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Why China’s Pork Giant WH Group Could Rally on Trade War Deal

Motley Fool Staff, The Motley Fool

WH Group Ltd (OTC: WHGLY) is the world's largest pork company, with US$22.6 billion in sales in 2018, and commanding leading positions in markets such as the US, Europe, and China. Through its integrated operations, WH Group specialises in hog production, fresh pork, and meat products.

Of the three, the company's packaged meat product division is the most important as it accounted for around half of total sales and approximately 90% of operating profit for 2018.

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Due to its size and financial profile, WH Group was added as a Hang Seng Index constituent back in September 2017. The Hang Seng is a "big company" index of the 50 largest companies on the Hong Kong market, by market capitalization.

Caught in the middle of the trade war

Although it was already a large company, WH Group expanded in 2014 by buying US Smithfield Foods for US$4.7 billion with the goal of improving margins through managing costs and operational leverage. At the time, Smithfield was the largest hog producer and pork processor in the world.

In terms of financial performance, the Smithfield purchase worked out well before the trade tensions between the US and China began to heat up in the middle of 2018. Basic earnings per share (EPS) rose from 5.75 US cents in 2015 to 7.58 US cents in 2016 and 7.79 US cents in 2017. WH Group's dividend per share (DPS) grew from HKD$0.125 in 2015 to HKD$0.26 in 2016 and HKD$0.27 in 2017.

Due to the trade tensions, the company's purchase of Smithfield Foods hurt WH Group's operations from 2018 on. The company's plan to export cheap hogs from the United States to China, for example, was affected when China imposed a 70% tariff on US pork.

The company's basic EPS fell to 6.43 US cents in 2018 and WH Group's DPS fell to HKD$0.20 in 2018 due to the decline in earnings. Although exports only make up a small part of WH Group's total profit, WH Group's share price plunged on the perception that the company's export business would be a big growth driver in the future (and would be hit by a trade war).

Soft first quarter but rebound potential

Due to the tariffs and trade tensions, WH Group reported a profit decline of 21% in the first quarter to US$196 million before biological fair value adjustments. Operating profit, meanwhile, declined by 10% to US$341 million as weak prices in the US and oversupply also hurt the company.

Although WH Group has been hurt by the trade tensions and associated import tariffs, it has potential. Due partly to African swine fever, China's agriculture ministry predicted that live hog prices could soar as much as 70% in the second half of 2019.

If China and the US end their tariffs for hog imports, WH Group could benefit by exporting cheap US hogs to China. That potential is one reason why WH Group's stock price recovered off its 2018 lows.

Although there is potential for a settlement, that scenario looks unlikely currently. On 4 August, China said it would suspend agricultural product imports from the US due to Trump's new 10% tariffs on US$300 billion worth of Chinese imports. China's actions could affect WH Group's exports from the US to China.

Foolish takeaway

WH Group is a leading pork company and worthy of a closer look. Due to the trade tensions between the US and China – and near-term oversupply – the company's financial performance hasn't been as great as it could be.

Due to the long-term trend of rising disposable incomes around the world, however, WH Group is in a solid position to grow given its dominant position. Its future remains promising if the trade tensions between the US and China resolve. Trading at a price-to-earnings (PE) ratio of under 14, WH Group is pretty fairly valued. I think if the two countries can come to a reasonable agreement in the near future then the stock could rally.

A version of this article originally appeared on our Fool Asia site. For more coverage like this head over to Fool.hk.en.


The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com