Smithfield Foods, Inc. Business Information, Profile, and History

Company Perspectives:

Smithfield Foods now owns roughly 50 percent of the hogs we slaughter and raises additional hogs, which we do not process, that are marketed under long-term contracts to other companies. We realize a number of benefits by vertically controlling such a substantial portion of our raw materials. By controlling half our hog supply, our processing operations are ensured of a consistent, high-quality source of raw materials for many of the company's fresh and processed meat products. Continued volume gains in processed meats are helping to further one of our most important goals: creating a balance between fresh and processed meats that maximizes that value from all of our cuts.

History of Smithfield Foods, Inc.

Smithfield Foods, Inc. is the world's largest pork processor, with fiscal 2000 production of 6 billion pounds of fresh pork and processed meats. It is also the world's largest hog producer (almost 12 million hogs annually). As a holding company, Smithfield Foods conducts its business through two groups, the meat-processing group and the hog-production group, each made up of a number of subsidiaries. In addition to North Carolina, where it operates the world's largest hog-processing operation, the company operates industrial pig farms in ten states. Known as a leader in vertically integrated pork processing since 1987, Smithfield raises, slaughters, and processes meat. Its line of hams, hot dogs, bacon, sausage, and deli and luncheon meats is marketed wholesale, under private labels, and under such brand-name labels as Smithfield, Esskay, Gwaltney, Luter's, Jamestown, and Patrick Cudahy. Beginning in 1998 Smithfield expands beyond the United States with acquisitions in Canada, France, and Poland.

1936 to 1969: All in the Family

Many would agree that Smithfield's competitive edge is synonymous with the leadership of chief executive officer Joseph W. Luter III. After reclaiming in 1975 what was his own company, Luter had ushered Smithfield into the high-tech age by acquiring companies, forging partnerships, reducing overhead, and instituting capital improvements to boost efficiency. More importantly, he had elevated Smithfield to the elite ranks of those Fortune 500 companies offering the highest total returns to investors.

Since colonial times the small town of Smithfield, Virginia, had been known for its quality hams. Even today, under Virginia law, a ham may only be marketed as a "genuine Smithfield" if it has been cured for six months within the confines of the town. One such marketer, family owned Gwaltney Packing, was the employer of Luter's father and grandfather during the 1930s. In 1936 these two decided to establish their own ham business and succeeded in raising $10,000 from local investors. They opened across the street from Gwaltney and built their small private company into a multimillion-dollar entity.

When Luter's father died suddenly of a heart attack in 1962, Luter, near graduation from college, shelved his plans to attend law school and returned to oversee the business. Seven years later the company, with annual revenues of $35 million, had attracted the interest of Washington, D.C.-based Liberty Equities Corp., a small conglomerate. Luter sold the family company for $20 million but was retained as manager. After being summarily dismissed by the new owners six months later, Luter promptly launched a second career in real-estate development.

Mid-1970s to the Mid-1980s: From Bankrupt to First Billion

The packing plant, now operating as Smithfield Foods, Inc., fattened itself through non-pork acquisitions and unnecessary staff expansion. By the mid-1970s Smithfield was floundering along with Liberty Equities and Luter saw an opportunity to repurchase the company at a fraction of its worth. Because of actions taken by the Securities and Exchange Commission, Liberty had essentially reduced itself to Smithfield Foods, a failing $100 million pork-processing and fish wholesale business, further hampered by a nonproductive chain of 27 seafood restaurants. Price inflation throughout the food industry, as well as poor management, had severely affected the company; its debt had risen to $17 million while net worth had plummeted to $1 million. Creditors were demanding a management change and Luter agreed to a salary and stock options package that encouraged turnaround. As one analyst in a 1988 Financial World article claimed, "Essentially, Joe Luter got the company back for ten cents on the dollar."

Luter quickly reduced Smithfield's debt by selling the non-pork operations. He achieved profitability within seven months by slashing nearly $2 million in overhead through the elimination of middle managers and via sharp reductions in data-processing costs. Thus streamlined and firmly back in the meat business, Smithfield began to expand through acquisition. In 1978 it purchased a plant in Kinston, North Carolina. In 1981 Smithfield snatched up Gwaltney (at 35 cents on the dollar) for $34 million. Luter derived special satisfaction from this acquisition because not only had Gwaltney been a longtime competitor, it had also succumbed to the trappings of conglomerate spending under ITT Corp. Luter continued to seek out and buy at bargain rates other underperforming pork companies throughout the 1980s. These included Hancock's Country Hams, Patrick Cudahy Incorporated, and Schluderberg-Kurdle Co. (renamed Esskay, Inc.). By 1988 annual revenues had skyrocketed to $864 million, well within striking range of the billion-dollar mark.

1987 to 1992: Consistent and Predictable Growth

In 1987, in a particularly prescient move, Luter launched a 50-50 partnership with Carroll's Foods, the country's fifth-largest pork producer. Strategically located in North Carolina—within single-day transportation to half the U.S. population—Smithfield-Carroll's had helped the company lessen its dependence on Midwest hog farmers, the traditional source for the pork-packing industry. Coupled with hogs supplied by East Coast giant Murphy Family Farms, the partnership-generated pigs helped to account for 50 percent of Smithfield's annual requirements. In addition to saving on high-transportation costs, Luter also benefited from lower weight loss during shipment, thereby enhancing his product line's quality and marketability.

According to Sharon Reier, "What is remarkable about Luter's resurrection of Smithfield is that he did it in an industry plagued by plant overcapacity and a flat consumption pattern in pork product over the past ten years, and dominated by large, well-heeled conglomerates that could subsidize poor margins in meat-packing operations with profits from other divisions." Of course, even Luter's Midas touch had little control over four-year cycles in hog prices, which directly affected the company's profitability. When prices are high, more pigs are raised and the eventual oversupply results in falling prices and undersupply—a true indicator of a high-risk commodity business. As a consequence of this predictable cycle, net income for Smithfield totaled $7 million in 1990 but rose sharply to nearly $29 million in 1991. Net income for 1992 began cycling downward again to $21 million.

Out of necessity, Smithfield was forced to take a long-term view of earnings performance through compound growth rates. In the 1991 letter to shareholders it explained, "an analysis of the Company's performance over the last 16 years provides some enlightening results. When the 16 years are divided into four, four-year segments, the Company's earnings fall into a consistent and predictable growth pattern. ... The Company's sales, net income and net income per share have shown compound growth rates of 14 percent, 31 percent, and 33 percent, respectively, over the last 16 years."

One distinct advantage of these cycles, both for the company and for investors, was that Smithfield stock prices also followed a dip-and-rise pattern. With his extra profits, Luter had capitalized on downswings to buy back some 50 percent of the company's shares during the same 16-year period and had increased his individual stake to approximately 20 percent, according to a 1992 Forbes article.

To keep Smithfield on the cutting edge, Luter had concentrated on his niche markets, avoided high advertising budgets, and relegated more than half of his production to nonbranded commodity pork sales for the supermarket and food-service industries. Most promising for the future was Luter's quest for the genetically perfect pig: lean, hardy, and easy-to-process. An exclusive contract between Smithfield-Carroll's and National Pig Development Co. (NPD), a family owned British firm, proved to supply the answer. The first generations of NPD's transplanted stock were raised at the North Carolina facility. In July 1992, according to David Ress, "Mr. Luter ran some tests on a 265-pound hog ... comparing it with an especially lean American hog culled from the best of Smithfield's current stock. The American pig had an inch of fat on its back. The British pig had less than half that, Mr. Luter said. The raw, or 'green' ham from the American pig yielded 52 percent lean meat after boning and after the fat was trimmed. The British pig's yield was 62 percent." Development and marketing of the pigs was expected to continue, particularly through Smithfield's formation of Brown's of Carolina and its centerpiece, a state-of-the-art slaughtering plant located in Bladen County, North Carolina, which opened for production in September 1992. Around this time, the company phased out a dated Baltimore facility, acquired a John Morrell plant in Wilson, North Carolina, and searched for a plant situated to serve the West Coast.

1990s and Beyond: Becoming a Pork-Industry Global Force

The Bladen County plant played a pivotal role in Smithfield Foods' transition from a small, regional packer to the largest pork-packer in the world. By April 1998 operations expanded, changing the primary nature of the facility from a pork-processing plant to the central warehousing/distribution center for Smithfield Packing Co. In 1999, Smithfield received approval to increase processing from 24,000 to more than 30,000 hogs a day. In 2001 the plant killed 32,000 hogs per day, twice the capacity of a typical plant.

By the mid-1990s, pork processing was an industry in flux. Production was becoming more horizontally concentrated and vertically integrated. At this time, the meat-processing industry faced mounting federal regulations, a seesaw marketplace, and food-safety challenges. But at Smithfield, the company saw a smoother road. A trade publication, National Provisioner, described Smithfield Foods as the market leader in vertically integrated fresh pork production, with the implementation system necessary to support future growth: long-term production agreements for hogs, and its high-tech North Carolina facility designed to ensure product consistency and quality.

Even in 1998, a year that saw a struggling pork industry, Smithfield was thriving. Planning and strategic initiatives contributed to sales of almost $4 billion in pork products, with profitable product sales and marketing achievements that allowed the company to turn its attention to global expansion. Product development strides included a new line of low-fat Italian sausage and a new precooked sausage line by Smithfield's Wisconsin-based Patrick Cudahy division. But Luter knew that turning America's chicken eaters into pork lovers wouldn't be easy. The company's meat would have to go outside this country. Smithfield Foods entered long-term production agreements with customers in Japan. And the company acquired Canada's Schneider Corp. (Kitchener, Ontario) a pork producer, in February 1999, a year after it first started pursuing the company. In August 1999 Smithfield further pursued its international expansion through a 50 percent owned integrated pork joint venture in Mexico. In September 1998 Smithfield acquired the largest private-label manufacturer of ham, pork shoulder, and bacon products in France. The following year, Smithfield acquired a French meat processor, which doubled the company's processed meats business in that country. Later Smithfield acquired Poland's largest meat-packing firm, Animex SA. Today, environmental and other concerns prohibit Smithfield from expanding in some of the richest hog-producing areas of the United States.

In recent years, Smithfield Foods has faced a minefield of opposition to corporate pig farming. In 1997 Smithfield Foods drew the largest civil penalty ever, assessed for violations of the Clean Water Act, a $12.6 million fine. It was also ordered to pay $3.8 million for about 22,000 pollution violations in Virginia. In September 2000 Smithfield Foods and its North Carolina swine-production firms signed an agreement with the state of North Carolina that included a $15 million research and development commitment to conduct research on environmentally superior swine waste technology to protect the state's water quality. Environmentalists, animal-rights activists, and independent farmers continued to rail against the company in 2001, with lawsuits charging that Smithfield Foods for years intentionally and systematically violated environmental laws including the Clean Water Act. In March 2001 a North Carolina judge dismissed two lawsuits brought against the company and its hog-production subsidiaries in the state.

In this hostile climate, Smithfield needed to diversify its offerings to supermarkets and find new arenas for growth. Between 1998 and 2000, Smithfield purchased or invested in 12 companies, many outside the United States. The acquisitions provided production operations to offset declining meat-processing margins. Because there was more money in raising pigs than slaughtering them, Smithfield bought out its hog-farm partners in 1999 and 2000 as the price of hogs fell to a historic low. Today, huge economies of scale enable Smithfield to raise pigs more cost-effectively than other producers.

Meanwhile, NPD genetics played a role in Smithfield's Lean Generation Pork Products, which Luter believed could emulate Purdue and Tyson's heart-healthy branding of chicken products. By late 2000 Smithfield was one of the few stocks that resisted the market's downswing, thanks to a contract to supply Wal-Mart with prepackaged meats, an agreement Luter predicted would triple Smithfield's sales of fresh-wrapped pork.

In early 2001 Smithfield and Tyson, the nation's largest poultry company, had fought for IBP, the country's largest beef company, which would have made either contender the nation's largest meat producer. Tyson prevailed, but later cut off the merger deal. Smithfield had no immediate plans to resume its pursuit of IBP. Shortly thereafter Smithfield agreed to buy Moyer Packing Co., a smaller beef processor. The acquisition broadened the company's line of prepackaged, branded meat, which doubles the profit margins of commodity meats. Meanwhile, the outbreak of "mad cow" and hoof-and-mouth disease in Europe portended well for Smithfield, as analysts speculated that the company might be able to boost exports to Europe, where it has a broad distribution network.

Principal Subsidiaries:Meat Processing: The Smithfield Packing Company, Incorporated; John Morrell & Co.; Gwaltney of Smithfield, Ltd.; Patrick Cudahy Incorporated; North Side Foods Corp. Hog Production: Brown's of Carolina, Inc.; Carroll's Foods, Inc.; Murphy Family Foods, Inc.

Principal Competitors:IBP Inc.; Tyson Foods Inc.; Hormel; ConAgra.

Chronology

• Key Dates:
• 1936: Smithfield Packing Co. is founded by Joe Luter, Sr.
• 1962: Joe Luter II dies. Joe III graduates from Wake Forest University and joins Smithfield Foods.
• 1966: Luter, age 26, becomes president of Smithfield Foods.
• 1969: Controlling stake of Smithfield Foods is sold to Liberty Equities Corp.; Luter leaves the company.
• 1975: Luter returns as president/chief operating officer.
• 1978: The company purchases a financially troubled North Carolina plant.
• 1981: Smithfield Foods buys their competitor Gwaltney.
• 1984: The company acquires Patrick Cudahy, Inc. and Esskay (processing only).
• 1987: Smithfield Foods begins joint hog production with Carroll's Foods.
• 1991: The company negotiates exclusive U.S. and Mexico rights to National Pig Development Co. (NPD) genetics.
• 1992: Smithfield Foods buys 82 percent interest in Browns of North Carolina; and opens a new $76 million Bladen County, North Carolina plant.
• 1995: The company purchases John Morrell & Co.
• 1998: Smithfield Foods buys North Side Foods (who supplies precooked sausage to McDonalds); and acquires Schneider Corp.
• 1999: Bladen County plant operates at capacity of 32,000 hogs per day.
• 1999: The company acquires the following: SFGP (French ham, sausage, hot dog producer); Animex SA (Poland's largest meat processing firm); and Carroll's Foods; in addition company announces intention to buy Murphy Family Farms.
• 2000: Smithfield Foods announces decision to purchase Farmland Foods' Dubuque, Iowa plant.