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Dividend Aristocrats in Focus Part 54: Hormel


Updated on February 26th, 2019 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 57 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.

 

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 32 years, a record that only a handful of S&P 500 companies can match.

Hormel operates in a stable industry, and has many strong brands. It has also rewarded shareholders with 52 consecutive years of rising dividends. Hormel has paid dividends for 90 years.

Not only is Hormel a Dividend Aristocrat, it is a Dividend King as well. 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. If you’d like to learn about Hormel’s dividend safety, you can do so in the following video:

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 more than $10 billion in annual revenue.

It has a diverse product portfolio today, across 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.

HRL Overview

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.

Revenue and operating profit numbers for Jennie-O have moved in the wrong direction for a number of years due to a variety of factors. After a very weak 2017 and 2018, Jennie-O saw its revenue, volume and segment profit all flat year-over-year in the company’s Q1 earnings report, which was released on 2/21/19.

While total volume and sales were flat, improved results in foodservice and commodity sales were offset by declines in retail. The company is seeing success with its raw and cooked boneless breasts, respectively, but continued weakness in retail ground turkey is offsetting those gains.

However, lower selling, general and administrative expenses helped offset that weakness, keeping segment profit flat year-over-year.

The good news is that other categories have helped offset weak performance in turkey products. The refrigerated foods segment saw its volume up 1%, while net sales declined 2%, but segment profits rose 3% during Q1.

Sales growth was led by the company’s Hormel Deli Solutions business, as well as strength from other deli meat and retail brands. Segment profit increased as higher volumes and contribution margins helped offset higher freight and operational expenses.

The grocery products segment was led by Herdez salsas and sauces, Wholly Guacamole dips and the SPAM family of products. In total, volume rose 3% but net sales were up just 1%, while operating profit fell 2%.

Declines in contract manufacturing took their toll, while operating profits fell due to some one-time benefits that were present in 2018 that did not reoccur in 2019. However, adjusting these out, the grocery segment performed well in Q1.

Despite the protracted deterioration of the Jennie-O segment, we believe Hormel’s long-term growth potential remains intact. Management reiterated guidance for fiscal 2019 after the Q1 report, implying that the ensuing three quarters will be stronger than Q1. The reaffirmed range of $1.77 to $1.91 in earnings-per-share has us keeping our estimate of $1.84 unchanged.

Subsequent to the end of the quarter, Hormel announced on 2/19/19 it was selling the CytoSport business to Pepsico for $465 million. The brand, which makes protein powders and Muscle Milk drinks, didn’t fit Hormel’s long-term plans.

The deal will cause Hormel to cede $300 million in annual revenue, but we see the sales price as favorable. Hormel can use the proceeds to buy back stock, acquire future growth or pay down debt.

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.

In fact, the company has increased earnings in 28 out of the past 32 years–a track record that only seven companies in the S&P 500 Index have reached.

HRL Growth

Source: Investor Presentation

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.

Segment profits were largely mixed once again in Q1 and some of that certainly is due to commodity prices, but freight inflation has hurt Hormel in recent reporting periods as well.

Importantly, our long-term growth estimate of 5% annually doesn’t require Hormel to see margin expansion; we are counting on sales growth providing essentially all of the company’s future growth.

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 5% annual growth to be quite reasonable.

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 35 product categories.

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 $1.77 to $1.91 for fiscal 2019. At the midpoint of earnings guidance, the stock currently trades for a price-to-earnings ratio of 23.3. 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.

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 just 2% annually in the coming years, consisting of the current 2% yield, 5% earnings growth and an offsetting 5% headwind from the valuation we believe needs to come down.

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.

Final Thoughts

Hormel has paid 361 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. Investors looking for stability and consistent dividend growth should give Hormel a closer look.

However, the stock is overvalued, meaning over the next five years investors are likely to receive the dividend but not much else. As a result, overvaluation means the stock is pricing in too much growth today, and we rate Hormel a sell.

Thanks for reading this article. Please send any feedback, corrections, or questions to support@suredividend.com.


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