Smithfield Could Be Worth Much More

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Smithfield Foods (NYSE: SFD) has received a lot of attention from the investment community with its recent buyout offer from the Hong Kong-based holding company Shuanghui International. The Chinese company offered to acquire Smithfield at around $34 per share, with the total transaction value of $7.1 billion including Smithfield’s debt.

Interestingly, in the middle of June, activist investment fund Starboard Value, the owner of a 5.7% stake in the company, wrote a letter to Smithfield’s board of directors suggesting that the company could be worth much more than Shuanghui's buyout offering price. 

Smithfield appears quite undervalued

In the letter, Starboard announced that it became Smithfield’s shareholder in March, two months before Shuanghui’s merger offer. It believes that Smithfield is worth much more than $34 per share, based on its sum-of-parts valuation. Smithfield operates in three main business segments: Hog production, international and pork. Starboard agrees with Smithfield’s management that hog production “was one of the most valuable assets within the company,” with around 851,000 sows producing 16 million hog annually.

The valuation of the hog-production segment was based on the asset-value basis due to the high volatility of hog-farming profitability, which is caused by the fluctuations in feed inputs and hog prices. Thus, in order to value the hog- production business, Starboard took into account the value of sows at market prices, unborn pigs, live hog inventory and the land and production facility values. With the per-sow space estimates of around $1,100 to $1,600, hog production could be worth around $1.9 billion to $2.3 billion.

For the international segment, what makes Starboard excited is Smithfield’s operations in Poland and Romania. With the market-leading position, Smithfield’s Polish operation might have a premium valuation at 6.5 to 7.5 times its earnings before interest, taxes, depreciation and amortization (EBITDA), including 25% of sales from the more volatile hog-production business.

In the Romanian market, Smithfield also enjoyed being the market leader, with around 30% market share. However, the hog-production business accounted for a greater percentage of sales than in the Polish market, at around 40% of the total sales. Consequently, it should have a lower valuation of 5.5 to 6.5 times its EBITDA.

Consequently, while the Polish operation was valued at $586 to $713 million, the Romanian operation might be worth around $358 to $455 million. Including a 37% stake in Campofrio Food and the Mexican joint-venture stake, the value of the international segment was around $1.3 billion to $1.5 billion.

Last but not least, the pork segment, the biggest revenue and EBITDA contributor for Smithfield, could be seen as the biggest pork-processing business globally. In the period of 2007 to 2012, the segment’s EBITDA climbed from $345 million to $752 million, with the EBITDA margin fluctuating in the range of 4.3% to 8.6%.

Interestingly, Starboard pointed out that Shuanghui’s $34 per-share offer would undervalue the Smithfield’s pork business after deducting the value of the hog- production segment and the international segment. Starboard calculated that the implied pork business’ EBITDA multiple would only be 4.7 to 5.8, a much lower valuation than the company's peers including Hillshire Brands (NYSE: SLE) and Hormel Foods (NYSE: HRL).

Its peers enjoy much higher valuation

Hillshire Brands is trading at $33.10 per share, with the total market cap of $4.1 billion. The market values Hillshire Brands at nearly 9.5 times its trailing EBITDA. Hillshire, the owner of several brands including Ball Park, Hillshire Farm, State Fair and Jimmy Dean, is one of the largest meat-focused food businesses in North America. It has the market-leading position in many niche markets including breakfast sausage, smoked sausage, hot dogs and super premium sausage.

Looking forward to 2015, Hillshire expected to deliver volume growth of 2% to 3% with revenue growth of 4% to 5%. The operating margin is expected to stay around 10%. The company estimates that its 2013 net sales will be a bit higher than last year, and projects adjusted diluted EPS of around $1.60 to $1.70 per share.

Hormel Foods is the most expensive business among the three. It is trading at around $38.60 per share, with the total market cap of more than $10.2 billion. The market values Hormel Foods at 11.9 times its trailing EBITDA. In the second quarter, while revenue experienced 6.9% growth to $2.1 billion, net income slipped a bit to $125.5 million from $127.9 million last year. For the full year, Hormel Foods expects to generate $1.93 to $2.03 earnings per share.

Income investors like Hormel Foods for uninterrupted dividends that have been paid for around 47 years. In the past 10 years, its dividend was raised from $0.21 per share to $0.60 per share. Recently, it announced that it would pay a quarterly dividend of $0.68 per share. At the current trading price, Hormel Foods offers investors a decent dividend yield at 1.8%. With the historical uninterrupted dividends in the past nearly five decades, Hormel Foods is expected to continue to consistently return cash to investors in the future. 

My Foolish take

Smithfield, under Starboard’s careful analysis, appears quite undervalued at $34 per share. After adjusting cash, gross debt and minority interest, Smithfield’s equity value is in the range of around $7.1 billion to nearly $9 billion, valuing the company at $44 to $55 per share, a 29% to 62% premium to Shuanghui’s offer of $34 per share.

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Anh HOANG has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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