October 31, 2018 / 3:59 AM / a year ago

Breakingviews - Trade and pig diseases infect China’s pork giant

A sow rests inside Guangxi Yangxiang's high-rise pig farm at Yaji Mountain Forest Park in Guangxi province, China, March 21, 2018. Picture taken March 21, 2018. REUTERS/Thomas Suen

HONG KONG (Reuters Breakingviews) - WH Group, $11 billion owner of U.S.-based Smithfield Foods, faces a fierce battle on two fronts. Swine fever is sweeping China, while tariffs hammer American markets. It will get worse before it gets better.

Beijing’s levies on U.S. pork are so severe trade is “not viable”, says Smithfield chief executive Ken Sullivan. That’s troubling: Sales to the mainland were high on a list of synergies when WH Group bought it in 2013. American farms also face an oversupply of pork and low prices at home. That hurt quarterly results released Tuesday - net profit fell by 31 percent from a year earlier.

Meanwhile, there is no vaccine for the deadly African swine epidemic. Victims can be slaughtered to stymie its spread, but the disease is highly contagious. Spain took three decades to stamp it out. Only one WH Group facility has been affected so far, but China has destroyed less than 1 percent of the country’s hogs; there could be more to come.

Shareholders are expecting the worst-case scenario. The Hong Kong stock trades at around nine times forecast earnings for 2019, less than half the multiple for Chinese rivals like Muyuan Foods and Wens Foodstuff. Suppose WH Group can’t sell any pork in the U.S., as evaporating exports stoke overcapacity; then imagine the company culls its Chinese herds. For good measure, assume diminishing pork supplies in China raise costs of raw materials for processing, halving the bottom line next year to around $450 million. In this nightmare, WH Group’s multiple would be around 23 times, much closer to peers.

Yet the future might not be so bleak, especially if China checks the epidemic. Packaged meats, which contributed 77 percent of operating profit, are somewhat insulated from tariffs because the finished product is made in China. Producing more premium hotdogs and hams could offset declines in other categories, and food safety scares in China tend to benefit established brands.

Almost all the analysts monitored by Refinitiv labelled WH Group a buy on Wednesday morning, at a median price target over HK$9 per share, nearly double its current level.  But it might take a long time for WH to bring home the bacon.


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