Contents
Summary
- HRL has embarked on a long-term strategy to move its portfolio away from low margin commodities to higher margin branded value added products.
- Acquisitions are part of HRL’s growth strategy. This brings an added element of risk as evidenced by the non-cash impairment charge associated with the CytoSport business it acquired in 2014.
- Although HRL will not appeal to dividend yield hungry investors, it has an enviable track record of dividend increases plus a conservative dividend payout ratio.
- HRL’s low stock price volatility will appeal to more conservative investors. The challenge is that HRL appears to be somewhat expensive relative to recently released FY2018 results and FY2019 projections.
Introduction
In previous 2017 and 2018 articles I indicated Hormel Foods Corp. (NYSE: HRL) was attractively valued. That tone changed somewhat when in my August 28, 2018 article I wrote:
‘HRL is not as attractively valued as it was when I wrote my previous articles. I now view it as fairly valued versus attractively valued. It does, however, still warrant a ‘buy’ recommendation for long-term investors seeking an equity holding that is unlikely to experience wild fluctuations in price should the long overdue market correction ever occur.’
At the time of that article, HRL was trading at $37.94. Fast forward to today and I am of the opinion HRL is overvalued at ~$44.50.
On November 20th, HRL released its Q4 and FY2018 results. It reported record Revenue, record Diluted EPS, and record Cash Flow. A closer look at the results for Q4 and FY2018 for its Refrigerated Foods, Grocery Products, Jennie-O Turkey Store, and International & Other divisions, however, reveals less than stellar results. Were it not for acquisitions and an effective tax rate of 14.3% compared to 33.7% in FY2017, HRL would not have reported these record statistics.
A high level overview of the reasons for a reduction in Net Sales and Volume (Refrigerated Foods and International & Other experienced an increased in these metrics but organic results were down) can be found in the Q4 and FY2018 Press Release. Despite these less than stellar results, readers should not lose confidence in HRL. HRL is currently experiencing commodity market volatility and global trade uncertainty, and therefore, it is not unreasonable to expect growth and profitability challenges in the short-term.
In my June 6, 2017 article I wrote about HRL’s strategic decision to evolve into a global branded food company. HRL communicated to the investment community that it had embarked on a long-term path to build its brands, deliver meaningful innovation, make strategic acquisitions, and to create an intentional balance to deliver long-term growth.
Q4 and FY2018 Financial Results and FY2019 Guidance
GAAP and non-GAAP results indicate that HRL is currently experiencing some challenges as without taking into consideration 2018 acquisitions and 2017 divestitures, HRL’s Net Sales have actually experienced a slight deterioration.
Source: HRL - Q4 and FY2018 Press Release
HRL is not immune from the higher freight expenses that have been reported by companies in several different industries. All 4 business segments reported an increase in freight expenses and while HRL increases its prices to offset higher transportation costs, there is a time lag as to the implementation of these price increases. As a result, HRL’s profit margins are inevitably negatively impacted until such time as price increases take effect.
It also didn’t help that HRL recorded a $17.279 million non-cash impairment charge associated with the CytoSport (a leading provider of premium protein products in the sports nutrition category) business it acquired in August 2014 for $0.45B.
When HRL acquired CytoSport, 2014 annual sales were expected to be ~$0.37B. At the time of the acquisition, HRL expected CytoSport to help it further diversify its portfolio. This acquisition was to serve as a growth catalyst for HRL’s Specialty Foods segment and to help expand HRL’s offerings of portable, immediate, protein-rich foods.
With the recent Goodwill write-down it is clearly evident this acquisition has not produced the results HRL anticipated. This goes to show how growth by acquisition can be risky.
Credit Ratings
HRL’s credit ratings remain unchanged from those reflected in my previous articles. Moody’s rates HRL’s senior unsecured debt A1 (top tier in the upper medium grade category) and Standard & Poor’s continues to assign an A rating (middle tier in the upper medium grade category).
Both ratings should be satisfactory for a conservative investor.
Valuation
At the time of my August 28th article, HRL was trading at $37.94/share and HRL’s forward PE was ~19.4 - ~20.96 based on EPS guidance. This was higher than the ~18.2 - ~19.6 range at the time of my May 24 article and the ~16.9 - ~18.2 range at the time of my February 22 article.
In my August 28th article I indicated that if we took the $1.88 mid-point of the EPS guidance of $1.81 - $1.95 and estimated a 6% growth in earnings for FY2019, we could expect HRL to generate EPS of ~$2. Using the $37.94 stock price at the time of that article we arrived at a forward PE of ~19.
Fast forward to November 20th and HRL is currently trading at ~$44.50. HRL reported diluted EPS for FY2018 of $1.86 thus giving us a current PE of ~23.93. This valuation is well in excess of what I anticipated at the time of my previous article and much of this has to do with Mr. Market bidding up HRL’s stock price by over $6.50/share within less than 3 months.
HRL’s fiscal 2019 EPS guidance is now $1.77 - $1.91 with a mid-point of $1.84; this is lower than my mid-point projection at the time of my August 28th article. With HRL currently trading at ~$44.50 we now get a forward PE range of ~23.3 - ~25.14 or ~24.18 if we use the $1.84 mid-point.
HRL’s 5 year average PE, for comparison purposes, is closer to ~23.7.
I fully recognize that given the current market environment many investors might gravitate to a company like HRL where earnings volatility is far less volatile than, for example, FAANG stocks. I do not, however, view HRL as a company which warrants the current valuation.
Dividend and Dividend Yield
HRL’s dividend and stock split histories can be found here.
Management has forecast another year of strong cash flows and as evidence of the company’s continued commitment to reward shareholders it announced another dividend increase on November 19th. The 12% dividend increase ($0.1875/share/quarter increased to $0.21/share/quarter) marks HRL’s 53rd consecutive annual dividend increase; as I compose this article the dividend history section of HRL’s website has not yet been updated to reflect this increase.
At the time of my August 28 article, HRL’s dividend yield was 1.98%. When I wrote my May 24 article, HRL’s dividend yield was ~2.1% and the dividend yield was 2.27% at the time of my February 22 article.
With HRL trading at ~$44.50, the new $0.84/share annual dividend yields ~1.89%. If dividend hungry investors thought HRL’s dividend yield was too low at the time of my previous articles then the current dividend yield will be even less appealing.
I periodically read articles in which a writer recommends a stock and heavily emphasizes the company’s high single digit or double digit dividend yield. In my opinion, a dividend yield of this magnitude in our current low interest rate environment should set off an investor’s ‘spidey sense’. When I read the notes to the financial statements of the company being recommended I am alarmed at the level of risk investors would assume if they were to invest in such a company.
I fully recognize we each have different goals and objectives and level of risk tolerance. As a result, some investors are prepared to invest in much higher risk companies, in which I would never consider investing, in the hope of generating superior investment returns.
In my opinion, a reasonably conservative investor who is not prepared to suffer a permanent impairment to their capital may wish to consider an investment in HRL….just not at the current valuation.
Options
Some investors may employ the use of bull/bear call spreads, condor, and butterfly option strategies by which they can potentially generate superior investment returns. I am, however, a relatively conservative investor who spends little time monitoring stock price fluctuations. As a result, I stick with a conservative covered call option strategy when I do employ the use of options. Recent examples in which I have employed this option strategy can be found here.
In addition to the examples in that article, I have written Microsoft (MSFT) and J. M. Smucker (SJM) covered calls within the past couple of months which have all recently expired worthless. This means I collected option premiums AND kept my shares.
Since I am of the opinion HRL shares are currently overvalued I looked into the possibility of writing short-term out of the money covered calls. The option premiums, however, are negligible and I will pass on using this strategy for HRL.
Final Thoughts
My modus operandi is such that I buy and hold shares for the long-term and very rarely do I sell shares….even though they may be slightly overvalued.
I have sufficient exposure to HRL (shares are held in the FFJ Portfolio) but if this were not the case I still would not acquire shares at the current valuation. I would patiently wait for Mr. Market to sour on HRL to the point where shares retrace to sub $39.
I hope you enjoyed this post and I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long HRL.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
