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Straight Talk From Smithfield's Joe Luter

Article-Straight Talk From Smithfield's Joe Luter

A self-described student of economics and business history, Joseph W. Luter III, president and chief executive officer of Smithfield Foods, has shaken the U.S. pork industry to its roots with a series of acquisitions.Whether one sees Joe Luter as a villain or a vigilante crusading for a greater share of the consumer dollar may depend on your roots, your open-mindedness and your appreciation for the

A self-described student of economics and business history, Joseph W. Luter III, president and chief executive officer of Smithfield Foods, has shaken the U.S. pork industry to its roots with a series of acquisitions.

Whether one sees Joe Luter as a villain or a vigilante crusading for a greater share of the consumer dollar may depend on your roots, your open-mindedness and your appreciation for the American free market system.

Luter granted this one-on-one interview for a reason: "I see this as an opportunity to establish a dialogue between the producer and packing segments in the industry. It doesn't serve either party well the way it's been going."

No question was considered off-limits. A few dealing with pending negotiations or litigation were left unanswered.

You will find Luter's comments to be straightforward and to the point. Agree or disagree, be assured his stance is business-based and well thought out.

His favorite phrase is "capital seeks opportunity." He uses it often.

His pride in Smithfield Foods' business accomplishments is reflected on the cover of the company's 1999 Annual Report to Shareholders. It reads: "We are proud to report that Smithfield Foods is now the largest hog producer and processor in the world."

The chronological history of Smithfield Foods presented in the margins provide more detail about the company's business growth.

First, a little background about Joe Luter.

Fresh out of Wake Forest University with a bachelor of business degree in hand, Luter joined the company his father, Joe Luter Sr., had founded in 1936. He spent four years with the company in various capacities before taking over the reins in 1966 as president/CEO at the age of 26. Smithfield Foods was then strictly a pork processor, killing 3,000 hogs/day in their sole plant located in Virginia.

Three years later, July 1969, Luter sold the company and left to pursue land development and ski resort development interests. "The people I sold the business to pretty much ran it into the ground within five years," he relates.

Luter returned on April 8, 1975, facing $17 million in long-term debt and a net worth less than $1 million. A six-year rebuilding program aimed at strengthening the balance sheet was begun. "By 1981, we were finally in a position to grow and we borrowed every cent we could find to buy our major competitor, Gwaltney, located in Smithfield, VA." This acquisition set Smithfield's course for growth in the packing industry which continues today.

"We have bought underperforming companies in the industry and turned them around," Luter explains. "I think you have to be out of your mind to build a pork packing plant today. There was over-capacity in the industry then as there is now. Quite frankly, we have been able to buy companies and capacity cheaper than building capacity," he adds.

Luter has held true to his belief that there is "over-capacity" in the U.S. pork packing industry - with one exception. In 1991, Smithfield began construction of the new Bladen County, NC, plant.

The exception was driven by an IBP announcement, about 1986, stating their intentions to enter pork processing, having dominated the beef packing industry for years.

"We looked at our competitive advantages and disadvantages and came to the conclusion that our one major disadvantage was our sourcing of livestock," Luter notes.

At the time, Smithfield bought about 35% of their hogs from the Midwest. They would soon be competing with IBP for those hogs, not to mention the transportation costs and shrinkage. It was also about then that Luter began taking a serious look at the production side of the pork business.

"We found that the vast majority of the profitability was on the growing side rather than the hog processing side," he explains. He started by forming an alliance with Carroll's Foods, thereby correcting the sourcing imbalance and shedding Smithfield's dependence on western hogs.

Later, driven by the need for consistent supplies to justify a new packing plant, Luter extended his alliance building to Murphy Family Farms, Prestage Farms and Goldsboro Hog Farms. The group, including Carroll Foods, is often referred to as "The Circle."

"We all agreed that if we worked together as a team, we would all be better off," Luter explains. Ground rules were laid. Luter set quality standards, alliance members standardized genetics and diets.

"The Bladen County facility, capable of processing over 30,000 hogs/day, was built to allow North Carolina's hog industry to grow," Luter says. "The gamble paid off. We went from a small, regional packer to the largest pork packer in the world.

"For the most part, we eliminated the traditional animosity between packers and producers," he adds. There were disagreements on pricing from time to time but, for the most part, the arrangement was mutually beneficial, he says. "We've worked together and we've all done extremely well, compared to our competitors," he notes.

NPD Genetics Luter took an early lesson from the poultry industry.

"If you look at the tray packs of Perdue or Tyson chicken, one looks just like the next," he explains. "Now, look at the bacon case. Packages are torn open. There's upheaval because people are looking for a pound of bacon that looks better than another. There's only one way to get consistency - that's to have common genetics, feed the animals the same way and process them the same way."

Luter's search for leaner, more consistent, higher quality genetic lines lead him to Europe where he bought the exclusive distribution rights to Northern Pig Development (NPD) breeding stock in the U.S. and Mexico. Two thousand nucleus animals were imported in 1991-92 to establish an NPD pyramid breeding herd.

"What we have done is not rocket science," Luter assures. "Poultry people have had a consistent product for years; pork people have not. The NPD hogs will allow Smithfield to move in that direction."

The NPD genetics are the foundation of Smithfield's Lean Generation Pork products, which Luter believes can parallel Perdue and Tyson's branding of chicken products. "It's a product that is as lean and has approximately the same calorie and cholesterol count as chicken breast," he says.

"You can't build a brand name or brand franchise unless you have a consistent product. McDonald's may or may not be the best hamburger in the world, but it is consistent, consistent, consistent," he emphasizes.

Recently, a separate genetics division has been spun off to concentrate on the development of NPD stock. The goal is to expand the NPD nucleus herd and eventually restock Murphy Family Farms' herds.

Producers Vs. Packers If you want to get under Joe Luter's skin a bit, mention the producer-packer relationship, then sit back and listen.

"I don't know of any other industry, other than farmers, who constantly criticize the people that buy their product," he says. "It serves no useful purpose - and it hurts the hog industry in the long run.

"It would be ludicrous for me to blame my problems on the chain stores and the food service purchasers in this country because they are not paying me enough money. It is up to me to look after the interests of Smithfield Foods. But, under no circumstances, would I attack the very people I am selling to," Luter states.

"As long as the hog farmers in this country attack the people that they sell to, it's not going to serve them well. The problem is certainly not collusion," he emphasizes. "It (the packing industry) is very, very competitive in this country. The problems we have had with prices are simply we had too many hogs. It's the old law of supply and demand that you learned in your first year of college."

Next on his list of irritants - those who say there is not enough packing capacity in this country.

Luter sees it differently. "We have processing capacity of approximately 390,000 hogs/day. For years, that was too much capacity and that encouraged more and more production. Finally, the production in the fall of 1998 got to approximately 390,000/day and we had the debacle that we saw in November and December.

"I am absolutely certain that the meat-packing side of the industry and the hog-growing side of the industry would be better off if there was less capacity. Keep in mind, I am in both in a substantial way.

"(Underutilized) capacity encourages overproduction," he stresses. "I think if we had a capacity today of around 370,000 and an average kill of approximately 355,000-360,000 in the fall, (and an average kill) of 330,000-340,000 at other times of the year, there would be profitabilityin the entire chain - from corn to the processed pork product.

"The idea that building another packing plant is going to help the profitability of the hog market is ludicrous. It is ludicrous, because it will encourage more production.

"The simple problem is the demand from the consumer is not out there today. As long as you exceed consumer demand, you're going to have low prices - be it hogs, corn, soybeans, wheat, cattle or chicken.

"If we had had more capacity in the fall of '98, would we have had $10 hogs? Probably not. But, we would have had a very unprofitable industry regardless. The consumer demand simply wasn't there."

Now toss into the discussion any NPPC-supported efforts to add slaughter capacity, build producer alliances or establish cooperative programs with existing packers and Luter's bound to get a little more agitated.

"Co-ops historically have not done very well competing against public corporations, such as IBP, Smithfield or ConAgra," he attests. "When you have a business run by committee - and that's really what you have with a co-op - it doesn't work because you've got too many people involved in the decision-making process. It's too slow.

"I have no objection if a group of farmers want to get together and put up their capital and borrow from a lending institution and compete. Fine. This is America. But, when you start talking about government grants, it must be remembered no one can compete against the government's unlimited resources, then I have a problem with that," Luter emphasizes.

Pork Checkoff The checkoff tab on Smithfield's more than 11 million hogs is nothing to sneeze at - $5-6 million, depending on hog prices.

Luter doesn't have a quarrel with the checkoff so much as he does with the way the money is spent. "For the most part, I think the money has been spent badly," he says. He cites the million-dollar Super Bowl commercials as examples and calls them "nonsense."

If he had his way, more checkoff dollars would be spent on educating consumers about the leanness of modern pork compared to chicken, for example. "Develop the data to show the nutritional profile of pork today, then convey the message to the American people."

He acknowledges the "Pork - The Other White Meat" was "a good campaign." But, he resents NPPC encouraging members to compete in the packing-processing side. "I feel strongly that NPPC has been spending their funds attacking their customers when we really did not cause the problems," Luter explains.

Unwilling to say how he will vote in the upcoming checkoff referendum, Luter levels a fair warning if it passes. "I think there are a lot of fairly large hog producers in this country who are uncomfortable with NPPC and the direction they are going. They question whether they (NPPC) are representing the interests of the entire industry.

"Unless something changes, or there is some understanding, we will form another organization," he warns. "Some of the major pork producers in this country would drop out of NPPC and approach the (National) Pork Board for funding. If 25% of the industry were not members of NPPC, and they had their own organization, I would think the Pork Board would want to be equitable in the disbursement of the funds," Luter says.

Additionally, Luter believes more funds should be spent cultivating foreign markets, closer working relationships with packers.

"I am a great believer that 95% of the problems in the world are created by a lack of communication," states Luter. "When was the last time you heard NPPC say anything good about the packing industry? We need a dialogue between the producer and packer at the trade association level."

Luter suggests the industry would benefit by a better working relationship between NPPC and the American Meat Institute, the packing industry's trade association.

Independent Producers What does the world's largest pork producer think it will take for independent producers to compete? "If an independent pork producer runs an efficient, low-cost operation, they will do just fine. But they have to be efficient and low cost. And, they have to be subject to the same competitive pressures as everyone else in America."

Luter points out that the majority of hogs slaughtered in Smithfield-owned plants in the Midwest come from independent producers. Roughly 40% of their total U.S. slaughter comes from independent producers. "Quite frankly, I don't expect us to go beyond that. And, we only represent about 20% of the market in this country in pork (slaughter capacity). Tyson has roughly 35% market share in poultry; IBP has roughly 40% market share in beef," he reminds.

"Hog producers have to be profitable, they have to be viable, or we don't have a source of raw materials to run our plants," he acknowledges.

Luter's quick to remind producers they have had a very profitable run. "In the last 10-12 years, the vast majority of the profitability has been on the growing side, not on the packing side. If I thought it would help hog prices, I'd build another packing plant."

Luter estimates a new, single-shift, 8,000 head/day, high-speed slaughter plant would cost about $100 million. These so-called "greenfield plants" are expected to lose $20-30 million during the 2-3 year start-up period because of training costs and extremely high (200%) labor turnover rates.

From a business standpoint, the inefficiencies of a dated, existing plant cost far less than the interest payment on new construction, he explains.

"As far as I'm concerned, anybody who wants to put in new hog operations or new packing plants today is mad at money - and you can quote me on that," he says.

And don't rely on government support, he pleads. "The government may subsidize you, but they will subsidize you at close to the subsistence level - whether you are on welfare or whether you are an American farmer.

"The American farmer needs to wake up to the fact that capital flows to opportunity. That's true whether it's a meat packer or it's an investment banker in New York City. People like that put big money into the business because of excellent profitability."

On a roll, Luter jumps to his next pet peeve - price reporting.

"It bothers me. Quite frankly, the growing side has enjoyed most of the profitability in the last 10-12 years. Then, they have a short period of time when they had tremendous losses, which they did, but it was of their own making - producing too many hogs. They blame the packing industry and think price reporting is going to solve it."

Luter doubts price reporting will have the desired effect, but he admits, "If I know exactly what my competitors are paying, it makes my job a lot easier when purchasing hogs."

What's Next For Smithfield? Luter's foreign business strategy hinges largely on what the pork industry, and Smithfield in particular, will be allowed to do.

"If you raise artificial barriers in this country, you're going to do what Iowa has done with their anti-corporate farming laws. Written and designed to protect the hog-growing industry, they have pushed hog production out of Iowa to North Carolina, Missouri, Texas, Oklahoma and Utah.

"We try to go to places where we can succeed. Some countries offer more opportunity than we see in the U.S. at this time. If regulations become too tight in this country, we'll invest in Canada and Mexico."

Smithfield's recent acquisition of Poland's largest meat packing firm, Animex S.A., was driven by Luter's belief that Poland will eventually serve as the breadbasket of Europe. Grain prices are cheap. Labor is plentiful and less expensive than in Western Europe. "I call it the Iowa of Europe," he says.

Will Smithfield Foods' pursuit on the hog production side level off?

"If the same economic conditions occur that existed four years ago, when hog producers were making in excess of $50/head and packers were losing $3-4/head, obviously capital chases opportunity," he responds. "For the month of April, we made $35/head raising hogs and lost $8/head in the slaughter plant," he adds.

"What we may or may not do in the future will depend upon the economic conditions at that time. As long as there is some balance of profitability between the hog processing side and the hog growing side, I am perfectly content to stay where I am today. If things change, I will deploy capital in any direction that we think will serve our shareholders best."

1936 Smithfield Packing Co. founded by Joe Luter Sr. (later named Smithfield Foods).

1962 Joe Luter II died (March). Joe III graduates, Wake Forest University (June), joins Smithfield Foods.

1966 Luter, age 26, becomes president of Smithfield Foods.

1969 Controlling stake of Smithfield Foods sold to Liberty Equities Corp. for cash and debt notes. Luter departs.

1974 Smithfield Foods exhausts cash reserves, performance deteriorates, debt payments due.

1975 Luter returns as president/chief operating officer (April 8); long-term debt, $17 million; net worth less than $1 million; stock valued at 50 cents/share; six-year business reorganization began.

1978 Bought financially troubled North Carolina plant.

1981 Bought Gwaltney (competitor, strong hot dog brands). Adopted opportunistic philosophy of purchasing poorly performing packing plant companies.

1984 Bought Patrick Cudahy Inc. and Esskay (processing only), Mash's brand name, Hancock Country Hams, Lykes Meat Group. (check)

1984 Luter designed long-term strategy of integrated system, joint production arrangements and long-term contracts with producers near Smithfield plants.

1987 Began joint hog production with Carroll's Foods.

1991 "The Circle" concept introduced (joint production arrangement, long-term contracts with Carroll's Foods, Murphy Family Farms, Prestage Farms supply 37% of hogs processed, by 1994, 62% of processing needs).

1991 Negotiated exclusive U.S. and Mexico rights to National Pig Development (NPD) genetics; 2,000 boars and gilts imported in 1992 to establish breeding nucleus herd.

1992 Bought 86% interest in Browns of North Carolina.

1992 Opened new $76 million Bladen County, NC, plant (built to Japanese and European standards; featured optical probes to measure backfat, loin eye depth, magnetic resonance imaging to measure fat content in hams, matching ham to optimum processing method for optimum value).

1993 Fresh pork 41% of sales; processed meats, 55%; (by 1994, proportions were 48% and 49%, respectively. Accomplished with case-ready program which supplied supermarket chains with prepackaged, weighed, labeled, priced for immediate sale).

1993 Smithfield part of joint venture, Circle Four Farms in Utah (est. 110,000 sows/2.2 million hogs/year by 1998) bought Murphy's interest in 1998 (giving Smithfield 77% ownership).

1994 Bladen Co. plant received preliminary approval by European Community.

1995 Purchased John Morrell & Co.

1998 Purchased North Side Foods (supplies pre-cooked sausage to McDonalds).

1998 Acquired Schneider Corp. (Canada's second largest meat processor, strong brand name).

1999 Bladen County plant operating at capacity 32,000 hogs/day (8.5% of total U.S. capacity).

1999 (April) - Acquired SFGP (French ham, sausage, hot dog producer).

1999 (April) - Acquired Animex S.A. (Poland's largest meat processing firm, 10 plants. Secured entree to European markets).

1999 (September) - Announced joint venture with Agroindustrial Del Noroeste of Mexico (produce, process, sell pork in Mexico, southwestern U.S.). Later closed a $22 million deal with Grupo Alpro South America, making Smithfield one of Mexico's biggest pork producers.

1999 (May) - Acquisition of Carroll's Foods doubled Smithfield's hog production (included Carroll's interest in Carroll's-Smithfield joint venture, Carroll's 16% of Circle Four, turkey holdings and some hogs in Mexico and Brazil).

1999 (May) Fiscal Year report to stockholders; $3.77 billion in sales, $94.88 million net income.

1999 (September) - Announced intentions to buy Murphy Family Farms, doubling size again (675,000 total sows; 11.1 million market hogs).

2000 (March 23) - Announced intentions to purchase Farmland Foods' Dubuque, IA, plant.