Smithfield BEEFS UP

Smithfield Foods Inc., the nation's largest pork producer and fifth largest beef producer, appears poised for a significant expansion into the beef processing business. That's following the Smithfield, VA-based firm's purchase of a 375,000-head-capacity cattle-feeding operation late last year. In October, Smithfield announced its purchase of MF Cattle Feeding Inc. from ConAgra Foods Inc., a feedlot

Smithfield Foods Inc., the nation's largest pork producer and fifth largest beef producer, appears poised for a significant expansion into the beef processing business. That's following the Smithfield, VA-based firm's purchase of a 375,000-head-capacity cattle-feeding operation late last year.

In October, Smithfield announced its purchase of MF Cattle Feeding Inc. from ConAgra Foods Inc., a feedlot system consisting of three Colorado and one Idaho yards. Smithfield spokesman Jerry Hostetter says Smithfield made the purchase because procuring cattle for its plants in Michigan, Wisconsin, Arizona and Nebraska was difficult.

The purchased yards, however, are a long distance from all but one of Smithfield's existing processing plants — the Gering, NE, facility (see graph above). Thus, industry observers say the move is likely preparation for Smithfield to buy another processor.

“It looks like Smithfield is after a long-run strategy of adding” beef processing capacity, says Roger McEowen, Iowa State University (ISU) ag law professor and expert in ag market concentration. “Smithfield needs plants all over the country to make a widespread presence and increase its share of beef. This gives Smithfield a toe hold in the Western part of the country.”

Smithfield has produced pork since 1936 and has tried aggressively to expand its beef processing since 2000. That's when it vied with Tyson Foods to buy IBP, then the nation's largest beef processor.

Smithfield lost that bidding war to Tyson in 2001, but later bought Packerland Holdings Inc. and Moyer Packing Co. The purchase in 2001 gave Smithfield an 8,500-head/day harvest capacity, making it the fifth-largest beef processor.

In 2002, Smithfield tried to expand its beef side by courting Farmland Industries before the farmer-owned co-op declared bankruptcy later that year. In 2003, Farmland sold its beef division to its partner, U.S. Premium Beef, and its pork division later to Smithfield.

Is Swift on Joe Luter's radar?

Analysts say Swift & Co., based in Greeley, CO, and owned jointly by Dallas-based-investment firm, Hicks, Muse, Tate & Furst Inc., and Vail, CO-based Booth Creek Management Corp., is the processor most likely to be on Smithfield's radar now. MF Cattle Feeding and Swift used to make up ConAgra Foods' beef operations. Swift currently operates six processing plants in Nebraska, Colorado, Utah, Idaho and Texas, with a combined processing capacity of 21,000 head/day.

“Swift does seem to fit the best,” says Christine McCracken, an FTN Midwest Research analyst. “It's the most logical.”

Swift's ownership may want to divest as it's had a substantial and growing amount of debt since a controlling interest was bought from ConAgra in 2002, analysts say. Swift's profitability was hurt in December 2003 after BSE closed most U.S. beef export markets.

During a conference call with analysts and reporters early in December 2004, Smithfield CEO Joe Luter hinted his company might be interested if Swift comes up for sale.

“It is no secret Swift is owned by financial in-vestors who will try to seek the maximum profits on that investment in a short period,” Luter said on the conference call. “Those assets will be sold to somebody in the foreseeable future whether it's (through a public sale of stock) or whether it's someone like Smithfield.”

Hostetter wouldn't say if Smithfield is negotiating to acquire Swift, but did say expanding Smithfield's beef processing operation “is a consideration.” A spokesman for Hicks, Muse, Tate & Furst also declined to comment on a sale of Swift to Smithfield.

Analysts say beef expansion by Smithfield would allow it to better compete to supply large retail chains like Wal-Mart that wish to streamline their supply chain. Offering more than one kind of meat and larger beef volumes would be key selling points, in addition to pricing advantages.

Smithfield is on the verge of benefiting from the higher volume of pork production made possible by its purchase of Farmland Foods, Luter says. He adds the firm is talking with three or four different retailers for pork orders that are the largest the company has ever seen.

“The size of customer discussions we're having, and the size of the opportunities they're talking to us about, are certainly new levels for Smithfield Foods,” Luter says.

Market protection

Expansion of its beef business would also shield Smithfield's earnings stream from violent swings in the pork markets. And, would allow it to capitalize on existing relationships with its retail customers.

“It's a good strategic move from a business perspective” to expand their beef operations, FTN's McCracken says. Beef plants “have a lot of the same customer base (as their pork business). If you can sell more product to the same customer, you clearly can do a little better,” she adds.

If Smithfield was to significantly expand its share of U.S. beef processing by acquiring Swift, its short-term impact would likely be limited to cash cattle markets in the areas it buys cattle for its processing plants. Analysts say the firm would essentially be reassembling ConAgra's old beef operations. Therefore, it wouldn't change the number of processors competing for cattle in those areas.

Under Swift's old configuration, the feedlots supplied just 40% of the 5,500 head/day harvested at its Greeley, CO, processing plant and a much smaller percentage of a 2,200 head/day facility in Hyrum, UT, a Swift spokesman says.

In the short term, having a new player aggressively bidding for cattle might even have a beneficial impact on demand for cattle, says Ron Plain, University of Missouri ag economist.

“I'd argue it would be good for the industry to have a new investor pumping money in,” Plain says.

Some industry observers are concerned about the effect on cash markets if Smithfield added processing capacity beyond the purchase of a firm the size of Swift. If Smithfield was to acquire Swift, its current beef market share of 6% would jump to 20%, second only to Tyson.

“The long term is the concern,” ISU's McEowen says. “If Smithfield gains a bigger percentage of beef production and packing, and we see continued concentration in the industry, the question is how many options cattlemen will have. If cattlemen have fewer meaningful options, they'd be at the mercy of what the only buyer wants.”

In the long term, fed-cattle markets could be affected if Smithfield tried to further vertically integrate its beef business, analysts say.

Luter says he expects to expand Smithfield's feedlot ownership because it allows the company to quote beef prices to retailers a year in advance. It would also make it easier to age and source verify cattle.

“Yes, we'll probably get bigger in the cattle feedlot business,” Luter says. “We're convinced we can manage that end of the business to where it will contribute to our overall strength and profitability.”

Smithfield has proved itself a savvy buyer in the hog industry. After hog prices plunged to Depression-era lows of 10¢/lb. in December 1998, Smithfield purchased two of the largest independent pork producers — Carroll's Foods in May 1999 and Murphy Farms in January 2000. Both are in North Carolina.

The overall impact of Smithfield expanding its fed-cattle presence and beef-processing capacity depends on how much of its needs could be met by its feedlots, analysts say. The feedlots Smithfield just bought in Colorado have historically only supplied a large share of the cattle at Swift's Greeley, CO, plant.

If Smithfield were to supply as much as half of its needs, as its does in its hog business, it could hurt fed-cattle prices in some areas.

“Any time you remove a buyer from the area, or that buyer is less active, there's some potential for downward price pressure,” says Dillon Feuz, University of Nebraska ag economist.

In Nebraska, for example, Feuz notes that if Smithfield integrated the Grand Island Swift processing plant, downward price pressure would likely be localized to cattle feeders near the west Nebraska plant. Cattle feeders in central and east Nebraska would be less affected because Tyson, Excel and some regional processors have plants in the area and compete for fed cattle there.

A focus on consistency

One consequence of a Smithfield expansion would be in feeding protocols for pre-arranged sale agreements, analysts say. Such standardized feeding would help Smithfield secure cattle that produce larger volumes of consistent high-quality beef.

Consistency is key to developing a brand identity for meat products. Smithfield, along with Tyson Foods, has been one of the industry leaders in the area.

“There's no question (building a brand identity) is more Smithfield's culture than in some other companies,” says John Lawrence, ISU livestock economist. He notes Swift traditionally has been more concerned with volume of production than higher quality.

In Wisconsin, where Smithfield has operated Packerland since 2001, the company established new feeding regimes for contract producers, Tod Fleming says. He's COO of Equity Cooperative Livestock Sales Association, a member-owned, livestock-marketing firm in Baraboo, WI.

Smithfield requires all contract producers in the state to use high-energy feed for cattle weighing more than 300 lbs., Fleming says. It's also held numerous group meetings to educate producers about the benefits of using a high-energy feed on the area's Holstein cattle. More than 60% of the cattle Packerland harvests are Holsteins.

Under Packerland's previous owners, contract feeders were required to use the feeding regimen for calves but not if they contracted with the company for yearling cattle, Fleming says.

The pork experience

But analysts say the beef side is unlikely to see sweeping shifts like those Smithfield has implemented in the hog industry.

Since the early 1990s, Smithfield's pork business has been driven by the goal of producing meat lower in fat content than competitors. It was a response to health concerns over dietary fat that first arose in the 1970s, as well as a desire to tap into the Japanese market, which prefers leaner pork products, says Ken Foster, Purdue University ag economist.

“We didn't have enough high-lean animals going through the system 15 years ago to say to the Japanese that we could supply them with a given quantity of pork at a certain price in the future,” Foster says. Denmark had that market locked up, he adds.

Smithfield countered by developing its own specially bred line of hogs and now markets its low-fat pork under the name of “Smithfield Lean Generation Pork.”

To accomplish this, Smithfield and a supplier purchased U.S. rights in the early '90s to a genetic line from England's National Pig Development Co., and imported more than 2,000 specially bred sows to form the nucleus of its effort. The company also began buying hog farms across the U.S. to better control the quality of animals processed in its plants.

Today, Smithfield owns a breeding herd of 540,000 sows using that genetic line, and raises 14.5 million hogs/year, or about 45% of its harvest needs and 14% of all hogs processed in the U.S./year. The company also contracts with independent producers using the same genetic line to control another 100,000 sows.

But, different consumer demands and the land-intensive nature of the beef business will keep Smithfield from enacting that strategy in the cattle business, analysts say.

For one, the beef industry lacks the same consumer-driven demand for a low-fat beef product since the advent of high-protein, low-carb diets such as the Atkins Diet, says Steve Meyer, economist and owner, Paragon Economics, Adel, IA.

It would also be extremely expensive to own the amount of land needed to maintain a herd of cows large enough to supply a significant percentage of the nation's fed-cattle herd, analysts say. Investors would expect better returns on their money than the 2-3%/year the land's value could be expected to appreciate, Purdue's Foster says.

Smithfield's spokesman concurs. “We have no plans to duplicate our hog and pork model” in the beef industry, Hostetter says. “It would be a task that would take forever and be quite expensive.”

Coordinating the genetics of calf production through contracts would also be unlikely, analysts say. With an average U.S. herd size of 40 animals, it would be difficult to assemble the large number of cattle needed to supply the fed-cattle industry.

Bob Finkelstein is a Philadelphia-based freelance writer specializing in meat industry market coverage.

Fact Sheet

Smithfield Beef Group

The Smithfield Beef Group was formed in 1960. It is now the fifth-largest beef packer in the U.S. and growing. Holdings include Packerland Packing, Green Bay, WI; Sunland Beef Co., Tolleson, AZ; and Murco Foods, Inc.; Plainwell, MI.

Headquarters: 2580 University Ave.
Green Bay, WI 54311

Employees: Approximately 5,500

Major brands: Packerland
Supreme Valu
Showcase Supreme
Showcase Foods
Steakhouse Classic
Cedar River Farms

Fiscal 2004 sales:
$2.4 billion

Fiscal 2004 volume:
2.4 billion lbs.

Major facilities:
Packerland-Green Bay, Green Bay, WI;
Packerland-Plainwell, Plainwell, MI;
Packerland-Gering, Gering, NE;
Moyer Packing Co., Souderton, PA; and
Sunland Beef Co., Tolleson, AZ