990828 S&P affirms Smithfield Foods ratingAugust 14, 1999New York - Standard & Poor's affirmed its triple-'B'-minus corporate credit and bank loan ratings, as well as its double-'B'-plus subordinated debt rating, for Smithfield Foods Inc. The ratings are removed from CreditWatch, where they were placed in February 1999. The outlook is negative. About $993 million of operating lease-adjusted debt was outstanding as of April 1999, pro forma for the acquisition of Carroll's Foods, the second-largest hog producer in the U.S. The affirmation reflects Smithfield's modestly improved business risk profile following the completion of the Carroll's acquisition in May 1999 for $231 million in assumed debt plus 4.2 million shares of Smithfield stock. This is offset by the company's increased debt leverage and the resulting weakened financial ratios associated with the Carroll's acquisition, as well as with several other smaller acquisitions completed in fiscal 1999. The Carroll's acquisition enhances Smithfield's business risk by increasing the company's level of vertical integration; this should help smooth out some of the earnings variability inherent in the pork processing industry, as the profitability of hog production and pork processing is counter cyclical. While the company's acquisition activity has weakened Smithfield's financial ratios on a pro forma basis, Standard & Poor's anticipates that the company's focus on debt reduction will result in an improved financial profile in the intermediate term. The ratings reflect Smithfield's market position as the largest vertically integrated fresh and processed hog processor in the U.S. These factors are partially offset by the cyclical, low-margined nature of the pork processing industry, Smithfield's relatively high debt levels, and the company's aggressive acquisition strategy. The company maintains a leading market share (about 20%) of the U.S. hog slaughtering industry, slightly ahead of the number two player, IBP Inc. As a vertically integrated company, Smithfield is involved in hog production, as well as hog processing, and controls about 30% of the hogs that it slaughters, pro forma for the Carroll's acquisition. This vertical integration, combined with the company's access to genetically developed breeding stock, ensures that the company has access to a reliable supply of high-quality hogs, and results in increased efficiency relative to industry competitors. Vertical integration also helps mitigate the impact of the cyclicality of hog prices, as the profitability of hog production and hog processing are counter cyclical. Historically, the company has been an active participant in the consolidation of the pork processing industry. Standard & Poor's expects Smithfield to continue to make strategic acquisitions; however, the company has little flexibility within the current ratings for debt-financed acquisitions. In part due to low hog prices, Smithfield generated solid operating results in fiscal 1999. Operating lease-adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to interest was about 5.6 times, and total debt to EBITDA was relatively modest at 2.8x. However, pro forma for the Carroll's purchase and smaller acquisitions completed during fiscal 1999, EBITDA to interest is weak, in the mid 3.0x range, and total debt to EBITDA is high, also in the mid 3.0x range. Standard & Poor's expects that in the near term, free cash flow will be largely used for permanent debt reduction. In addition, some near-term improvement in hog prices is assumed. As a result, EBITDA to interest is expected to approach 5.0x in fiscal 2000. Financial flexibility remains solid, as the company's $300 million revolving credit facility is more than sufficient to fund seasonal working capital needs. OUTLOOK: NEGATIVE Smithfield's financial profile is weak for the current ratings. If the company is not able to reduce debt and improve its financial ratios, the ratings could be lowered, Standard & Poor's said.
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