hand values have declined materially. So they're down about 25% or came down about 25% down in the low 70s. And that's for a number of reasons where you can point to the HAM market you can point to recovery in Mexico, for example, if some of their herd, you can look at international, total international markets. It just has created a lot of short-term pressure on the HAM complex, which in turn drove that spread compression. When you look at the spread altogether, the spread was down about 50% compared to July, so August compared to July. and it was down 50% compared to August of 2025. So a lot of short-term volatility compressing that spread on the fresh pork side. And then on the hog production side, the way hogs are priced in the U.S. through the CME index, A large part of that is tied to the meat values. And so as we have seen meat values come down, we've seen a corresponding decrease in the revenue side in our high production operations. Bottom line, what I would tell you is this isn't anything structural. We're still executing our strategies. We're still investing in our businesses. This is really what I think is some short-term volatility that we're seeing in the commodity markets.

Okay. So talking in a little bit more detail on fresh pork maybe first. So yes, the spreads have obviously been softer year-over-year, but you're kind of like still potentially looking for some recovery into 4Q. Is that supply-demand driven? What would you say is the driver behind it?

Yes. I would tell you that we will provide an outlook for the full year, fourth quarter when we do our earnings call a little bit later. What I can tell you today is that Fresh pork, in general, is a spread business. The industry gross market spread is the largest single variable in profitability and performance in Fresh pork. Q3, again, the spreads have been more challenged than we anticipated back when we issued our original guidance in early August. The fourth quarter is typically seasonally the strongest quarter for Fresh pork and historically, we would have been seeing the -- or we would be seeing the historical rotation between hog profitability and meet profitability due to holidays, cooler temperatures. Typically, we would see Fresh work showing profitability or their strength in Q1 and Q4 for hogs is more Q2, Q3. So some normal seasonality would come back, but to investors, we would advise you to look at and monitor the USDA cutout. And specifically inside of that cutout, how hands and bellies are trading. Right now, that is having the biggest impact on the overall spread component.

Okay. Now on the execution side, obviously, there are a couple of specific actions that you've taken to offset that spread compression. what else could you do to really maximize dollars per head in your whole hockey utilization program?

Yes. Historically, we have been successful in offsetting a large part of the spread when we see compression. And I think -- if you looked at our results for the second quarter, I think that's the biggest proof point of how that's working. We saw industry spread compression in Q2 of unfavorability of about $37 million. Now from the things we're executing inside of fresh pork, we were able to offset about $21 million of that $37 million, and that's a combination of things from our next best sales strategy. So that's kind of talking about how we look at the channels, how we sell our meat and the off-fall product, whether that's through export markets, through pharmaceutical -- our pharmaceutical chain through pet food, which is something we've really been leaning into the past few years. So we're looking at every pound and where it goes in every channel. and what has the highest net realizable value. So how do we create the most revenue out of that hub. Some of the things we've been doing in Fresh pork to offset some of the spread compression is also in value added. So we've taken a lot of the lessons that we've learned as a company in packaged meats. and think about how we apply that on the fresh pork side from branding Fresh pork from creating value-added fresh pork. So you can think of case-ready and marinated and things like that. And we've been pretty successful there. So in Q2, our Case Ready or our value-added part of our fresh pork business was up about 4%. In food service, we've really leaned into the fresh pork going into food service chains. So our fresh work on a sales basis in Q2 was up about 12%. Our volume in foodservice was up about 8%. And again, looking at how do we get more of the pieces and parts of the pigs and that we don't eat into things like pharmaceuticals. So you can think of things like the pancreas, pituitary glands mucosa coming out that we make heparin with. So looking at how we continue to do those. And then internally, a lot of what we've been focused on to last, I would say, 5 years or so is really about how do we invest in automation so that we lessen our reliance on labor, we become more efficient. We take cost out of the system and we've really been focused on that to bring down that cost structure so that on the commodity side of the business, we're really lessening that exposure to volatility like we've seen in the last few weeks on the spread.

Okay. Got it. Now you've talked about some export stuff, et cetera. And obviously, the fresh pork business is very international. So how is currently demand in some of the key markets, especially with the fairly high Chinese demand?

Yes. So for China, I think it's important to level set what we sell to China. So on a consolidated Smithfield basis, our sales to China represent less than about 2% of our total company sales. And what we sell to China is off all product. So we're not exporting meat to China. We have an exported meat to China in many years now. So we're selling the pieces and parts of the pig that people typically don't eat here in the domestic market. So you can think of things like ears and stomachs and kidneys and those type of things that are going to that export market. And China is an important market for that product. And we don't expect to see much change in the China market given their domestic surplus. China has really recovered very strongly from ASF. So we don't expect to see meats begin to move. We do still think there's a little bit of a deficit on the off-fall side. There's a higher level of demand. And 1 thing that I think gives us a competitive advantage is we've been there a long time, we have a sister company there where we're actually selling with boots on the ground that gives us some type of advantage in that. you look to other Asian markets in the export arena. So Japan, for example, we're seeing good growth in Japan. We've been experiencing really solid growth in Japan. Mexico is a very important trading partner for U.S. pork. It's an important trading partner for Smithfield. Demand there does remain strong. But again, if you go back to my opening statements on the HAM complex, we are seeing some pressure on the HAM markets coming out of Mexico. And I do think that's a little more near term than not. Key point in exports the way we think about exports in international markets. We have access to over 30 different export markets around the globe. We look at each of those markets to fulfill a specific piece of the whole hog balance. So 1 market may be really good for off all product. Japan may be really good for buts. Korea may be really good for Lloyd's. Mexico, really good for HAM. So we look at the export markets as a way to, again, go back to that net realizable value model for Fresh pork to make sure we're getting all the dollars that we can for that whole cares or that whole pig as we harvest it.

Okay. So moving further on the integration side, Hawk production, obviously, another thing that's been touched on the guidance. And we've seen that the pork at out just trended lower despite drop in slaughter. So what do you think has driven this? And do you see any upside potential? And then also what reports data points are you looking at as you evaluate supply-demand for like coming couple of months.

Yes. This year, again, the biggest issue with the cutout has been the demand and mix that exists within the cutout, particularly HAMs. Now again, I go back to that global supply and export market competition have really weighed on those hand values. And again, that's led us to an extremely challenging third quarter when we think about it in the context of the market spread. And at the same time, USDA has lower cut-out prices. Again, there's just pressure in the CME market to go much lower. We look at a number of reports Ben. So we're looking at everything from the USDA with their outlook on hot production faring intentions, all of the things that go into building up through that commodity chain. But I do think as we move seasonally into a stronger fourth quarter, we'll see some upside, and that would come from greater demand. as well as seeing some of the supply tightening and if a whole end production develops later in the year, then that will also create some upside both in meat values and in high prices. I do think that pork today remains a very strong relative to beef, but consumers are still price sensitive right now. And I don't think it's a surprise to anyone in the room, some of the pressure that the consumer is facing. When we talk about hard production, if you look at the June Hogan pig report, they're reporting that the breeding herd is down about 1.2%. That's being offset by some productivity gains across the industry. And then you look at the cash market, the cash odd market, it's remained, I would say, relatively strong so far this year. I don't know if there's any other specific ports that we may look at, and it's really an accumulation of a lot of different data points.

Okay. Got it. Within Hawk production, I remember when you did the IPO process, it was all about the medium-term goal to actually further reduce internal headcount target, I think, was around 30%. Where do you stand right now on that journey? What's kind of like the missing pieces? And is 30 the right number? Should it be lower? How should we think about this?

Yes. When we started our hot production optimization strategy 4 or 5 years ago, at that time, we were killing or we were producing about 17.5 million hogs across the U.S. We looked at that strategy and all the changes that have taken place since it was implemented and said, you know what, we don't need to be 50% vertically integrated. Let's find the right number. And so when we arrived at a number and a goal of reducing our hub to $10 million, it was really a function of math. So we looked at each of our 7 harvest facilities across the U.S. And we looked at what is available in that area. So is there an independent hog producer base that we can pull hogs from? Or is this an area to support the plant that we need to grow our own hogs. And to give you an example of how different that calculation can be our Sufal, South Dakota plant, which is our second largest facility. We're probably less than 2% vertically integrated, meaning 98% of the hogs that we bought to supply that plant are coming from independent hog producers. You contrast that to an East Coast plant where that model was built more on contract grower relationships, we're probably 75% to 80% vertically integrated. And so if you do the math across all 7 harvest facilities, what's available, what's reasonable, how do we continue to support fresh pork so they can continue to support packaged meats. the number we come to is about 10 million hogs sort of 30% you alluded to. So -- but I think it's important. $10 million for us, it's not written in stone. And so we'll get to $10 million, and we'll further evaluate what other opportunities do we have to maybe go lower. So in general, I would say the strategy is only grow the number of hogs that you have to support, again, the fresh pork business and the -- ultimately, the packaged meats business.

That makes sense. Now what -- is there anything you can do? We saw the guidance was down a little bit. But are there things within Hawk production that are actually under control where you can potentially do operationally to outperform the industry margin? Because 1 thing is the industry is at and so on. But given the size, any opportunity to outperform here,

Yes. We use a number of tools, and we've done a number of things inside for the -- I would say, for the 10 million hogs out of that initial $17.5 million that will remain in Smithfield, they're in a much better cost structure today. And in many cases, I would tell you they're in the top 5% or 10% of cost structures in the U.S. We have completed what was a 5-year genetic changeover. We've invested in FEED initiatives, so how we buy grain and then how we mill that grain and feed it. We've invested in health and biosecurity initiatives and we've seen that cost structure come down where today, you look at some of the external public models that are out there to show you how good farm is performing, we're exceeding that model now. So we've done a lot of work there. At a higher level, we do have a really robust hedging program. And so we've been hedging whether it's corn and soybean mill on the input side. or whether it's hog prices on the output side. And even on fresh pork, where we're buying that other 20 million hogs now, we're maybe buying some hogs using hedge instruments to protect the purchase side of that equation as well. So there's a lot of things we do to help lock in or pick points of entry and points of exit in our hedging program. And it's a really good program run by some really smart people.

Okay. And then you've touched on cost a little bit. Obviously, grain is 1 at the very beginning, but then the subsequent ones, lines, et cetera. It's been very volatile and actually on the up as well to a degree. So as things normalize, how should we think about that slowing that into results? I mean, all this disruption right now.