Smithfield Takes Walmart Approach with Grain Producers

Reduces reliance on commercial grain handlers by purchasing grain directly from farmers

s1Smithfield Foods Inc., the world’s biggest pork producer and a wholly owned subsidiary of Hong Kong-based WH Group Limited, is reducing its reliance on commercial grain handlers and purchasing grain directly from farmers, as reported by Reuters on December 30th, 2016. Such a move could have an adverse impact on grain handlers that are already reeling from multi-year lows in corn and soybean prices.

In addition, the Virginia-based company bought two grain elevators in September 2016, which enables the company to ship grain directly from Ohio to its Tar Heel, North Carolina, hog-slaughtering and processing plant. The Tar Heel plant is the world’s largest slaughtering facility, processing about 32,000 hogs daily. Smithfield now buys 65% of its animal feed directly from farmers, up from the 10% in 2010, as part of its efforts to bypass grain handlers and lessening its reliance on these middle parties.

Smithfield’s direct buying strategy is aimed at lowering feed costs and could be a model for other large meat companies such as Tyson Foods Inc. (NYSE: TSN) and Sanderson Farms Inc. (NASDAQ: SAFM), which still largely rely on commercial grain handlers such as Chicago-based Archer-Daniels-Midland Co. (NYSE: ADM). Grain currently accounts for up to 60% of Smithfield’s operating costs. The company’s expenses totaled $4.67 billion in 2015. Smithfield buys about 150 million bushels of corn, soybeans, wheat, and sorghum per year to feed its 16 million hogs.

s2In 2014, Smithfield canceled a grain handling contract with CHS Inc., the largest US farmer-owned cooperative, a supplier to Smithfield’s feed mill in Yuma, Colorado. In 2015, the company exited a 20-year relationship with MaxYield Cooperative in Algona, in northern Iowa. MaxYield was the supplier to a Smithfield-owned feed mill in Algona that can grind 50,000 bushels of corn per day.

Less reliance on grain handlers

Smithfield also aims to work directly with farmers to influence farm management, from crop rotations to fertilizer and fungicide applications that could result in higher-quality grain that speeds weight gain in hogs. Smithfield could have a say in the seeds that are planted for the grain to feed the hogs that it slaughters to produce pork.

Smithfield’s push to go directly to farmers comes at a time when Archer-Daniels, Cargill Inc., and other leading grain handlers are facing sharp drops in corn and soy prices following record-large US harvests. Handlers generally make money buying, selling, storing, transporting and processing grains, earning small profit margins on each bushel they trade. Trading fees for commercial grain handlers are about $0.20 per bushel in tight-supply markets, but drop to just a few pennies when grain prices are low. For instance, Archer-Daniels reported weak margins and a 26% fall in profits in Q2 FY16 and Q3 FY16 due to weak grain prices.

Record harvest leads to fall in soy, corn prices

During 2016, US farmers built up their elevator storage to better control their harvest, and held back supplies when prices were low, thereby reducing profits for handlers. In Q4 FY16, Archer Daniels and other commercial grain handlers sold grains overseas by cashing in on abundant US supplies. Smithfield’s move is not expected to hurt the big grain handlers immediately since the company still relies on Archer-Daniels and Cargill to crush soybeans into soy meal, an animal feed. However, such companies could lose substantial business in the long run if other meat producers follow Smithfield’s lead, while smaller grain handlers are already feeling the impact.

Smithfield is also importing cheaper feed from South America and Europe. It has imported soy from Brazil and Argentina and feed wheat from Europe when it is cheaper than supplies shipped out of the Midwest.

Smithfield closes acquisition of Clougherty Packing

Smithfield announced on January 03rd, 2017, that it has completed the acquisition of Clougherty Packing LLC, parent company of Farmer John and Saag’s Specialty Meats brands, and PFFJ LLC farm operations from Hormel Foods Corporation (NYSE: HRL). The closing followed the approval of the sale by the Committee on Foreign Investment in the United States. The acquisition is aimed at creating a more efficient supply chain and expanded its operations, product portfolio, as well as its customer and consumer base. Altogether, the operations will add 2,000 employees, growing Smithfield’s total workforce to 52,000.

s3The purchase price was $145 million in cash, adjusted for working capital. Farmer John harvests approximately 7,400 hogs per day and in FY16, the businesses accounted for approximately $500 million in sales and EPS of approximately $0.03. The acquisition will bring three farms located in Arizona, California and Wyoming under Smithfield’s hog production division. Kenneth J. Baptist, vice president of operations for Smithfield’s packaged meats division, will now lead Farmer John operations, which includes both the Farmer John and Saag’s Specialty Meats brands.

Adopts greenhouse reduction goal

On December 05th, 2016, Smithfield became the first meat producer to announce a greenhouse gas (GHG) reduction goal throughout its entire supply chain. By 2025, Smithfield will reduce its absolute GHG emissions by 25%. When achieved, this goal will reduce emissions by more than 4 million metric tons, equivalent to removing 900,000 cars from the road. Smithfield collaborated with Environmental Defense Fund (EDF) in setting its goal.

This commitment impacts operations across Smithfield’s supply chain, on company-owned farms, at processing facilities and throughout its transportation network. In its grain supply chain, Smithfield is collaborating with EDF to improve fertilizer efficiency and soil health, which will reduce nitrous oxide emissions from grain farms. On its hog farms, Smithfield will incorporate renewable energy and reuse projects that utilize technology such as anaerobic digesters and lagoon covers. Smithfield aims to install these technologies on at least 30% of company-owned farms. Smithfield will also continue to adopt measures that improve animal efficiency, resulting in improved feed conversion and productivity while reducing carbon emissions.s4

With the direct buying approach, GHG reduction goals, and acquisition strategy in place, it remains to be seen if these moves have a positive impact on Smithfield’s bottomline, especially at a time when hog futures have been sinking over the past few months amid record American production of pork, leaving US meat producers grappling with lower prices since the beginning of 2016.

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