Smithfield Foods Inc (SFD) 2016 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Smithfield Foods' 2016 second-quarter earnings results call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the call over to our host, Ms. Keira Lombardo. Please go ahead.

Good morning, and thank you for joining us today for Smithfield Food's conference call for the second quarter and first half of 2016. This is Keira Lombardo, Senior Vice President of Corporate Affairs. Joining me on our call today is Ken Sullivan, President and Chief Executive Officer; and Glenn Nunziata, Chief Financial Officer.

We would like to caution you that in today's call, there may be forward-looking statements within the meaning of federal securities laws. In light of the risks and uncertainties involved, we encourage you to read the forward-looking information section of the Company's 10-K for calendar year 2015. You can access the 10-K on our website at SmithfieldFoods.com. I will now turn the call over to Ken.

Thank you, Keira. Good morning, everyone. Hope you're all having a great summer. We are trying our best to beat the heat here in Smithfield. I think we clocked in at 100 degrees yesterday, so I hope wherever you are, you are having a little bit cooler summer.

But we are having a good summer here at Smithfield, if for no other reason than the fact that the 10-Q we filed this morning contains record-operating profits for the first half. Glenn will provide a comprehensive rundown of the numbers in a few minutes. Before he does that, though, I will recap, at a high level, operating profits in each of the segments.

From my standpoint, there is a lot of good news in our year-to-date numbers, but I'm equally excited about what we have in front of us over the next few years. Let me get to the numbers.

Total US GAAP operating profits totaled $447 million for the first half. That's against $374 million in the prior year. That represents a record first half for our Company.

Here's the quick rundown. Packaged meats profits totaled $380 million versus $349 million a year ago. Fresh pork profits totaled $158 million versus $18 million a year ago. International profits totaled $33 million versus $31 million a year ago. Hog production losses totaled $68 million versus profits last year of $33 million.

You add it all up, deduct the corporate segment, and you get to $447 million in total operating profits. What makes this result particularly encouraging is the fact that we actually lost $68 million in our live production segment. That's a $100 million-plus negative delta or swing in the numbers year over year, and yet we still managed to record a record first-half nonetheless. I think it's fair to conclude our One Smithfield initiative has indeed been a catalyst for earnings improvement, and our investments in our brands are really paying off.

Our domestic packaged meats business again led the way, with very strong 11% operating margins. Our domestic fresh pork also delivered strong 6% operating margins, a dramatic improvement over the prior year. I'm pleased with the progress we're making in fresh pork, but believe we still have significant opportunities to improve our margin structure ahead of us.

Starting with domestic packaged meats, let me point out a few of our highlights. First, Smithfield retail bacon volume rose by 10%. Smithfield-brand bacon continues to toggle between the second- and third-largest individual retail bacon brand in the country. Of course, when all of our brands are aggregated, Smithfield is the largest bacon producer nationally.

Eckrich Smoked Sausage volume was up 5%, and the brand is now number two nationally in market share. And Nathan's Famous held on to its number-one ranking among premium hotdog brands, with 15% volume growth.

I hope you all got to see the nationally televised hotdog eating contest over the Fourth of July weekend. If you did, you will appreciate that I think Joey Chestnut and Matt Stonie alone contributed to our volume growth in the first six months. It's a fun event, and if you haven't seen it before, you really ought to tune into it. It's an unusual event, let's call it that.

Speaking more broadly, though, about our packaged meats business, we achieved a year-over-year market share gain in 16 of the 22 IRI categories that we compete in. From a channel standpoint, we had bright spots in foodservice. Notably, our Smithfield foodservice bacon sales were up 9%, and our deli sales volume rose 11%, with strength across all major product categories.

Moving to the fresh pork division, we also made impressive strides there, with an increase in operating profits of an amazing 772% over the first half of last year. Obviously that's a little bit of a small loss -- small numbers coming into play last year. Nonetheless, I'm pleased with the performance of our fresh pork division, and again, I think we've got opportunity in front of us there as well.

Our export sales volume was up by just over 10%, led by a noteworthy 87% increase in sales volume to China and Hong Kong. We have continued to leverage the power of our WH Group trading platform in the sales channels of our sister Company, Shumway Development.

Also in domestic fresh pork, we continued to grow our branded fresh pork volume by over 25%. Our trademark Smithfield Marinated Fresh Pork, which continued to drive share leadership, surpassed its top competitor by 5.9 share points to achieve 32% market share.

In our international division, we achieved volume and margin growth in our key packaged-meats product categories. Hotdog volume was up by 5%, sausages rose by 15%, cooked ham by 7%, canned meat was up by 10% -- all of this coupled with margin improvement. As I've said before and I'll repeat it again, I think our international platform will be another catalyst for growth for Smithfield.

Finally, moving to hog production, our hog production business continued to achieve notable progress against industry benchmarks in areas such as feed conversion, daily weight gain, finishing livability. And while the fundamentals in the US live production end of the business have been challenging, we will continue to actively mitigate our risk with our hedging strategies.

Again, it is a disappointment to lose money in the live side of the business. But to the extent our vertical integration platform provides us with, I think, some unique competitive advantages, we will do our best with that end of the business and continue to mitigate our risk there.

The bottom line -- we continue to generate forward momentum across the board, witnessed by our first-half results. But we're not done. Our One Smithfield initiative and investments in our brands will continue to pay dividends, and we're actively exploring growth opportunities in a number of areas.

I will turn it over to Glenn so he can run down the numbers in more detail, and then we will take questions. Glenn?

Thanks, Ken, and good morning to all of you on the call. As Ken mentioned, Q2 was another terrific quarter. In fact, the results for the six months of the year represent the best January through June in Smithfield's history. As Ken mentioned, we have good momentum and our One Smithfield initiative is truly paying off.

We just filed our financials this morning, and I'd like to remind you, especially for those WH Group analysts on the call, our results are reported on a US GAAP basis. So if you're looking at the WH Group financials, those are reported on an IFRS basis, and there may be some differences.

I'm going to start by covering total Company results, and then we will dive into segments. Our second-quarter sales totaled $3.5 billion -- pretty much flat with last year. Our sales year to date totaled $6.8 billion compared to $7.1 billion for the previous year.

Packaged-meat sales dollars were up. International, while up for the quarter, was relatively flat on a year-to-date basis, and that's after a 6% negative impact from foreign currency. Fresh pork and hog production were both down in sales dollars for the year-to-date period.

For the quarter and year-to-date period, the story is consistent. Volumes are down in our US business, and prices are up. In Europe, we actually had the opposite effect. Volumes are up, but pricing is down.

Q2 operating profits, as Ken mentioned, totaled $237 million compared to last year's $186 million. That's an increase of 27% or $51 million. For the year-to-date period, our operating profit increased from $374.4 million in the prior year to $447.2 million this year. Our operating profit margin has continued its upward trend. We went from a 5% margin in the prior year to 7% this year.

Net income for Q2 totaled $137.8 million versus the $104.2 million we earned in the prior year. On a year-to-date basis, net income totaled $258.8 million compared to $201.2 million last year. As I mentioned at the outset, our results for the first six months set a record for the best January through June in our history.

Turning to segment performance, fresh pork results had a big factor for us this quarter. Fresh pork swung from a loss of $15.2 million in Q2 last year to profit of $57.9 million this year. Year to date, operating profits are almost $140 million higher, in spite of lower volumes and lower selling prices. The story here is that the value of meat cuts has significantly outpaced our raw material costs.

Packaged meats results remained strong at $172.9 million of profit for the quarter compared to a record $176 million last year. Volume was slightly down, but our selling prices continue to be strong.

Lastly, on the domestic front, let's discuss hog production. After an $83.5 million loss in Q1, Q2 profits came in at $15.2 million, an almost $100 million swing. Last year's Q2 profit was $39 million. The decline from 2015 was due to more favorable hedging results included in last year's numbers. The decline in those hedging gains was partially offset by lower feed costs in the current year.

On the international front, our Q2 profits totaled $19.2 million compared to $14.8 million in the previous year. Higher volumes in key categories in Eastern Europe, as Ken mentioned, along with lower pig prices in Mexico, have helped our earnings.

Turning to our financial position and liquidity, I'm going to run through some metrics. Our net debt to EBITDA ratio is around 2 times. Our debt-to-capital ratio is approximately 33%. And we're covering interest expense almost 8.5 times.

We have over $1.4 billion of global liquidity. We have maintained our strong debt liquidity level, despite having made a $125 million voluntary pension contribution and a $336 million dividend payment to our parent.

While there are no further pension contributions expected this year, our cash flow plans do reflect an additional dividend payment to WH Group in the back half. We expect to round that to full year at approximately $400 million of total dividend payments for WH Group.

Finally, on a CapEx front, we have incurred approximately $160 million year to date. Our capital budget for 2016 is on target at $350 million, and that's compared to an expected full-year depreciation expense of approximately $240 million.

That concludes my prepared remarks for the period. Keira?

Thanks, Glenn. Operator, please open the line for questions.

(Operator Instructions)

Bryan Hunt, with Wells Fargo.

Good morning, and thanks for taking the questions. Glenn, can I ask you -- wondering if you could touch on the numerical benefits of One Smithfield, and just give us some context of how it has benefited the Company in Q2 and/or year to date?

Sure. Bryan, this is Ken. I think I've consistently talked about One Smithfield as being a 200-basis-point improvement. In fact, I initially started out by saying I thought it would be a 100- to 200-basis-point improvement. And that is really on our domestic business, which is -- call that somewhere between $120 million to $150 million of improvement.

I have also consistently said that I think we realized 100 basis points of that last year when we announced One Smithfield in March of 2015. And the market improvement that you saw in our packaged meats business and the way we're managing our sales platform and our brands, I think, is what really translated and came through in the earnings in 2015, and has continued into 2016. I've also said, though, that there are other components of One Smithfield, including our transportation and logistics, including our manufacturing platform, that I think is another 100 basis points. And that is the part that is slower to come, and the part that we are working on this year.

I think I've also said that we are working on One SAP at the same time, meaning, in March of 2015, we announced the organizational changes and we have been hard at work ever since with the back-office piece of this, trying to put together One Smithfield from that standpoint -- which is, really, the backbone of which is One SAP. We expect to go live with One SAP next year in 2017 -- sometime hopefully in the first six months -- although it is an enormous project and is, frankly, consuming a lot of our resources to get that done. But I do expect that, that will help achieve that second 100-basis-point improvement in our earnings, comparing sort of 2017 to a base of full-year 2014, if you will, from that standpoint.

So what I would tell you is, we are achieving some of that second 100-basis-point improvement, and some of those improvements are in our numbers in a year-to-date basis, Bryan. But I think the majority of it is still to come. And we will realize that, particularly on a run-rate basis, closer to the end of this year, and certainly into 2017 -- we should begin to be on a full run-rate basis by sometime in 2017.

And I'm a little reluctant to put a little more definition around it, Bryan, because there is a tremendous amount of work that goes around the transportation and logistics and the manufacturing piece. And I can tell you, it's on the come. It may not be coming as fast as I would like it to, but it is definitely there and we will realize it.

Exciting changes taking place. I was wondering if you could talk about hog-raising costs in Q2 and what the outlook is, considering the dramatic improvement sequentially in hog-raising profits?

I think where you saw the improvement wasn't really so much from the cost side, it was the hog prices. Of course, in the US anyway, we have got a pretty seasonal business there with live production. So what you saw is the typical pattern, I think, which is, you've got sort of depressed prices coming into the year; and into Q2, those prices rise; and into Q3, those prices rise. And then you get the fall hog run, and they fall back down in Q4. And certainly I think that is what you saw in our numbers. And what you are seeing in our numbers is, in the second quarter, pig prices improved quite a bit.

So I would tell you, from a raising-cost standpoint, yes, we have seen some moderating of our raising cost, but it's really in the pig prices where the delta is coming from. And I would tell you, for the full year -- and I know others on the line are going to want to ask this question, so I will address that right now -- from an outlook standpoint in live production, I would expect the second half to look, frankly, a lot like the first half, only a little bit in reverse.

Meaning, the first quarter, we lost money; the second quarter, we made money. I think the back half of this year will be the same thing, only in reverse, in the sense that third quarter, we'll make money; and the fourth quarter -- the futures markets look like we're going to be losing money in the fourth quarter. And I would end that by saying we continue to be active in our hedging program, and we have taken protection provisions there. So at this point, Bryan, I expect the second half to look a whole lot like the first half.

All right. And then my last question. There's been announcements of -- and I think I asked this last quarter, but I wanted to get your take once again -- announcements of multiple facilities that are going to be opening over the next, call it, 24 months. I was wondering if we could get your take on, one, the capacity addition of all the facilities that have been announced; and, two, the potential outlook to earnings for the packing industry. Thanks.

Sure. Well, you are right. It's no secret that there are new plants coming online, and certainly those are, at this point, right around the corner. I think, in 2017, the four or five plants that have been announced, most of those will come online in 2017. I've said consistently in the past that I think we are, in the end, going to have more meat, and our export markets will have to absorb that increased production.

I think, in the short term, the $64,000 question is whether it is accretive to live production earnings in terms of the additional packing capacity and our people chasing pigs, and what kind of impact does that have on pig prices. I think that is conceivable that, that scenario comes to fruition. I think, as it always does in live production, a lot of it will depend on disease vectors and how that is impacting our herd, and how that is ultimately impacting total pork production in the United States.

So I think we will have to keep a close eye on that. But it won't surprise me that, initially, there will be some jockeying for hogs. But, in the end, I think when you look at who is behind a number of these plants, I think there is a strong packer -- sorry, producer affiliation with a lot of these plants, and I think you will see the live side catch up eventually. Whether that is in 2017 or not, I don't know. Maybe 2018. But we will see.

Obviously, the pig numbers are up slightly year over year. Not as much as the other proteins, by the way, but up -- I think it is 2% to something on that order of magnitude year over year. So, Bryan, I think that is about as much I'd like to say on that topic.

No problem, I appreciate it. And good luck next quarter.

Okay, thanks.

(Operator Instructions)

Hale Holden, with Barclays.

Thanks for taking the call. Ken, we are big Joey Chestnut fans here, so 70 hotdogs looks amazing.

(Laughter) 70 is quite a number. I have threatened to people around here that I want to get in that contest. But I would tell you, after watching that 70, I'm not sure it is a contest I want to get in.

Yes, we watched it here. It was just mind-blowing. Can you give us a little color on the 3% decline in volume in packaged meats in the quarter? I heard your comments around the bacon volume increases, so I was wondering, what was the drag?

Yes, I wouldn't read too much into that. We don't see any particular trends or anything that is concerning us so much in that end of the business. And I do expect on a full-year basis, we are not going to see a volume decrease. In fact, I think for the six months, we are kind of flat for the six months. I do expect by the end of the year, we will actually see a volume uptick. So the way I'm going to answer that question is, I don't see anything that has taken root there that I need to flag for anybody.

Okay. And then, as a sort of a continuation of Bryan's last question there, is there any risk that the international demand doesn't materialize to absorb the additional US hog production in the next year or two?

Well, I think certainly the risk always exists, that, that takes place. The way I tend to think about it is, protein consumption worldwide is growing, and is forecast to grow, really, for the next 30 years. I think protein demand worldwide will continue to grow. I think the bigger risk to our markets is trade disruption, in the form of political-type disruptions and trade wars and those sorts of things that tend to cut off the free trade of flow of pork. I don't think that somehow routine consumption is going to drop off. I think those trends continue to be positive.

I think the thing to always look for is the political aspect of things. And is it a risk? Sure. But I also take comfort from the fact that if you look over the last 15 or 20 years, and look at the trends, somehow, some way, we have continued to find markets for our pork products. And it's been really quite remarkable in terms of how US pork has grown internationally going back to 1999/2000-type of time frame. If you look at that chart, it's encouraging.

And then, last quarter, you mentioned the potential to sort of think about your options in Poland, and I was wondering if there was any update there.

Sure. I said at the outset that our international platform, I think, represents another growth opportunity for us and a potential earnings catalyst for Smithfield going into the future. I continue to believe that. I think our business in Poland -- we are the number one player in Poland.

And I think in terms of, if you broaden it beyond Poland and you look at the Central European region, I think that we are major force in that Central European region, with our Romanian and Polish businesses. And I would tell you, that is as far as I'm going to go on that, Hale, is simply to say that, that is an area that we're actively looking at for future growth for Smithfield Foods.

Great, thank you for the time. And I appreciate the later call this quarter.

(Laughter) So do we, by the way.

We like sleep, too.

I'm sure.

(Operator Instructions)

Chen Luo, with Bank of America.

Hi, Ken. I've got a question on our fresh pork business. I know this segment has been a key earnings driver in first half, but actually in first half last year, the base for the fresh pork segment was also pretty low. But heading to the second half -- actually, we noticed in second half last year, the fresh pork business did pretty well, especially for Q4. So given that the [easy] base of easy comp impact is no longer there, are we still comfortable that the fresh pork will continue to see pretty solid earnings growth in second half this year? Thank you.

Thanks for the question, Chen. Yes, you are right that we're coming off a strong comparable last year. Our fourth quarter in fresh pork last year was a strong comparable, and so we are up against that. And what I would tell you is the fresh meat business -- I am confident in the changes we are making in our fresh meat business and the improvements we're making in the underlying base business. I'm confident about those.

At the end of the day, though, the fresh meat business is a spread business between hog prices and meat prices. And at the end of the day, it always is about demand for the meat. And domestic demand in particular, notwithstanding the discussion we just had on the export front, domestic demand is important. And so that, at the end of the day, will be the story of fresh pork in the fourth quarter.

The way I would answer it is, I am as confident as I can be in terms of our business positioning going into that fourth quarter. And I think we are better poised to manage the market impacts than we ever have been. But at the end of the day, we will see what those dynamics end up looking like. At this point, I am cautiously optimistic.

Got it. And another question is about our packaged meat business. I noticed that in Q2, the OP margin has declined slightly year on year. And heading to second half, what is our outlook or guidance for the OP margin for the packaging meat business? Are we going to see some [downward] pressure, or are we confident with that, in second half, the margin should trend up?

Well, I would tell you again, the packaged meats business is an area of the business that does have more stable margins. Having said that, there is a raw material component to it and a formula pricing component to it, with a lot of our business, meaning, some of our business is forward priced. Certainly a good chunk of it is formula based off of the primal raw materials that support our packaged meats business in the United States end of the business and our domestic packaged meats business. We have -- almost our entire portfolio is low-temperature product, and therefore, we have a very high raw material component to it.

So you should not be sort of paying attention, I think, to the quarter-to-quarter variation in OP margin, because it doesn't signal something is happening there. It could just be the timing of our formulas and the timing of when that hits the P&L.

What I would tell you is, our packaged meats business, over the last several years, has been on an upward trend. That trend has continued to the point where we are now looking at double-digit operating margins. And certainly on a year-to-date basis, we have double-digit operating margins in packaged meats, and I expect to end the year with double-digit packaged meats margins in that end of the business. So the guidance for you there is that I think we have moved our margin structure up to a double-digit type of margin structure there.

And of course, we don't rest on that. We don't say that our work is done. We obviously are hard at work trying to improve our margin structure, day in/day out, week in/week out, month in/month out. We will continue to do that. By the way, we think we have got opportunity to do that. I've said on a number of occasions previously that our ASP relative to our competition -- I think we have more opportunity in that end of the business than perhaps some of our competitors do.

But I would also point out to you, Chen, that it is a very competitive, very mature business in the United States. And competitors do fight back, and we have seen that. In fact, if you look at the gains that Smithfield has made over the last 18 months, and certainly this year, it does not come without competition. And our competitors are clawing back because this is not an environment in which product categories are growing 10% a year. In fact, some of the product categories are shrinking.

And so any market share gains that we have -- and I said at the outset in my remarks that we were up in 16 of our 22 product categories -- that means that we are taking share. So I would balance it by saying, it is a competitive business in the US.

Got it. Thank you very much.

Lillian Lou, with Morgan Stanley.

Good morning, Ken. Just a quick question on the marketing side as well. We have been achieving quite a decent improvement in the fresh pork on the unit profit level, i.e., I think in the last couple of quarters, we have $13 a head and $18.5 per head in fourth quarter -- the first quarter. So going forward, as you mentioned, that means there is still some fluctuations. But what kind of level we are target at in terms of normalized margin?

And similarly for packaged meats, because we have been seeing that unit profit has been staying above $0.20 per pound. So are we going to continue to aim that as a long-term profit? Thanks.

Sure. Let me answer that in reverse, Lillian. Certainly on the packaged meats end of the business, you referenced $0.20 a pound-type of margin. And I would tell you, we are sort of getting away from that type of metric in talking about our packaged meats business, preferring instead to focus on operating profit margin. And I would tell you, though, that as maybe a final answer to that type of question, yes, I believe we have crossed that threshold, and that we are solidly into that territory. And I don't see -- save for a quarter here and there in which we have rapid movements in raw material, I don't see a return to that. I think we have, again, sort of altered our margin structure there by all the things I've talked about in the past.

Now, on fresh pork, you referenced some numbers that, frankly, I think were a little bit high in terms of per-unit contributions. Nonetheless, it is obvious from looking at just the raw numbers of operating profit, that our margins have improved in the fresh pork end of the business. I do think that the operational improvements that we are working on should translate into margins of perhaps $2, $3, $4 a head better than what we've been in the past, and working on even further opportunities ahead of that.

In terms of forecasting, what it will look like in the fourth quarter -- again, I would go back to my earlier answer, which is, ultimately, that's all about what demand holds up, and how meat values migrate into the fourth quarter.

Okay. Thank you, Ken.

Thank you.

(Operator Instructions)

Christine Peng, with UBS.

Hello, Christine.

Hello, Management? I have two questions. Hello, this is Christine. Management, I have two questions regarding the cash flow. One question is regarding the operating cash flow. So I realize that the operating cash flow was actually negative, despite an increase in net profit in the first half of 2016. And I think it's primarily because of negative working capital during the period. But could you elaborate on what is the reason behind this? So this is the first question regarding the negative operating cash flow in the first half of 2016.

And, secondly, I also realize that Smithfield starting to pay pretty substantial amount of dividends [down] to WH Group, I think, this year. I think earlier, the Management also mentioned on a continuing basis, Smithfield is struggling to pay WH Group $400 million of dividends? Am I catching number right? Or Smithfield Management has some [safety] dividend pay-out policy going forward to the parent?

Christine, this is Glenn, and I appreciate the questions. I was having a hard time hearing that back half, but I will try to answer them the best I can. Regarding your question about operating cash flow, it is actually not unusual for Smithfield to generate some negative working capital cash flow contributions in the first half of the year. There's some pretty specific differences, if you compare 2016 to 2015, but like I said, nothing unusual. As a matter of fact, it is really all timing on receivables and inventory. There was pension contributions in both periods, although those differed a little bit. And then there are some swings in income taxes payables versus income tax receipts in that period as well.

There has been no change -- adverse change in payment metrics, collectibility, et cetera. There's been no change in the way we procure inventory. There's been no degradation in our receivable collection days, et cetera. So, from a trends perspective, again, it is not unusual for Smithfield to experience negative operating cash flows from a working capital perspective this time of year.

With respect to your question on dividends, I didn't get all of it, but I can give you some basic facts about this. At a high level, these dividends are being used by WH Group to fund debt [served]. So there has been a major push at the WH Group level, and I don't want to enter their world too much here, but they had some acquisition-related debt that they've been focused on paying down, and we have been a significant part of that cash flow to help them achieve those targets. And I want to remind you and those on the phone that, until 2016, we haven't made any dividend payments to China.

We expect full-year dividend payments to be approximately $400 million. We planned for that from the outset, it was baked into our cash flow forecasting and budgets for the year. Like I said earlier, we expect the remainder of those payments to occur in Q3 and Q4. But we do expect those to cap out around $400 million.

Christine, this is Ken. I would just add to Glenn's explanation on the cash flow -- remember that it is typical in our business to have deferrals that accumulate towards the end of the year, which get liquidated in the first half of the year. And that's certainly a contributor to that first-half number. As Glenn said, if you look back over the last few years, you'll see a similar type of pattern, I believe. It is really the second half of the year in which cash flow generation really takes hold.

So would a dividend payment to WH Group a recurring practice going forward?

That is something that we will decide with the WH Group, with Lijun Guo, the CFO of the WH Group. But I would tell you, it is my expectation that we would have dividends as part of our membership, if you will, in the WH Group. Certainly our cash flow generation supports it. And so, I expect that we will continue to make dividends, at the exact level of which I'm not sure. And I think that is a more appropriate question for Gordon or Lijun Guo. But I would tell you that we are comfortable with the level of dividends that we are providing to the WH Group.

Thank you.

(Operator Instructions)

Xiaopo Wei, with Citigroup.

Good morning, Ken. This is Xiaopo of Citigroup. I have one question regarding the One Smithfield. It seems that, in the past one year, this One Smithfield initiative has helped us to save cost and to mitigate the volatility of the business, especially in the upstream business. But it seems that by end of year, this year, the low-hanging fruit is pretty much done. Are you guys planning any other new initiative to get the operational structure even better? Could you give us more color on that looking forward?

Sure, Xiaopo. The way I would answer that is, I don't think we are out of gas, if you will, on One Smithfield. And I would disagree a little bit with the characterization. You said that the cost benefits have come through and the low-hanging fruit have been realized from cost benefits. I think it is the opposite actually. I think the low-hanging fruit we have realized to date has been more on the sales side, and I think that, that has been what you have seen come through.

The opportunities we have on One Smithfield -- I've been just consistent as I can be on this point about transportation, logistics, and manufacturing. And I believe that those savings are there, and we will realize those. And we are -- it will not be all in 2016. It will be in 2017, frankly, where we realize the majority of that benefit, if you will, of that second leg of One Smithfield.

Obviously, the only thing I would add to that is that we are not a business with our feet in cement. We are not standing still here. We are actively looking at other growth opportunities. We are constantly looking at operational improvement opportunities. I said before, I think we've got those in our fresh pork business, and we're going to be actively working on those as well.

Thanks. A follow-up question on your international business. You were mentioning that you were seeing the international business going to be another growth driver looking forward. Is that comment based on your positive forecast for their target market international operation? Or is any organizational changes you are bringing? And (inaudible), could you give us more color on that? Thank you.

Sure. My optimism around the international part of the business ultimately relates to the market fundamentals in the areas of the world in which we are doing business, specifically Central Europe. If you look at the entire European pork complex, Europe is long pork.

But I would tell you, if you further analyze it and look at the swath that is Central Europe -- which, by the way, is where we have substantial operations and where, from a pork production standpoint, is a great place to do business because there is very fertile land there and the feed grains are relatively cheap. We have characterized it before as the breadbasket of Europe, meaning it's where the grains are grown. It's similar to the Midwest of the United States. We just believe that the market fundamentals there are very strong. Central Europe is short pork, and we think that we can be that provider of high-quality protein products in Central Europe.

So that's one aspect. I would tell you another aspect of our business is our Mexican operations, and for similar reasons, meaning, market fundamentals there. I think that, that also presents an opportunity for future growth for us.

Thanks.

(Operator Instructions)

Lincoln Kong, with Goldman Sachs.

Hi, Ken. So one more question about the One Smithfield initiative -- actually, more about the brand management. First, (inaudible) so on an average, Smithfield brands sort of have a relatively lower retailer SP positioning versus the other peers. So going forward, maybe in the mid-to-longer term, like three to five years, how do we see the positioning of our brands average versus of our peers?

And in terms of this package being margin improvement, obviously some of the peers could have like mid-teen OP margins. So do we think that is an achievable target for us as well? That's the first question. The second question --

Hold on, let's take these one at a time. You just mentioned mid-teen OP margins. I'm not aware of anybody who's got mid-teen OP margins that is selling a meat portfolio. You may be thinking of other consumer packaged-goods companies that may have that type of margin portfolio. Again, I don't think that we are done once we reach double digit. But mid-teen -- meaning 15, 16, 17 -- that's not something that I think any of our competitors have. Now, you threw me a little bit by that question. What was the other part of the question? It was --

In terms of the brand management --

Okay, right. So the simple answer to that question -- it's a good question, by the way. But the simple answer is: investment in our brands. We have got to continue to build the value of our brands. And that is through consumer advertising -- things like radio and television and print ads, these sorts of things -- that continues to build the value of the brand and the association of our brand with the consumers, such that, when they go in the grocery store, we are the brand of choice that they want to buy.

We've got to do that in a way that's responsible fiscally, in terms of maintaining our margin structure. We are sensitive to our shareholders. But I believe our shareholders want us to build the value of those brands -- certainly any shareholders who's in this for the long term understands well the idea that brand-building does not happen overnight, and that is something that you work on over a long period of time.

Candidly, I think we are a little bit in the -- I won't say the beginning stages of our brand-building, but certainly if you go back 20 years ago, it was not something that Smithfield was actively talking about, and trying to build the value of brands, and talking about being a CPG company. That is in contrast, by the way, to some of our competitors who have been doing that for 50 years. So I think that we've got opportunity to do that. But the short answer is, investment in the brands is what is going to carry us forward.

Sure. The second question is more about the hog production. I know you touch a point that the third quarter will have profit and the fourth quarter probably will have loss. So just on a full-year basis, do you think we can reach a break-even level for 2016?

No, at this point we are halfway through the year. We have got losses through the first half of the year. And as I said, I expect that to -- the first half to look like the second half. So I think that I don't expect a breakeven. But I think it's important to understand and put into context that, notwithstanding that loss on the live production side, we are still talking about a record year for Smithfield.

So I'm not down in the mouth about it. I'm not suggesting that it's going to ruin our year. In fact, we've managed around it. I would tell you, it is the power of the vertical-integrated platform. We are optimizing in other areas of the business. While that particular end of the business, on the domestic side -- and I think it's important to distinguish between the domestic side of the business, live production on the domestic side, which as I said, will look a lot like the first half, which was about $68 million -- on a US GAAP basis, a $68 million loss.

The international side of our business, on the other hand, I'm actually kind of optimistic about in the second half, in terms of where hog prices are going in our international operations. And you should know that, in the international segment -- as Smithfield reports in segments -- that includes live production in Poland and Romania and Mexico. So, when you look at the US GAAP statements and the segmentation that Smithfield has, that international business has live production in it, and I do expect that to be profitable for the year. All right?

Sure, thanks.

And, currently, no further questions in queue.

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