Hormel Foods: A Dividend Growth Turkey? – Hormel Foods Corporation (NYSE:HRL)


Hormel Foods Corporation (NYSE:HRL) is a producer of various meat and food products that it sells globally. The company’s shares recently popped up on our radar screen as its dividend-growth shares are trading at 52-week lows along with many other major American food companies. HRL operates within five businesses: 1) the grocery products business – consisting of shelf-stable food products sold mostly in the retail market; 2) the refrigerated foods business consisting of branded/unbranded pork and beef products; 3) the Jennie-O Turkey Store business consisting of branded and unbranded turkey products; 4) the specialty foods business consisting of private label shelf stable products, nutritional products, sugar and condiments to industrial/retail/foodservice customers; and 5), the international and other business. HRL’s second quarter earnings saw it recording $0.39 earnings per share, a 2.5 percent decrease from the year-ago quarter. Sales for the quarter decreased 5 percent on an 11 percent volume decrease. Adjusted sales increased 2 percent while adjusted volume grew 1 percent. For the quarter, three of the company’s five businesses recorded earnings growth: refrigerated foods, international, and grocery products. Specialty products earnings, however, decreased 16 percent.

Despite HRL experiencing double-digit declines in its Jennie-O Turkey Store business and divesting two profitable but non-strategic businesses, it was able to record earnings within $0.01 of its year-ago quarter’s results. The company was able to accomplish such results given stronger results from its meat products, foodservice, grocery products and international businesses. In addition, all of the company’s businesses proactively controlled expenses. HRL’s Jennie-O Turkey Store business experienced another difficult quarter as earnings decreased 29 percent with sales decreasing 8 percent. Profit margins for such business decreased 16 percent due to declining turkey prices; increased competition; and increased expenses. The company noted that turkey prices remain at multi-year lows due to an oversupply of turkey, but suggested that the turkey industry will balance supply and demand and market conditions will improve in the coming months. HRL also noted increased competitive activity from other turkey suppliers and competing proteins such as beef continued to pressure Jennie-O’s results. Finally, the company incurred higher operating expenses relating to “bird performance issues” as it continued to invest in consumer trends such as its “raised-without-antibiotics” products. Despite such adverse market conditions and operating challenges, HRL was able to grow Jennie-O Turkey Store product volumes.

HRL’s grocery products operating profit increased 15 percent as volumes increased 2 percent and sales increased 8 percent. (The inclusion of Justin’s specialty nut butters and brands such as Wholly Guacamole, SPAM and Herdez, all contributed to growth.) The company’s international business operating profit increased 38 percent as volumes grew 17 percent and sales increased 19 percent. (Fresh pork exports and branded exports such as SPAM had strong results in addition to the SKIPPY peanut butter business in China performing well.) The company’s refrigerated foods operating profit was flat with sales decreasing 6 percent and volumes decreasing 14 percent. (Reflecting the divestiture of the Farmer John business but showing growth in retail/foodservice value added products.) The company’s specialty foods operating profit decreased 16 percent with sales decreasing 24 percent and volume decreasing 33 percent. (Excluding the divestiture of Diamond Crystal Brands, adjusted volume increased 3 percent while adjusted sales were flat. Muscle Milk ready to drink protein beverages performed well and new Muscle Milk bars were well received.) Given HRL’s current operating environment, it has made some short-term reductions to SG&A expenses such as to advertising expenses.

HRL reduced its fiscal 2017 expectations for its Jennie-O Turkey Store business as it does not see pressures abating until the entire industry starts to reduce production levels. For the refrigerated foods business, the company expects growth in many of its retail brands and strong growth for its foodservice brands. The company also expects continued growth from grocery products such as Justin’s specialty nut butters, Wholly Guacamole dips, Herdez sauces and SKIPPY peanut butter. For the international business, the company expects strong exports of both branded and fresh pork products. Finally, the company expects its specialty foods to deliver double-digit earnings growth driven by CytoSport and the Muscle Milk brand sales. Accounting for the lowered Jennie-O Turkey Store outlook, HRL maintained its full year 2017 earnings per share guidance of $1.65 to $1.71. Just weeks after the company’s earnings announcement, during its investor day conference, it reaffirmed its goal of achieving 5 percent annual revenue growth, 10 percent profit growth and margins that are in the top quartile of its peers by 2020. Over the past six years, HRL quickly diversified its product portfolio with the acquisitions of product portfolios such as Skippy, CytoSport and Justin’s specialty nut butters.

HRL has set out a strategy to give it the momentum to achieve its goals. Such strategy includes: 1) continuing to become a more diversified food company; 2) accelerating its food service business; 3) expanding its international footprint; 4) decreasing volatility and increasing balance throughout its businesses; 5) divesting assets that do not perform; and 6) modernizing its supply chain. With such strategy in mind, the company acknowledged that while it was “deeply rooted in the meat protein space,” over time it needed to become a broader food company and build a balanced product portfolio. As noted above, HRL has rapidly diversified its product portfolio in recent years. Beyond diversifying into non-meat protein products, the company has also increased its presence in the flavor enhancement market with products such as salsas, sauces, dips and hot sauces. HRL also sees opportunities to translate its branded product successes it has had at the retail level to the food service market. The company’s food service business represents 27 percent of its total portfolio and it creates products that meet specific operator needs such as pizza toppings, sliced meats, bacon and precooked products, making its food service operators’ preparation easier and more cost-effective.

With only about 5 percent of HRL’s sales coming from markets outside the U.S., HRL is quite focused on expanding its businesses internationally. Specifically, the company stated that it needs to find a way to create its U.S. model globally whereby it would be able to establish its products as Number 1 or Number 2 brands. In particular, HRL believes international sales growth will come from the export of HRL-branded products around the world and strategic acquisitions. For example, in recent years the company has made some significant capital investments to grow its business in China. To expand into other countries, it remains on the prowl for acquisition opportunities that it can use not only to establish a foothold in a country with an established brand but also to gain an additional distribution network for its current portfolio of HRL brands. With such international expansion efforts in mind, HRL views globalization, multiculturalism, wellness and on-the-go foods as enduring drivers of overall food consumption behavior. The company sees the key to unlocking future growth as being heavily reliant upon its ability to translate food behaviors into shopper, patron and operator insights. By understanding such food behaviors, HRL acknowledged that it will then be able to identify attractive product growth spaces.

With respect to it retail business, HRL has identified strategic growth in the following product categories: ground turkey; protein beverages, bars and powders; nut butters; meat snacks; sauces and condiments; and natural and organic meats. Such product categories represent about $13 billion in retail sales and HRL holds a 17 percent market share of such categories. With respect to such food categories, the company noted that “Collectively, [such] categories have been growing at a compound annual growth rate of 6% for the last five years.” The company also recognizes that the key to growth in such categories is millennials. For example, its Justin’s nut butter products and its Applegate meat products receive 43 percent of its dollar volume from millennials respectively. HRL sees that its organic brand development efforts and recent acquisition activity has positioned it for faster growth with the highly sought-after consumer group, the millenials. The company also sees e-commerce playing a role in how it executes its strategies. As the digital economy continues to evolve it will create new consumer behaviors, and, as such, the company has estimated that the U.S. on-line edible grocery market will reach $23 billion in sales by 2021 and represent 4.5 percent of total grocery sales.

Given the expanding importance of e-commerce sales, HRL recognizes its need to grow its enterprise-wide on-line edible grocery sales by more than 17 percent per year to maintain its market share. The company sees three sources of overall digital on-line growth: 1) digitally transacted sales on the retailer.com site; 2) digitally influencing off-line sales or the business that is influenced by an on-line social media presence, a search, a content or reviews, et cetera; and 3) increasing sales from improved analytics such as media-mix analysis, shopper audience segmentation modeling and personalized messaging.

Our view

We believe that the negativity surrounding food companies (including HRL) and their shares is beginning to peak. Now while we cannot predict a bottom in the company’s shares, we believe that investors should consider accumulating HRL’s shares on any overall market weakness at the price range below. There are many uncertainties surrounding HRL and the food market generally. For example, investors are greatly concerned about HRL’s ability to compete against popular store-branded products such as those that sell at Trader Joes. Investors are also concerned about the effect of Amazon’s (NASDAQ:AMZN) purchase of Whole Foods (NYSE:WF) on the food market generally. While such concerns are legitimate, we find investing during a time when such concerns exist is when the best gains are made. When shocks occur to a staid industry such as the food industry, investors tend to shoot first and ask questions later by assuming that existing players in a market will fail before the battle has even begun. We believe differently and that is why we believe long-term investors should consider beginning a position in HRL’s shares.

HRL’s strategy for long-term revenue/earnings growth appears well-thought out and sound. The company, however, is experiencing pockets of weakness, particularly in its Jennie-o turkey business. There is a cyclical over supply in the turkey market causing turkey prices to remain at multi-year lows. While the company believes that the turkey industry will balance supply and demand and market conditions in the coming months, near-term increased competitive activity from other turkey suppliers and competing proteins such as beef continued will continue to pressure Jennie-O’s results. Despite such adversities, grocery product margins will likely benefit from manufacturing efficiencies and growth in key brands. Strength will also continue in the Spam, SKIPPY and CytoSport product lines as well. Risks to HRL’s performance include weaker-than-expected demand and worse-than-expected commodity cost pressures. With the company’s strategies, near-term business results and market conditions in mind, we see HRL’s shares as expensive on a historical basis and sporting a dividend yield lower than the shares of many of its competitors. Given investors’ acquisition-related mindset with respect to major American food companies, we can assign a slightly higher price to earnings ratio to our buying range for HRL’s shares as set forth below.

Despite near-term adversities, HRL will succeed long term due to its strong brands; product and marketing innovations; its push into the growing functional foods market; profitability and cash flow; and long-term record of earnings and dividend growth. HRL shares currently have a dividend yield of about 2.05 percent. Earnings estimates for fiscal year 2017 are $1.66 and for fiscal year 2018 are $1.71. We should note that earnings estimates have remained relatively steady for each year in recent months. The company has a price-to-earnings ratio of about 20.00 based on fiscal 2017 earnings estimates and a price-to-earnings ratio based on 2018 fiscal year earnings of about 19.70. Over the past 10 years or so, the price to earnings ratio for HRL’s shares ranged from about 15 to 25. With this in mind, we add a slight takeover premium to the company’s shares to come up with our buying range. Therefore, we recommend that an investor wait to buy the company’s shares in the price range of $29.95 to $31.65 (a price-to-earnings ratio range of about 17.50 to 18.50 based on 2018 fiscal year earnings).

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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