WH Group is barrelling ahead with the integration of its US and Chinese businesses less than a month after the pork producer raised $2.05 billion from an initial public offering at the second attempt.
Wan Long, chairman and chief executive of the Henan-based group, discussed the company’s plans with FinanceAsia, which include boosting pork imports from Smithfield Foods, the US pork producer it acquired in a landmark deal in 2013.
The group also aims to open more stores in China that solely sell pork produced in the US; incorporate US technology in China; and ensure its supply chain is integrated globally.
In the past two years, Shuanghui Development, WH’s Chinese arm, set up 20 Smithfield-branded kiosks in supermarkets in the Henan province, which sell Smithfield mid-to-high end chilled fresh pork to Chinese customers.
By year-end, WH hopes to have a presence across China.
“We have set up 20 brand store [kiosks] in the mainland to sell Smithfield’s fresh meat, and they are very successful,” Wan told FinanceAsia. “In the next six months, we will expand to the rest of the country, with plans to enter tier-one cities and establish high-end sales channels for F&B chain restaurants and hotels.”
The company also plans to increase Smithfield imports to the mainland, although rising pork prices in the US as a result of the porcine epidemic diarrhoea (PED) virus will affect the timing. Higher hog prices are good for the US arm, which produces the pigs, but not so much for the Chinese arm, where the pigs are consumed.
Typically the cost of producing pigs is 40% cheaper in the US than in China but the PED virus has narrowed the gap. Wan said it usually costs 1.5 to 1.6 times more to process pigs in China compared to the US. That number now stands at 1.2 times.
“We will wait for the right time to import products from Smithfield,” Wan said.
“We expect the hog price gap between China and the US will start to normalise in the second half of the year and will increase trading volume accordingly.” He declined to offer specific import forecasts.
WH will also use Smithfield’s technologies to produce meat in China under the Smithfield name. Management teams from the US and China have been exchanging information on farming techniques, processing technology, packaging technology, pig by-product utilisation, automation and food safety control.
“The [Smithfield] brand has strong bargaining power in the market [and] the lower labour cost here will decrease production costs,” Wan said on integrating Smithfield’s technologies into China. “Our value here is that we have the wide distribution network and a massive market.”
Combining the supply chain is also a top priority for the company — WH established a team focused on global integration.
“For example, one of our clients is the world’s largest meat packaging material providers. We introduced them to Smithfield, in the hope that this material provider can reduce Smithfield’s packaging costs,” Wan said. “Basically, we are integrating our resources in every aspect.”
Dud to darling
WH Group aimed to raise between $4.8 billion and $6 billion in its first attempt to go public, which put a hefty valuation of 15 to 20.8 times 2014 earnings.
The issuer and 29-syndicate banks tried to argue that WH deserved to come at a premium to other global meat businesses because the company benefits from a dominant global market share — one that will likely get larger due to Chinese government-sanctioned domestic consolidation.
But it proved difficult to convince investors the company deserved such a high valuation. This coupled with the enormous 29-bank syndicate put investors off and led to the deal being pulled.
Just four months later, however, WH went from dud to darling after the issuer fired 27 banks from the syndicate and restructured the deal by dropping the price range and valuation.
The remaining two banks on the deal — Morgan Stanley and BOC International — lowered the share price to HK$6.20 from HK$8 to HK$11.25, which valued the company at 11.5 times 2014 earnings, much more appealing than the 15 to 20.8 times 2014 earnings.
Its aftermarket performance suggests the company was priced correctly the second time. Shares in WH have risen 9% since its August 4 market debut.
WH’s performance is more impressive considering it is occurring at a time when anxiety about food safety in China is at an all-time high. Chinese regulators in July shut down a Shanghai factory after local media alleged it used rotten meat in products sold to McDonald’s, KFC, Pizza Hut and other fast food chains.
“There are two key factors in food safety control,” said Wan (pictured left). “First, companies have a responsibility and obligation to guarantee food safety. Secondly, the government needs to be very strict in supervision and law enforcement.”
Wan claims the company has higher standards of food safety checks than the government. “The government does random checks on pigs, whereas we examine every single pig,” Wan said. “We have a sizeable inspection and quarantine team of over 800 people. It costs us more than Rmb100 million ($16.3 million) every year.”
Debt repayment
The smaller deal size will have repercussions for the company — WH Group will not be able to pay down the debt it took on when it acquired Smithfield last year for $7.1 billion. This acquisition brought its debt gearing ratio to 286%.
It was another concern highlighted by prospective investors the first time the pork producer tried to come to market — funds felt as though WH was trying to rush to the public markets to pay down the debt instead of taking the time to integrate its US and Chinese businesses.
But Wan seemed nonplussed when asked about the company’s net debt, which currently stands at $4 billion. “We have around $4 billion debt to pay back. It’s not a big deal. We will use $2 billion from the IPO proceeds to pay it down,” Wan said, noting that the debt did not prevent the IPO from happening the second time. “We just completed an IPO when investors had concerns over our debt problem.”
There are no plans for follow-ons or bond issuance to help pay down the debt, he said, although he acknowledged that in order for the company to pursue M&A opportunities it must be more financially stable.
“We need to become stronger and hold more capital to fund future M&A deals,” Wan said.
The Chinese government has been pushing to improve efficiency and have better quality standards to improve margins and mitigate food scandals. As a result, the number of slaughterhouses in China has dropped from 28,560 in 2008 to 9,989 in 2013. The government’s new target is to cut capacity by a further 50% in the next two years.
At the moment, the company’s Ebitda stands at $2 billion per year, allowing WH to tap into this cash flow. Also, the majority of its bank loans have a tenor of more than five years, giving the company more time to restructure debt, he added.
“The [Smithfield] deal seemed very expensive at the time,” Wan said. “However, if you look at it today, it’s a good deal. US-based Tyson Foods just acquired Hillshire Brands for $8.6 billion. And Hillshire is a smaller brand with revenues of $3.9 billion, compared to Smithfield’s, which has [annual] revenues of $14 billion.”
Indeed, the benefits of the acquisition are already clear. WH reported record first-quarter earnings. Smithfield posted net income of $105.3 million in the first three months of the year, a 479% increase over the year-ago period. Combined, net income for the Chinese and US segments rose 225% year-on-year to $407 million.
Technology transfers should improve Shuanghui’s productivity, while using Smithfield’s brand name will help it expand market share in China, where consumers prefer imported food because they believe it is safer.
Still, there is inherent volatility in the hog-rearing business — in addition to the PED virus, there are plenty of other factors to consider, such as rising feed costs (namely corn prices), as well as export restrictions imposed by the US government.
Ultimately, the company’s biggest selling point is the Chinese consumption story. The country accounted for 75.34% of global pork consumption in 2012 and is forecast to contribute 80% of global growth over the next five years.
