NEW YORK — Moody’s Investors Service lowered the long-term credit rating of Smithfield Foods, Inc. to B2 from B1. The agency said the downgrade was prompted by its concern that weak hog prices, precipitated by the H1N1 virus outbreak and global recession, will undermine the company’s efforts to improve earnings.

Moody’s also rated at Ba3 $500 million in new Smithfield senior secured notes to be issued. With the changes, Moody’s revised the company’s outlook to stable from negative.

The B1 rating that had previously prevailed had been premised on "expectations that industry capacity reductions would bring higher hog market prices" in the company’s fiscal year ending April 2010, Moody’s said. A significant moderation in feed grain prices also was expected lift profits.

"However, the outbreak in late April of influenza A (H1N1) — incorrectly known as swine flu —– impacted U.S. fresh pork demand initially, and hence market prices," Moody’s said. "While the domestic pork market seems to have returned to more normal levels, some international markets such as China continue to place restrictions on pork imports, hurting major U.S. hog producers."

Since the outbreak, the U.S. Department of Agriculture has lowered its forecast for 2009 hog prices to $43 to $45 a cwt, down from $46 to $48.

The timing of the outbreak was unfortunate for Smithfield, Moody’s said. The company had been earning record profits in its packaged meat and export businesses but still recorded an operating loss for the year ended May 3, 2009, of $135.7 million, based on ongoing operations. The hog production segment sustained an operating loss of $521.2 million. Recent market prices for live hogs of $43 per cwt were well below domestic costs of raising hogs, estimated at $63 per cwt, Moody’s said. The agency added that Smithfield has locked in place corn costs of $6 per bu, well above current market prices.

Calling the outlook "stable" reflected Moody’s expectation that Smithfield profitability in fiscal 2010 will modestly improve because of the lower feed costs and capacity reductions.

"Smithfield has already cut the size of its U.S. sow herd by 10% and has initiated another 3% reduction," Moody’s said. "Smithfield’s restructuring initiatives should also boost profitability, with approximately $55 million of annual cost savings targeted in fiscal 2010 and $125 million in fiscal 2011."

Another positive looming are changes Smithfield is making to its capital structure, Moody’s said. For instance, a $1.3 billion domestic revolving credit facility is expected to be replaced by a new $1 billion asset-based line. The line’s only financial covenant will be a fixed charge coverage ratio that will be tested only when usage exceeds a high threshold that is unlikely to be met often, the agency said.