Dividend Aristocrats In Focus Part 52: Hormel Sure Dividend

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Dividend Aristocrats In Focus Part 52: Hormel


Updated on January 16th, 2020 by Josh Arnold

As the saying goes, slow and steady wins the race. This comes to mind when discussing the Dividend Aristocrats, a select group of just 57 companies in the S&P 500 Index, each with at least 25 consecutive years of dividend increases.

The Dividend Aristocrats are among the best stocks for investors looking to generate long-term wealth that can last for generations. With this in mind, we created a full list of all Dividend Aristocrats, along with relevant financial metrics such as price-to-earnings ratios.

You can download your full list of Dividend Aristocrats by clicking on the link below:

 

Hormel Foods (HRL) is the very definition of a slow-and-steady stock. While it will not make investors rich overnight, it has steadily built wealth for its shareholders over many years.

Indeed, Hormel has grown earnings in 28 out of the last 33 years, a record that only a handful of S&P 500 companies can match. Fiscal 2019, however, showed a slight contraction of earnings, straying from Hormel’s long-term trend.

Hormel operates in a stable industry, and has many strong brands. It has also rewarded shareholders with 54 consecutive years of rising dividends. Hormel has paid dividends for 90 years in total.

Not only is Hormel a Dividend Aristocrat, it is a Dividend King as well thanks to its outstanding track record of returning cash to shareholders. The Dividend Kings have increased their dividends for 50+ consecutive years. You can see all the Dividend Kings here.

This article will discuss why Hormel is a high-quality dividend growth stock, and provide some perspective on the company’s growth and valuation outlook.

Business Overview

Hormel was formed all the way back in 1891, when George A. Hormel established the Geo. A. Hormel & Company in Austin, Minnesota. Consumers took a liking to Hormel’s fresh pork products, which were a novelty at the time. In 1926, the company produced the world’s first canned ham.

Hormel has continued to grow in the decades since, and now generates nearly $10 billion in annual revenue following some recent portfolio moves.

It has a diverse product portfolio today, spanning several categories. Some of its major brands include Skippy, Jennie-O, Spam, Hormel, and Dinty Moore. In recent years, it has added more natural products to compliment its processed offerings, such as Justin’s and Applegate.

Source: Investor Presentation

This is a challenging time for Hormel, because the company’s large Jennie-O segment has been under pressure for years. Record turkey production has caused significant price deflation, and volume has suffered as well. However, the Jennie-O business, along with other segments, produced modest growth in the company’s recently-completed fiscal 2019.

Total revenue was down 1% in 2019, but organic sales were up 1%. The company has made portfolio moves in recent quarters to enhance its margin profile and long-term growth prospects, and while we like the moves in total, it has taken a toll on the top line temporarily. Volume was down 1% in 2019 due to these moves, but organic volume was flat.

Margins have begun to improve as operating income was up 1% on a dollar basis, and up 20bps as a percentage of revenue to 12.6%. Hormel’s SG&A costs were down 14% in 2019 as the CytoSport business was divested, as well as due to lower internal expenses thanks to cost saving initiatives. Advertising expenses were reduced as well, saving the company $21 million over the course of the year.

Earnings-per-share fell 3% in 2019 over 2018, from $1.86 to $1.80 thanks primarily to lower revenue. Cash flow from operations was down 26% year-over-year as well, but that was due to a building of working capital, not deterioration in the company’s fundamentals.

We think Hormel is on track to slowly build revenue and margins moving forward thanks to improving volumes and a higher margin product portfolio.

Growth Prospects

Hormel has an extremely impressive history of generating consistent growth from year to year, regardless of the broader economic climate. This speaks to the company’s strong brands and its staying power during recessionary periods.

In fact, the company has increased earnings in 28 out of the past 33 years–a track record that only seven companies in the S&P 500 Index have reached. Hormel’s growth prospects depend upon a few different levers it can pull in the coming years. We see organic growth as a small but meaningful variable in the company’s growth outlook as it appears Jennie-O has stabilized.

This is important because in recent years, that segment has offset any gains that have been seen in other segments, so if Jennie-O stabilizes and eventually grows, we could see a low single-digit tailwind from organic growth. In addition, Hormel has made a living buying its growth over the years. The company has made many acquisitions and divestitures over the years as it continues to move its mix around to accomplish its growth goals.

The CytoSport divestiture is the latest example of the company exiting a business it doesn’t feel meets its long-term goals, and it will use the ample proceeds for something else that does.

Margins are the wildcard for Hormel as the food processing business is notoriously volatile on that front. Hormel has seen its margins move around for many years and we don’t expect that will change. However, management has committed to getting some of that variability under control and seeing margins become a source of earnings growth, rather than a factor the company needs to try and offset with more sales growth.

Source: Investor Presentation

Above, we can see some of the recent portfolio actions the company has taken to build its margins over time. Divesting lower-margin brands for others that have higher margins will help the company build profitability over time. In essence, Hormel is taking some of the lowest margin businesses it has and divesting them, using the proceeds to purchase businesses with better margins.

This should also help with some of the variability in the company’s profit profile over time as it is no longer as focused on commodity-based profits. Hormel’s recent portfolio actions support value-added revenue streams, which have better – and more predictable – margin profiles.

Importantly, our long-term growth estimate of 4% annually doesn’t require Hormel to see meaningful margin expansion; we are counting on sales growth providing essentially all of the company’s future growth. That means that if these actions continue to work and margins do indeed improve, there could be upside to our modest growth forecast.

Hormel has committed to evolving its mix to be broader than it is today, building upon the strength in its foodservice business, expanding internationally to increase diversification, divesting non-core assets and lastly, modernizing its supply chain.

All of these things should support earnings growth as they grow sales and/or margins, respectively, so we believe 4% annual growth to be quite reasonable, particularly if organic revenue growth picks up.

Competitive Advantages & Recession Performance

Hormel has a number of operational advantages. First, it operates in a wide variety of food businesses, which are very stable. Everyone has to eat, which provides the company with a certain level of demand, even during recessions.

In addition, Hormel’s products are affordable for everyone, so that stability should shine through during tough economic times.

In addition, Hormel has many strong brands, which give the company pricing power. In all, Hormel has brands with the #1 or #2 position in over 40 of its brands.

Source: Investor Presentation

Its popular products make it difficult for competing food companies to take market share. In fact, Hormel has been in that enviable leadership position for years, so it is certainly a lasting advantage.

Hormel’s competitive advantages provide the company with a recession-resistant business model. Hormel’s earnings-per-share during the Great Recession are below:

As you can see, Hormel experienced a mild earnings decline in 2008, then racked up two consecutive years of 20%+ earnings growth. We expect Hormel to perform very well whenever the next recession strikes.

Valuation & Expected Returns

Hormel expects earnings-per-share of $1.69 to $1.83 for fiscal 2020. At the midpoint of earnings guidance, the stock currently trades for a price-to-earnings ratio of 25.5. This is well above Hormel’s 10-year average price-to-earnings ratio of 18, which we also see as fair value.

As a result, it appears Hormel is overvalued quite significantly. The stock trades above its fair value and earnings growth has slowed in recent years, which is not a favorable combination. Hormel has improved its revenue and margin growth outlook with recent portfolio actions, but we don’t see cause for such a high price-to-earnings multiple at this stage.

While the stock is not likely to see a higher valuation multiple, it can still generate somewhat positive returns from earnings growth and dividends.

We see total returns of around -1% annually in the coming years, consisting of the current 2% yield, 4% earnings growth and an offsetting ~7% headwind from valuation changes, as we believe the P/E ratio will contract from present levels.

The company’s dividend is very safe and will almost certainly continue to grow for many years, but given that the yield is roughly in line with the broader market and that the valuation is so high, we rate Hormel a sell.

We would be apt to upgrade Hormel to a hold or buy if the valuation weren’t so high, but until that happens, we recommend investors steer clear, even taking into account the improved growth trajectory.

Final Thoughts

Hormel has paid 365 consecutive quarterly dividends without interruption. It has established one of the longest streaks of dividend increases in the market, and is a Dividend King.

Consumer staples stocks, particularly food companies with strong brands, enjoy steady demand and pricing power. There is no question that Hormel has a strong business with a high-quality brand portfolio.

However, the stock is overvalued, meaning over the next five years investors are likely to receive the dividend but not much else. Even with projected EPS growth and dividends, overvaluation means the stock is pricing in too much growth today.

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