Thursday, September 08, 2011

Smithfield Foods Will Nourish Your Net Worth

The world's largest pig meat purveyor, Smithfield Foods (NYSE: SFD) reported strong earnings growth Thursday morning. Should this be a signal to buy its stock?

In its quarter ending July 31, Smithfield beat earnings expectations. It earned $82.1 million up 8% from the year before. It beat by a penny analysts' adjusted EPS expectations of 68 cents a share. And revenue rose 7% to $3.09 billion but was $50 million short of Wall Street expectations. Thanks to rising demand around the world, Smithfield boosted prices 8% which helped offset its rising pig food costs for corn and soybeans.

Is all this good news enough to make Smithfield part of your portfolio? Here are three reasons to consider it:
  • Good earnings reports. Smithfield has been able meet or beat analysts' expectations in five of its past six earnings reports.
  • Rising sales and profits and strengthening balance sheet. Smithfield's sales have decreased while its profits rose. Its revenue fell at a 6.7% annual rate from $9.4 billion (2007) to $12.2 billion (2011) while its net income has increased at a 32.9% rate from $521 million (2007) to $521 million (2011) — yielding a slim 4% net profit margin. Its debt has fallen while its cash has risen. Specifically, its long term debt fell at an 8.1% annual rate from $2.8 billion (2007) to $2 billion (2011) and its cash rose at a 59.4% annual rate from $58 million (2007) to $374 billion (2011).
  • Out-earning its cost of capital. Smithfield is earning more than its cost of capital – and it’s improving. How so? It’s producing positive EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first half of 2011, Smithfield's EVA momentum was 6%, based on first  2010 revenue of $11.2 billion, and EVA that rose from 2010's -$404 million to 2011's $245 million, using a 7% weighted average cost of capital.
One reason against:
  • Somewhat high valuation. Smithfield's price-to-earnings-to-growth ratio of 1.42 (where a PEG of 1.0 is considered fairly priced) means its stock price is fairly high. It currently has a P/E of 7.1, and its earnings per share are expected to grow 5% to $2.61 in fiscal 2013.
Smithfield's ability to raise prices is a good sign for this company's earnings potential. However, much depends on whether its pig food costs rise faster or slower than Smithfield can increase prices. I would keep an eye on this stock and consider buying on a market drop -- given recent volatility, that could happen soon.


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