With stock valuations appearing on the full side these days, equity investors may wish to get a bit more defensive. One place to look is the food industry, which is noncyclical, relatively stable, and apt to hold up pretty well in the event of an economic slump or significant market correction. And one of the notable standouts in the space is Hormel Foods (HRL). Shares of the Austin, Minnesota-based food outfit have pushed higher over the past year, appreciating almost 25% in value, far more than the broad-based S&P 500 Index. In fact, the large-cap issue recently hit a fresh all-time high in the upper $50s after the company posted better-than-expected results for the January interim. (Fiscal years end on the last Saturday in October.) Earnings growth, which amounted to 21% during the quarter, is being driven by robust demand for Hormel’s core pork and turkey products, the introduction of more high-margined value-added products and a leveraging of the recently acquired Skippy peanut butter brand. Favorable input costs and healthy pricing trends are helping matters, too, lifting the operating margin to near-record levels. So, will this impressive bottom-line momentum persist in the coming periods? And how does the long-term picture look? In this brief article, we will attempt to address these questions by taking a look at Hormel’s business and performing an easy-to-follow SWOT analysis of the company, evaluating its Strengths, Weaknesses, Opportunities, and Threats.
The Business
Founded way back in 1891, Hormel began as a commodity-oriented meatpacker serving the U.S. market but gradually transformed itself, with the help of innovation and acquisitions, into a more diverse, multinational manufacturer of consumer-branded food and meat products, many of which are among the best known in the food industry. Today, the company employs 20,400 people worldwide, generates annual sales of about $10 billion and maintains an enviable roster of leading brands, such as Hormel Chili, SPAM, Jennie-O, Skippy and Dinty Moore. (There are more than 30 brands that have the No. 1 or No. 2 market share positions in their categorIES.) The business is divided into five segments: Refrigerated Foods (roughly 48% of the top-line mix); Jennie-O Turkey Store (18%); Grocery Products (17%); Specialty Foods (11%); and International & Other (6%).
Strengths
Product Innovation: In order to gain market share, spur volume growth, enhance profitability and fUrther distance itself from its meatpacking roots, the company is constantly rolling out new value-added food items. (Between 75% and 80% of sales are value added.) Successful recent additions to the portfolio have included Hormel REV wraps, Skippy singles, Wholly Guacamole 100-calorie minis and Jennie-O turkey breakfast offerings. We expect the pipeline to remain full, too, given the company’s commitment to R&D and to entering new international territories where products often have to be modified to better conform to local tastes. Hormel demonstrated its commitment to R&D in 2008 when it opened a 5,000-square-foot Idea and Innovation Center in China. The plant has helped the company more effectively target the large Chinese market. And it should prove invaluable as Hormel endeavors to widen distribution of the Skippy label throughout the Asia/Pacific region.
Strong Balance Sheet: The company has one of the best balance sheets in the sector, with cash assets of over $500 million (as of January 25, 2015) and a low debt-to-capital ratio of just 6%. In fact, a good case can be made that Hormel is underleveraged at present and would do well to tap the debt markets to make more transformative deals. Such actions would likely boost shareholder returns over time. Meanwhile, the company, with excellent free cash flow and a consistent record of hiking the quarterly payout each year, should continue to return a healthy measure of its cash to investors in the form dividends. The issue now yields around 1.8%, which is slightly below the Value Line median.
Veteran Management Team: Led by CEO Jeffrey M. Ettinger, Hormel has a seasoned management team with an average tenure at the company of more than 25 years and a track record of sound execution in all sorts of protein markets. This wealth of experience ought to come in handy as the company looks to leverage its brands, expand overseas and optimize its balance sheet.
Weaknesses
Dependence on Protein: Hormel’s exposure to the pork and turkey markets remains quite high as we head through fiscal 2015. Consequently, the company’s fortunes would likely falter if the global demand backdrop for these proteins deteriorates markedly. That said, diversification efforts are gradually paying off, and a heightened emphasis on value-added products means that Hormel is less sensitive to commodity fluctuations than it was in the recent past. Pricing power is decent, too, especially with regard to the Jennie-O turkey business. This suggests that the company should be able to offset some volume softness with strategic price hikes.
Opportunities
Skippy: The peanut butter label is still fairly new to the company (it was purchased from Unilever in 2013), and we expect distribution gains, both at home and abroad, to be a major tailwind for some time to come. Specifically, we see Skippy sales benefiting from a new national advertising campaign in the U.S. (the first such campaign in a decade) and from deeper inroads in China, where it already holds the top market position. The Skippy transaction, which included a manufacturing plant in Weifang, China (not to mention one in Little Rock, Arkansas), should also garner cost savings by producing economies of scale overseas. In fact, we think that Hormel will be able to use the Skippy assets to widen the international reach of some of its mainstay meat brands, most notably SPAM.
CytoSport: In mid-2014, Hormel bought CytoSport Holdings, the maker of Muscle Milk and a number of popular whey powder products, for about $450 million. This deal got the company into the thriving market for high-protein supplements and protein-enriched foods. And the CytoSport product line, which already had quite a following prior to the takeover, will probably be an even better performer with Hormel’s vast resources now behind it.
Growth Categories: The company, to its credit, is always endeavoring to add diversity to its business and enhance its growth profile. To this end, Hormel has been shifting into growing food categories, like snacks, on-the-go meals and Mexican-themed fare, via strategic acquisitions and its own internal initiatives. It has also been introducing more better-for-you products (e.g., the Hormel Natural Choice collection) in the hopes of capitalizing on the public’s newfound fascination with health and wellness. Interestingly, the trend toward healthy eating looks to be bolstering Jennie-O sales, since turkey is viewed by many as a better, leaner protein alternative to beef and pork.
Emerging Markets: Food service in China, in particular, represents an attractive growth opportunity for the company. In the U.S., Hormel has been making strides in the food service channel (part of its Refrigerated Foods segment) by targeting large university and health care customers. And we envision the company making similar advances overseas, which should be a big part of the enduring bull story here.
Threats
Raw Material Inflation: The company, like many of its industry peers, is benefiting from a benign commodity environment these days, especially lower feed costs. But high input expenses have a history of pressuring margins from time to time. In addition, a deterioration in dynamics across the protein markets would likely be bad news for the bottom line. Though protein prices are strong now (and exhibit little sign of easing), this could change in short order if global turkey and pork supplies were to increase materially.
Competition: To be sure, Hormel has plenty of rivals in the domestic food sector, from traditional protein-based companies like ConAgra (CAG) and Tyson Foods (TSN) to large packed food outfits like Mondelez International (MDLZ) and Kraft Foods Group (KRFT). Thus, it will need to execute well as it continues to climb the value ladder. Any missteps would likely result in market-share erosion.
Conclusion
In sum, although competition and commodity exposure are modest concerns, Hormel’s strengths and opportunities easily appear to outweigh its weaknesses and threats at this juncture. And while the issue, already trading at a premium to the broader market, does not seem to be a bargain at recent levels, we believe that risk-adjusted returns (when factoring in good dividend growth) ought to be decent. What’s more, our longer-term projections and those of the Wall Street crowd are probably conservative, considering Hormel’s underleveraged balance sheet and knack for inking accretive acquisitions. Indeed, M&A activity is apt to stay high on management’s agenda, as the company seeks further diversity and an acceleration in growth in this mature industry.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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