Hormel Foods - Stock Analysis

When I initiated a position in Hormel Foods Corporation (HRL) in June 2017, one of the factors I took into consideration was that The Hormel Foundation controls more than 48% of HRL's stock. While some investors may have a negative opinion of the Foundation's degree of control, I viewed this as a 'positive'.

HRL is one of the many companies in which I have invested where I would gladly increase my exposure were shares to be attractively valued. HRL's current valuation, however, appears to be somewhat rich. I think investors would be disappointed with their investment returns for the next few years if an investment in the company were to be made based on projected earnings.

Summary

  • Hormel is a global branded food company with over $9B in annual revenues across 75 countries.
  • Its brands include SKIPPY®, SPAM®, Hormel® Natural Choice®, Applegate®, Justin’s®, Columbus®, Wholly® guacamole, Hormel® Black Label® and more than 30 other beloved brands.
  • The Hormel Foundation controls more than 48% of HRL's shares.
  • The company has an envious dividend track record.
  • HRL's use of leverage is conservative which enabled it in June 2020 to borrow $1B of 10 year money at 1.8%.
  • A great company does not necessarily make it a great investment if shares are richly valued.

Introduction

In this June 2017 article I disclosed that I had initiated a position in Hormel Foods Corporation (HRL). At the time I wrote that article, HRL was fairly valued based on current and forward earnings.

I knew HRL was not the type of investment which may appeal to investors seeking high octane growth from their investment holdings. My decision to invest in HRL, however, was driven from the perspective of safety and reliability.

Sure enough, my investment in HRL has been exactly that. I very rarely look at HRL's 10-Q and 10-K reports! What has prompted to look at HRL is that I recently received an email informing me of the annual general meeting on Tuesday, January 26, 2021 and that 'My Vote Counts' so I should vote by January 25, 2021.

Let's be real! If you look at 'Item 6. Selected Financial Data' in HRL's 2020 10-K found on page 13 of 77, you will see that the diluted Weighted-Average Shares Outstanding in FY2020 was just under 547 million. I hold 423 shares in one of the accounts which I include in the FFJ Portfolio and additional shares in another account for which I do not disclose details. My vote really doesn't count for much and I knew this when I invested in the company.

One of the factors I took into consideration when I acquired shares is that The Hormel Foundation controls more than 48% of HRL's shares and would vote against any proposal to purchase the Corporation. This truly appeals to me because I know the likelihood of me waking up one morning to find that HRL's management has gone out and done something from an ownership perspective is slim to nil. In addition, the Foundation's sizable voting rights suggests to me that business decisions are being made not with just the bottom line in mind (ie. chasing the almighty dollar). I can't say this is the same for many other publicly traded companies.

If you look at my recent Tyson Foods (TSN) articles (here and here), you will see that the founding family also had the long-term in mind but they structured matters differently from the founding family of HRL. The Tysons created 2 claseses of shares with 'insiders' essentially controlling the company.

Since I invest in companies for the long-term, the extent to which The Hormel Foundation and TSN 'insiders' control the companies really does appeal to me.

Business Overview

A great overview of the company and the business, operational, and industry risks can be found in Part 1 of the FY2020 10-K.

FY2020 Results and FY2021 Outlook

On November 24, 2020, HRL released Q4 and FY2020 results.

In FY2020, HRL's cash flow benefited from lower working capital. Even though HRL generated cash from operations of $1.1B, a YoY increase of 22%, the company secured $1B in debt to provide liquidity and to allow it to take advantage of strategic opportunities.

Looking at 'Note E - Long-term Debt and Other Borrowing Arrangements' (page 44 of 77) in HRL's FY2020 10-K, we see that HRL has very little long-term debt. In fact, long-term debt was only ~$0.25B until mid June 2020 at which time it issued $1.0B of 1.80% senior notes due June 11, 2030! When you have a credit rating like that assigned to HRL's long-term debt (see Credit Ratings section below) you get to borrow at a very attractive rate for a 10-year timeframe.

Management has indicated this capital will be used to:

  • gain market share in e-commerce and retail;
  • support leading brands through advertising and marketing;
  • achieve the company's 15% innovation goal;
  • invest in value-added capacity;
  • expand the authentic foodservice portfolio with the Sadler's acquisition;
  • transform and modernize HRL through Project Orion and One Supply Chain initiatives.

During 2020, HRL repurchased 300,000 shares for $12 million. Capital expenditures were $0.368B compared to $0.294B in FY2019. The company also recently completed an expansion at the Burke pizza toppings plant and completion of the new dry sausage facility at Nebraska is fast approaching.

On the Q4 and FY2020 Earnings call with analysts, management indicated the company will continue to prioritize investments to support the growth of the value-added businesses. In fact, HRL's capital expenditures target in FY2021 is $0.35B.

The hog market has recovered from 20-year lows due to strong domestic and export demand and the United States Department of Agriculture is projecting domestic production of pork to increase 1% in 2021.

Hog prices are expected to rebound significantly in 2021 and management expects to have continued ample access to hogs and pork raw materials through the company's balanced mix of hog and pork supply contracts.

Pork trim markets are expected to decline in 2021, but the value is highly dependent on the pork industry's operating level. Management anticipates belly prices will increase from the current levels and this is based on moderate foodservice growth.

Fundamentals in the turkey industry remain mostly unchanged. The benefit of favorable whole bird prices, lower pork placements and reduced cold storage levels are being offset by lower breast and thigh meat markets due to lower demand.

Management anticipates lower turkey commodity prices in 2021 with a sustained recovery in the foodservice industry likely benefiting turkey markets.

Labor availability will continue to be a significant factor in the industry's ability to operate efficiently. The COVID-19-related higher cost structure is expected to continue through the first half of FY2021 but management expects the majority of the COVID-19 costs to subside as the pandemic comes under control.

Credit Ratings

I have mentioned in several previous articles that I completely flabbergasted at how so many investors overlook the risk associated with an investment. Far too often I only see mention of return/potential return. If any attention were paid to risk associated with some of those investments, however, the potential return (in my opinion) does not adequately reward the investor for the risk being assumed.

At this stage of my life I have no interest in taking on above average risk, and therefore, I typically limit my investments to companies in which I think the probability of default is remote.

While I look at credit ratings assigned by major ratings agencies I also take into account that these ratings are for a company's debt. As an equity investor I rank well below that of debt holders so I need to take into account that if a company's long-term debt is rated B2 (middle tier of the Highly Speculative - Non-investment Grade category), for example, then my risk is substantial/extremely speculative. I don't mean to pick on Tesla, Inc. (TSLA) but Moody's rates this company's long-term debt B2!!!

Looking at HRL's long-term debt ratings, we see that Moody's upgraded the rating from A2 to A1 on January 27, 2015 and this rating has remained unchanged since then. This rating is the top tier of the Upper Medium Investment Grade range.

S&P Global assigned an A rating May 31, 2001 and this rating has remained unchanged. This rating is the middle tier of the Upper Medium Investment Grade range.

Valuation

When I initiated my HRL position in 2017, HRL had reported FY2016 diluted EPS of $1.64 and the mean FY2017 adjusted EPS estimates based on input from 13 brokers called for $1.65 in FY2017 and $1.71 in FY2018. At the time, shares were trading at $33.95 so HRL's PE was ~21 and the forward adjusted PE based on estimates was ~20.

HRL had a challenging year in FY2020 and generated $1.66 in diluted EPS. With shares currently trading at $47.17 we get a PE of ~28.

Using the trading platforms of 2 major Canadian financial institutions, I see HRL's mean adjusted diluted EPS guidance from multiple analysts at the $1.77 level. Using the current $47.17 share price we get a forward adjusted diluted PE of ~26.5.

In my recent TSN article I was of the opinion shares were attractively valued and there was potential for share price appreciation if the valuation level returned to historical norm. In the case of HRL...I think there is a greater probability that valuation will shrink. Looking at HRL's PE levels for FY2010 - 2019 we see PE levels of 17.55, 16.83, 16.78, 23.16, 23.36, 31.13, 21.23, 23.18, 22.95, and 25.06.

In my opinion HRL is not engaged in the type of business which warrants a valuation level in the upper 20s but rather a valuation level in the high teens or lower 20s. If HRL's valuation were to retrace to 22 (still a generous valuation) and we used adjusted diluted EPS guidance of $1.77 then a share price of ~$39 would be more reasonable. Keeping in mind that adjusted guidance is generally higher than actual results, then a share price below the mid $30s would present an attractive range at which to acquire additional shares.

Dividend, Dividend Yield, and Share Repurchases

HRL's dividend history can be accessed here.

We can see from the following that HRL's dividend growth has been impressive over the past 3 decades.

HRL - Dividend Growth 1990 - 2021

On November 16th when HRL distributed its 4th consecutive $0.2325 quarterly dividend, it marked its 369th consecutive quarterly dividend!

On November 23rd, HRL announced its 55th consecutive increase to its annual dividend. On February 16, 2021, shareholders of record at the close of business on January 11, 2021 will receive $0.2450/share/quarter.

While this is only a ~5.4% dividend increase we need to keep in mind that COVID-19 has presented enormous challenges. Maintaining a strong financial position and having the resources to grow, possibly through strategic acquisitions, is far more important than increasing the dividend by a few extra percentage points.

With shares currently trading at $47.17, the forward dividend yield is ~2%.

Looking at HRL's weighted average shares outstanding, we see (in million of shares outstanding) 544, 538, 540, 540, 541, 542, 539, 544, 545, and 547 for FY2011 - 2020. Given that The Hormel Foundation controls more than 48% of HRL's issued and outstanding shares and does not sell its shares, I would not expect a huge fluctuation in the number of shares outstanding.

Final Thoughts

HRL is an attractive investment for long-term investors seeking a low volatility/low risk investment which generates a steadily increasing stream of dividend income. The challenge I currently see with HRL is that the valuation appears to be somewhat elevated relative to earnings projections and historical levels.

If an investor were to invest in HRL based on current metrics I think it would be a challenge to generate a reasonably attractive return over the next several years.

I am not prepared to currently add to my position but would be open to revisiting a further investment in HRL if the projected metrics pan out and HRL's share price retraces to at least the mid $30s. Naturally, any further investment in HRL will need to take into consideration what other investment opportunites exist.

Stay safe. Stay focused.

I wish you much success on your journey to financial freedom!

Note: Thanks for reading 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.