A Match Made in Hog Heaven

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Shuanghui International has just created an opportunity for Smithfield Foods (NYSE: SFD) to rapidly grow its sales in the coming years. Smithfield, the world’s largest pork processor and based in Virginia, has been bought by Shuanghui International Holdings, for a value believed to be around $5 billion. Shuanghui International is the majority shareholder of Henan Shuanghui Investment & Development, which is China's largest meat processing enterprise

The acquisition means Shuanghui will be controlling the world's largest pork producer, and a company with domestic roots will have more access to the world's most populous nation. The growing demand for pork in China was a key catalyst for the acquisition, and Smithfield should benefit from an increased market share.

Shuanghui offered $34 per share for Smithfield, representing a 34% premium based on the company’s closing price on May 28. Shuanghui will now be holding two major strengths in the processed meats industry, which should result in synergy benefits for Smithfield.

Strong third quarter earnings

It's most recent results came back strong compared to last year. Smithfield reported a net income of $81.5 million, or $0.58 per share, on sales of $3.6 billion. The packaged meat business unit was up 7% in operating profit to $126 million year over year, after sales volume grew by 5%. Its international profitability was strong, as demonstrated by a margin of 11%. Smithfield returned cash to investors when it repurchased 8.2 million shares for $174 million.

Other business segments such as Fresh Pork posted solid results with an operating margin of 4%, or $7 per head. Exports were up 19% from last year, an indication of a widening demand for the company’s products globally. Smithfield’s hog production stayed well above market competition, with an operating margin of 8%, or $15 per head. However, market prices for live hog were down 2% year-over-year to $60 per hundredweight. 

According to Smithfield President and CEO, C. Larry Pope, the company expects solid full year 2013 results:

We are excited about the growth prospects for this company as we continue to transform Smithfield into a more value-added consumer packaged meats company. We expect solid earnings in fiscal 2013 and look forward to even stronger results next year.

The Shuanghui effect

Smithfield aims at widening its market share as part of its strategy to increase margins against declining prices and increasing costs. Its packaged meats products seem to be in perfect position to spur this growth, since the unit already enjoys solid margins. Smithfield will benefit immensely from the acquisition by Shuanghui since taking up the hog producer's net debt is part of the deal.

China is one of the largest consumers of pork, with an average annual per capita consumption of 75 lbs. And with a population of more than 1.4 billion, demand is bound to be high. This deal will create more channels for Smithfield to sell its products in the Chinese market.

The only way to beat high production costs is through mass production. For a company that operates at low margins, to gain a wider addressable market is a major event. Therefore, the Shuanghui deal is not just about ownership and money. This is more of a synergy-based acquisition that will help with several inefficiencies in Smithfield’s business structure.

At this point it doesn't make sense for new investors to jump in because Smithfield will cease to trade after the close of the deal. But existing shareholders have already received a 30% premium.

Competitors

Hormel Foods (NYSE: HRL) is Smithfield’s main competitor. With a market cap of around $10 billion, the Minnesota-based meat products company dwarfs the much smaller Smithfield. But it won't have as much access to China.  Like Smithfield, it struggles with margins and see's it's packaged segment as the way of the future.

Tyson Foods (NYSE: TSN), is a meat product company based in Arizona. Similar to Hormel, Tyson is larger than Smithfield with a market cap of $9 billion. However, its business could be challenged since Smithfield's entry into China could spark a rapid increase in revenues, earnings, and of course value. Smithfield is taking its strength (world's largest pork producer) to the right market, at the right time.

Despite its size, Smithfield is the only company that registered positive earnings growth in the most recent quarter. While Hormel's earnings declined a modest 2%, Tyson's earnings were down by more than 40% year over year. The competition seems ready for slaughter.

The bottom line

Shuanghui’s acquisition of Smithfield Foods, just opened a door to the worlds largest market and there are a lot of hungry mouths to feed. Smithfield should become the global pork producer and increase its scale many times over.   

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Nicholas Kitonyi 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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