On more than one occasion I've written of my preference for companies that serve the processed/packaged food space in favor of those that sell commoditized fresh/frozen products. That's certainly true in the protein sector, where I much prefer the prospects of a company like Hormel (NYSE:HRL) to those of Tyson (NYSE:TSN). However, Smithfield (NYSE:SFD) is a curious case. Although it is one of the many ways traders can invest in everyday products, this company has both a sizable fresh and packaged meats business.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

First Quarter a Tale of Two Businesses
How well Smithfield is doing depends upon which details get your focus. The company's reported revenue missed only slightly and operating earnings were slightly below expectations, but there was more at play beneath the headlines. Revenue fell slightly this quarter, with pig farming (production) revenue down about 3%, while processing, fresh pork and packaged sales were up/down less than a point. International sales dropped more than 7%, but make up only about 10% of sales.

Profitability is where things get interesting. Operating income plunged 40% from last year and about 4% from the prior quarter. Although hog farming profits were steady on a sequential basis at about $6 a head, which marks an 80% decline from last year. Likewise, fresh pork profitability plunged to a loss of $2 per head (versus a normal range of $3 to $7 a head in profits). On the flip side, packaged meats came in at 21 cents per pound in profits - up almost one-quarter from last year and 30% from last quarter - and stand above not only sell-side expectations but management's own guidance for long-range profitability.

Battening Down the Hatches
Investors have had ample time to process the impact the drought has had on the American economy and on the fresh/frozen meat businesses of companies like Tyson, Smithfield, Pilgrim's Pride (NYSE:PPC) and the like. For now, Smithfield management is keeping a brave face, believing that lower production levels and the company's advantaged cost position will support margins.

Maybe, but I'm skeptical. I think the bigger risks to Smithfield are that feed/raising costs go up even more than feared and that consumers really push back on prices. Although packaged food companies like Kellogg (NYSE:K) have been seeing more favorable price elasticity lately (that is, higher prices are resulting in less lost volume than before), I'm not so confident that will hold for Smithfield. Likewise, I think expectations for big export contributions need to be tempered with the reality that there are foreign competitors with more advantageous cost structures targeting the same markets.

Is Packaged Obscured by the Fresh Pork Business?
Companies like Hormel and Hillshire Brands (NYSE:HSH) get quite a lot of attention for their higher-margin packaged meat businesses. There's nothing wrong with that per se, as packaged food businesses does show stronger profits and price stability during tougher times. The thing is, though, is that the market seems to forget that Smithfield has a pretty large and profitable packaged meat business as well. Smithfield doesn't offer all of the information an investor might want in teasing out the value of individual businesses, but one of two conclusions seems to be true. Either the market values Smithfield's packaged meats business much less than Hormel's or Hillshire's (despite good growth, margins and brands), or the market believes that the company's fresh meat operations destroy value. Now, I'm fine with the notion that commodity protein businesses aren't worth a lot, but I don't think I'd go so far as to say it destroys value.

The Bottom Line
I do believe that the market is currently undervaluing Smithfield, especially since consumer staples is often a popular sector among investors, but I also acknowledge the risk that packaged meat profits will normalize while fresh pork performance could worsen even further. Then there's also the risk that the market will always more or less punish Smithfield for having that fresh meat business (or at least do so during periods where fresh protein is out of favor). At today's prices I much prefer Smithfield to Tyson. I also think investors with a value inclination ought to run their own numbers on the packaged-versus-fresh value conundrum. It may just be the case that Smithfield is a decent enough stock to consider buying today for its packaged businesses and that the eventual recovery in fresh pork could lead to decent gains in the year or two ahead.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    How Toyota Succeeds at Home and Abroad (TM)

    Japan's biggest car manufacturer is also one of North America's biggest, delighting shareholders with its high profit margins.
  2. Stock Analysis

    Analyzing Microsoft's Return on Equity (ROE) (MSFT)

    Discover a detailed analysis of Microsoft's historical return on equity, and learn how its ROE stacks up to its competitors in the tech industry.
  3. Stock Analysis

    Starbucks: Profiting One Cup at a Time (SBUX)

    Starbucks is everywhere. But is it a worthwhile business? Ask the shareholders who've made it one of the world's most successful companies.
  4. Stock Analysis

    How Medtronic Makes Money (MDT)

    Here's the story of an American medical device firm that covers almost every segment in medicine and recently moved to Ireland to pay less in taxes.
  5. Investing News

    Latest Labor Numbers: Good News for the Market?

    Some economic numbers are indicating that the labor market is outperforming the stock market. Should investors be bullish?
  6. Investing News

    Stocks with Big Dividend Yields: 'It's a Trap!'

    Should you seek high yielding-dividend stocks in the current investment environment?
  7. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  8. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  9. Investing News

    Who Does Cheap Oil Benefit? See This Stock (DG)

    Cheap oil won't benefit most companies, but this retailer might buck that trend.
  10. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
RELATED FAQS
  1. When does a growth stock turn into a value opportunity?

    A growth stock turns into a value opportunity when it trades at a reasonable multiple of the company's earnings per share ... Read Full Answer >>
  2. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  3. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  4. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  5. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  6. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center