Give credit where due - Hormel (NYSE:HRL) is not just playing lip-service to the idea of being a more diversified packaged foods player. While many companies talk about wanting to make bold moves, Hormel has shown over and over again that its management team is actually willing to do it. The question, though, is whether the company's $700 million purchase of the Skippy peanut butter brand from Unilever (NYSE:UL) is a bold move forward for the business, or a step too far outside of its competency.
What Hormel Is Getting
I suspect every reader (at least in North America) knows exactly what Skippy peanut butter is; you likely either grew up as a Jif-eater or a Skippy-eater. This brand goes back about 80 years, but Unilever has only owned it for about the last dozen years (having bought it with the Bestfoods deal in 2000). Skippy currently has 11 varieties in the U.S., where it is the #2 peanut butter brand (behind Smucker's (NYSE:SJM) Jif).
Hormel is paying $700 for this iconic brand, against about $370 million in trailing revenue. That works out to a relatively steep 1.9 times revenue - a 20% premium to industry norms right now. While paying a premium for a leading brand can make sense, Skippy's approximately 16% share in the U.S. is about half that of Jif.
ConAgra's (NYSE:CAG) Peter Pan is a distant #3 (sub-10% share), while Boulder Brands (NASDAQ:BDBD) (formerly known as Smart Balance) is also active in the space, as well as many private label producers. Last and not least, Kraft Foods (NASDAQ:KRFT) is making another push into peanut butter with its Planters brand.
In addition to the brand, Hormel will be acquiring two manufacturing facilities (one in Arkansas, the other in China).
Broadening The Line-Up
Hormel has been quite active over recent years in doing deals to broaden its addressable market beyond traditional products like SPAM, Dinty Moore and Hormel Chili. In particular, Hormel has spent aggressively to build and support a growing Mexican/Latino foods business, primarily through its MegaMex joint venture. At the same time, the company has ramped up its internal product development efforts, delivering product lines like Hormel Compleats to store shelves.
While addressing the Hispanic market is a good opportunity for growth within North America, Hormel is also increasingly working on building its brand overseas. To that end, it's worth noting that Skippy is actually the leading peanut butter brand in China (ahead of Jif), but less than 30% of the brand's sales come from outside the U.S. today.
Risk Versus Opportunity
If you compare the margins and returns on capital of businesses like Kraft Foods or General Mills (NYSE:GIS) to those of protein producers like Tyson (NYSE:TSN) and Smithfield (NYSE:SFD), it's not hard to see why Hormel's putting so much more emphasis on packaged goods. Likewise, looking at Hormel's internal returns basically supports this analysis - its packaged/processed businesses generally produce better (and more consistent) returns. Moreover, Hormel management's own guidance suggests that Skippy could be about twice as profitable as its current base business.
To that end, it's not terribly surprising that Hormel would be interested in a business like Skippy. I think investors should also take note that Unilever hasn't been doing all that well with its food businesses recently, and has been selling off brands (including selling the Bertolli and P.F. Chang's brands to ConAgra this summer). So while Hormel is buying a brand that's a distant #2 today, I wouldn't automatically assume that that's always going to be the case - particularly given Smucker's own recent challenges with promotions and price/volume elasticity. It's also worth noting that Smucker locked itself into some hedges in the peanut butter business that should lead to higher near-term production costs, giving Hormel perhaps a little more pricing flexibility.
Of course, there are many ways this could all go wrong. Peanut butter is a food category that seems to have an above-average risk level with contamination/recalls, and just because Hormel can sell SPAM and pre-packaged BBQ, that's no guarantee it can do any better with the Skippy brand than Unilever did. Hormel's past success with brand/category expansion is a mark in its favor, but this deal still represents some risk.
The Bottom Line
I've liked Hormel for a long time, but this is a relatively popular company/stock that rarely trades at a significant discount to fair value. Hormel's sub-10 EBITDA multiple may look like a relative bargain compared to other food companies like Kellogg, Kraft Foods or Nestle (NSRGY.PK), but there is a reason for the discount. While Hormel earns solid returns on capital, it generates substantially less free cash flow per dollar of revenue than those aforementioned companies. Because of that less-efficient free cash flow conversion, Hormel is actually quite a bit more expensive than Kellogg, Kraft or Nestle on a discounted free cash flow basis.
All in all, then, while I do like this deal for Hormel, it doesn't really move the needle enough in terms of per-share fair value, and the valuation today doesn't entice me to buy.