Fitch Upgrades Smithfield Foods to 'BB-'; Outlook Stable

Fitch Ratings has upgraded the following ratings of Smithfield Foods, Inc. (Smithfield; NYSE: SFD).

--Long-term Issuer Default Rating (IDR) to 'BB-'from 'B+';

--Senior unsecured debt to 'BB-' from 'B/RR5'.

Fitch has simultaneously affirmed the following ratings:

--Asset-based Inventory Revolver at 'BB+';

--Secured term loan at 'BB+';

--Secured notes at 'BB+'.

Recovery ratings have been withdrawn due to Smithfield's lower overall probability of default.

The Rating Outlook is Stable. At Oct. 30, 2011, Smithfield had approximately $2.2 billion of total debt, inclusive of about $40 million of unamortized debt discounts.

Rating Rationale:

This rating action follows the revision of Smithfield's Rating Outlook to Positive from Stable on June 16, 2011. The upgrade is due to considerable debt reduction concurrent with consistently better than expected operating performance and credit statistics. Smithfield has paid off approximately $1 billion of debt since the fiscal year ended May 2, 2010.

The two notch upgrade of Smithfield's unsecured debt reflects the firm's significant deleveraging. Furthermore, Fitch believes the relatively low amount of higher priority secured debt improves recovery for unsecured bondholders if there was an event of default. At Oct. 30, 2011, about 35% of Smithfield's debt was secured while 65% was unsecured.

Smithfield's ratings incorporate Fitch's expectation that total debt-to-operating income will approximate 3.0 times (x) to 4.0x and that the firm will generate FCF in most years. As such, ratings have room to withstand modest additional leverage resulting from lower operating earnings or small-to-mid size acquisitions.

The company's ratings recognize the negative impact volatile grain and potentially lower pork and live hog prices can have on it's earnings and operating cash flow. Additionally, Fitch believes Smithfield's lack of diversification across proteins results in higher business risk.

Partially offsetting these negatives is the firm's meaningful and growing portfolio of branded value added packaged meats products. For the fiscal year ended May 1, 2011, Smithfield had $5.7 billion of packaged meats sales which represented 47% of its total $12.2 billion of annual revenue. The largest of the firm's core brands include Farmland and Smithfield, each with over $1 billion of sales. Other large brands include Eckrich, Armour, John Morrell, and Cook's.

Rating Drivers:

Meaningful additional deleveraging such that debt levels are maintained below $2 billion and total debt-to-operating EBITDA is sustained below 3.0x could result in future upgrades of Smithfield's IDR and senior unsecured debt. Fitch believes lower debt levels would further lessen the impact of periodic downturns in the pork industry on Smithfield's credit profile.

Conversely, a more aggressive financial strategy characterized by large debt-financed acquisitions or share repurchases would be viewed negatively. Materially higher debt levels or considerably weaker operating earnings and cash flow that results in total debt-to-operating EBITDA consistently above 5.0x could result in a downgrade.

Credit Statistics:

During the LTM period ended Oct. 30, 2011, Smithfield generated over $1.2 billion of operating EBITDA and had an operating EBITDA margin of more than 9.0%, well above an average of about 6% since 2001. Total debt-to-operating EBITDA was 1.9x, in line with levels at the fiscal year ended May 1, 2011 while operating EBITDA-to-gross interest expense increased to 5.2x from 4.4x.

LTM FCF was $64.4 million, down from the $439.6 million generated during fiscal 2011. Smithfield's FCF during the six-month period ended Oct. 30, 2011 was negatively affected by high seasonal working capital requirements, voluntary pension fund contributions, and heightened capital expenditures to support additional investments in its packaged meats capabilities. Fitch believes Smithfield is capable of generating an average of about $100 million of FCF annually.

Recent Operating Performance:

Fitch believes Smithfield's consolidated operating earnings could continue to track at or above normalized levels through the first half of fiscal 2013. Industry fundamentals remain favorable with good export demand, particular from Asia, and relatively stable pork supply. Furthermore, pork consumption trends in the U.S. are expected to improve in 2012. These operating conditions should provide support to hog and pork prices in the near term. Smithfield is also benefiting from the realization of $125 million of annualized efficiency improvements in its pork segment and is on track to achieve $90 million of annual benefit from restructuring its hog production business by fiscal 2013.

For the first six-months of fiscal 2012, the period ended Oct. 30, 2011, consolidated sales increased 9% to $6.4 billion due mainly to higher pricing. Average selling prices in Smithfield's pork segment were up 9% versus the same period last year while volumes rose 1%. The firm's pork segment represented 84% of net sales and 69% of operating profit excluding corporate expenses in fiscal 2011. Consolidated gross profit increased 3% to $826.7 despite higher raw material costs and Smithfield remained profitable in all of its business segments. Reported operating profit declined 12.6% or $57.8 million to $397.9 million due mainly to a $39 million litigation-related cash charge and lower equity income from its 37% interest in Campofrio Food Group, Inc. and Mexican joint ventures.

During the same period, Smithfield used internally generated cash to repay $77.8 million of unsecured notes due Aug. 1, 2011 and to repurchase $37.1 million of its 10% senior secured notes due July 15, 2014 and $110.6 million of common stock. The firm also made a $100 million voluntary pension contribution, as mentioned previously. Cash declined from $374.7 million at the end of fiscal 2011 to $136.4 million at Oct. 30, 2011.

Liquidity and Upcoming Maturities:

Smithfield has good liquidity and financial flexibility. At Oct. 30, 2011, the firm had $1.1 billion of liquidity consisting of an undrawn $925 million inventory-based revolver and the $136.4 million of cash mentioned above. The firm's $275 million accounts receivable securitization, which expires June 9, 2014, was nearly fully drawn due to seasonal working capital requirements but has since been repaid. The inventory revolver is due June 9, 2016. However, it will mature on March 15, 2014 if the outstanding principal balance of the company's 10% senior secured notes due July 15, 2014, net cash in excess of $75 million, exceeds $300 million on that date. The notes had an original face value of $850 million when issued in July and August of 2009 but, due to periodic market purchases, approximately $600 million are currently outstanding.

Smithfield does not have significant any debt due in fiscal 2012 and fiscal 2013. Significant upcoming maturities include $160 million of 7.75% senior unsecured notes due May 15, 2013, $400 million of 4% convertible notes due June 30, 2013, and the roughly $600 million of 10% 2014 secured notes mentioned above. Smithfield's $200 million secured term loan due June 9, 2016 does not amortize but requires the firm to pay $25 million of principal on June 9, 2015.

Financial Covenants and Significant Debt Terms:

Smithfield has considerable cushion under the maximum leverage and minimum interest coverage financial maintenance covenants. The firm's funded debt to capitalization ratio, which was approximately 39% at Oct. 30, 2011, may not exceed 50% and its minimum EBITDA to interest expense must be at least 2.5x. Smithfield is allowed to incur a limited but meaningful amount of incremental debt as long as it is in compliance with these covenants but has indicated that it has no intentions to lever up its balance sheet. Smithfield may be required to repurchase all of its outstanding notes at 101% of principal plus interest if there is a change of control.

Additional information is available at 'www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 12, 2011);

--'Smithfield Foods, Inc. Full Rating Report' (July 28, 2011);

--'Fitch Revises Smithfield's Outlook to Positive; Rates New Secured Credit Facility 'BB+/RR1' (June 16, 2011).

Applicable Criteria and Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229

Smithfield Foods, Inc.

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=643709

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