Hormel - Pass on This Dividend King

I last reviewed Hormel (HRL) in this May 21, 2021 post at which time I concluded it was an overvalued Dividend King.

This Dividend King has a history of 375 consecutive quarters of dividend payments and dividend increases of 56 consecutive years; it has paid a regular quarterly dividend without interruption since becoming a public company in 1928.

This streak of uninterrupted dividend increases is impressive. Making investment decisions based on a company's dividend metrics and/or on a company's stock price relative to historical levels, however, is ill-advised. Investors would be wise to look at an investment's TOTAL potential return.

With the release of Q2 and YTD 2022 results on June 2, 2022, I now revisit HRL.

Business Overview

HRL, founded in 1891, started as a processor of meat and food products. Over the years, it has transformed into a company with a diverse portfolio of products spanning the retail, deli, food service and international channels. Furthermore, it has expanded beyond meat protein. This has opened new areas for growth, while further diversifying the business away from the fluctuations associated with commodity meat businesses.

HRL consists of 4 reporting segments:

  • Grocery Products;
  • Refrigerated Foods;
  • Jennie-O Turkey Store; and
  • International & Other.

A comprehensive overview of the company and the risks that may adversely affect it are found in Part 1 of the FY2021 10-K.

One particular risk is that during FY2021, sales to Walmart Inc. (Walmart) represented ~15% of the HRL's consolidated gross sales excluding returns and allowances. In addition, the top 5 customers comprise ~35% of consolidated gross sales excluding returns and allowances. A loss of one or more of these top customers would have a material adverse effect on HRL's results.

Planters Acquisition

Details of the brands acquired from The Kraft Heinz Company (KHC) are found commencing on page 43 of 78 in the FY2021 Form 10-K.

Financing was from cash on hand and a combination of long-term and short-term debt. Deleveraging is to occur during the first 18 - 24 months following the June 7, 2021 closing of this acquisition.

Financial Results

Q2 and YTD2022 Results

NOTE: HRL's FYE is at the end of October.

On June 2, 2002, HRL released Q2 and YTD2022 results.

HRL continues to battle extreme input cost volatility and inflation. It has experienced increases across all input costs including raw materials, packaging and supplies, freight and logistics and labour but expectations are for stabilization as demand and supply come more into balance.

Costs for packaging and supplies are up double-digits on average over last year and this cost increase accelerated during Q2.

Trucking freight is also up significantly; this is being driven by volatility in the spot market and soaring diesel fuel prices. While HRL is noticing some relief in spot markets in Q3, increased fuel surcharges are partially offsetting this benefit.

Ocean freight rates and export logistics continue to challenge HRL's international team.

Operating cash flow in Q2 increased ~24% to $0.193B from Q2 2021's level of ~$0.156B. YTD2022 operating cash flow increased 60% to $0.577B.

HRL - Continuing To Generate Strong Cash Flows

Source: HRL - Q2 2022 Earnings Presentation - June 2, 2022

YTD CAPEX is $0.128B and the FY2022 CAPEX target is unchanged at $0.31B.

HRL generated 394, 385, 531, 588, 848, 784, 813, 852, 629, 761, and 770 (millions of $) of Free Cash Flow (FCF) in FY2011 - FY2021. YTD FCF is ~$0.449B.

FY2022 Outlook

In the second half of FY2022, management expects protein and feed costs to remain volatile and elevated compared to historical levels.

HRL continues to see positive trends in staffing levels thus enabling it to increase production in important product lines. Inefficiencies related to new team members and turnover, however, continue to impact operation but management expects an improvement in the back half of FY2022.

HRL is reaffirming FY2022 sales guidance but is narrowing earnings guidance.

HRL - Fiscal 2022 Outlook

Source: HRL - Q2 2022 Earnings Presentation - June 2, 2022

Credit Ratings

Far too often, investors pay little or no attention to the degree of risk they are assuming when investing. Stories abound on social media from 'investors' who lost their life savings after having invested in 'junk'. People who were saving money for tuition, the purchase of a new home, or to start a business ended up 'investing' their money in cryptocurrencies or in companies that were doomed for failure.

Not every investment decision will be a 'winner'. A little bit of research BEFORE investing in a company, however, can improve our chances for success.

HRL's leverage increased when it incurred long-term debt to assist in the 2021 multiple brand acquisition.

The plan is to maintain an investment-grade rating and deleverage to 1.5x - 2x EBITDA by 2023. Expectations are for the first payment in the deleveraging program to begin in the second half of FY2022.

Looking at HRL, the current domestic unsecured long-term debt ratings and outlook are:

  • Moody's: A1 (stable)
  • S&P Global: A (negative)

The rating assigned by Moody's is the top tier of the upper-medium grade category. That assigned by S&P Global is one notch lower and is the middle tier of the upper-medium grade category.

Both ratings define HRL as having a STRONG capacity to meet its financial commitments. However, it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

Both ratings are investment grade and are acceptable for my purposes.

Dividends and Share Repurchases

Dividend and Dividend Yield

HRL's dividend and stock split history dating back to 1989 are accessible here.

When I last reviewed HRL, shares were trading at ~$49.36 so the $0.245 quarterly dividend yielded ~2%. Shares are now trading at ~$45.50 so the $0.26 quarterly dividend yield is ~2.3%.

I consider a company's dividend policy when I make investment decisions. However, I focus on an investment's total potential investment return.

Another consideration is the type of account in which we hold HRL shares. Hold shares in a taxable account and the dividend income must be declared annually. Depending on an investor's circumstances, the after-tax dividend yield could be below the level posted on various stock screeners.

Furthermore, Canadian investors who hold HRL shares in taxable accounts incur a 15% dividend withholding tax. That $0.26/share/quarter dividend drops to $2.21.

Share Repurchases

HRL's average number of issued and outstanding shares (millions of shares rounded) in FY2011 - 2021 is 544, 538, 540, 540, 541, 542, 539, 544, 545, 547, and 548. For the 3 months ended May 1, 2022, the weighted average number of issued and outstanding shares had risen to 550.

When HRL announced its intent to acquire Planters on February 11, 2021, management indicated dividend growth has been and will remain a top long-term priority. However, share repurchases will have a lower priority as HRL deleverages its debt. In fact, we see from the Condensed Consolidated Statement of Cash Flows that HRL has not repurchased any shares in the current fiscal year. Furthermore, on the Q2 earnings call management stated share repurchases will be opportunistic and will be based on internal valuation.

Valuation

Deciding to purchase a company's shares because they are at or near a 52-week low has to be one of the most asinine ways by which to make an investment decision. Many investors, however, rely heavily on a company's stock price when making their investment decision yet a company's stock price is meaningless when viewed in isolation!

Case in point...Nikola Corporation (NKLA). Before it was exposed that its development of an electric truck was outright fraud, the company's shares peaked at ~$66 in mid-2020. The shares now trade below $7. Does this suddenly make NKLA a good investment? I think not.

In addition, comparing a company's current and future performance can lead to misleading investment decisions especially when a company completes various acquisitions and divestitures that significantly change the business.

Using a company's guidance and estimates generated by the brokers who cover a company to determine a company's valuation is preferable. If you want, you can also use HRL's historical diluted PE levels to see how the current valuation stacks up relative to the historical valuation. However, it is important not just to take these historical PE levels at face value. Sometimes there are unique circumstances that may have skewed a company's valuation in prior years.

HRL's PE levels for FY2010 - 2021 are 17.55, 16.83, 16.78, 23.16, 23.36, 31.13, 21.23, 23.18, 22.95, 25.06, and 29.40.

At the time of my May 21, 2021 post, HRL shares were trading at $49.36 and it had generated $0.82 in diluted EPS for the first half of FY2021. In addition, management's adjusted diluted EPS guidance for FY2021 was $1.70 - $1.82 and adjusted diluted EPS guidance from 13 brokers was a mean of $1.74 and a $1.66 - $1.87 range.

Management expected the Planters acquisition to be dilutive to the extent of ~$0.02 - $0.07/share in FY2021; I arbitrarily decided to give HRL the benefit of the doubt that dilution would only be $0.02/share. On this basis, adjusted diluted EPS guidance following the Planters acquisition was likely $1.68 - $1.80.

Shares were trading at $49.36 so the forward adjusted diluted PE range for FY2021 was ~27.4 - ~29.4.

Management had not provided adjusted diluted EPS guidance for FY2022 but guidance from 13 brokers was a mean of $1.88 and a range of $1.75 - $2.12. I had completed my review shortly after HRL's earnings release so I expected that broker estimates had yet to be updated on the 2 discount brokerage platforms I use. Since management indicated the Planters acquisition would be accretive in FY2022 to the extent of $0.17 - $0.20/share, I added $0.20 to the FY2022 broker estimates to get a mean of $2.08 and a range of $1.95 - $2.22.

Using the $49.36 share price, the forward adjusted diluted PE range for FY2022 was ~22.2 - ~25.3.

Now, HRL shares are trading at ~$45.50 and management has amended its FY2022 diluted EPS guidance from $1.87 - $2.03 to $1.87 - $1.97. Using the new guidance, the forward PE range is ~23 - ~24.

The forward adjusted diluted PE levels using current broker estimates are:

  • FY2022 – guidance from 13 brokers is $1.78 – $2.09 with a mean of $1.93 thus resulting in a forward adjusted diluted PE of ~23.6 based on the mean value.
  • FY2023 – guidance from 13 brokers is $1.86 – $2.23 with a mean of $2.09 thus resulting in a forward adjusted diluted PE of ~22 based on the mean value.
  • FY2024 – guidance from 6 brokers is $1.91 – $2.28 with a mean of $2.17 thus resulting in a forward adjusted diluted PE of ~21 based on the mean value.

HRL only recently released its Q2 earnings. I envision revisions to these estimates over the coming days.

Final Thoughts

I initiated a 400 share position @ $33.84/share on June 16, 2017 through one of the 'Core' accounts within the FFJ Portfolio. My reason for this purchase was to have a component of my portfolio that would experience low volatility. Although my exposure has increased over the years, the increase is solely from the automatic reinvestment of dividends.

I recommend you pass on HRL because there are far better investment opportunities to be found. Many such investment opportunities are companies that distribute no dividends, or which are very low dividend-yielding. Despite these inferior dividend metrics, they have a track record of reinvesting earnings to generate very attractive returns. I fully appreciate the past does not predict the future but if a company has a proven long-term track record, there is reasonable probability investors can expect more of the same going forward.

Several such high-quality companies are reviewed in recent posts that are accessible through the Archives.

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

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I am long HRL.

Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.

I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.