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Shares of Hormel Foods (HRL) rose 3.7% in Thursday's trading session. The diversified food manufacturer announced the acquisition of Skippy peanut butter from Unilever (UN).

The Deal

Hormel Foods announced that it has agreed to acquire the number 2 peanut butter brand of the country in a $700 million deal.

Skippy sells 11 varieties of the popular peanut butter. The brand is furthermore leading in the fast growing natural peanut butter sub-category. The total US peanut butter market is $2 billion dollar large, according to market research. Additionally, Skippy holds a leading position in China and is sold in over 30 other countries. The J.M. Smucker Company (SJM) is still the market leader with its well-known CIF brand.

Jeffrey M. Ettinger, Chairman of Hormel, commented on the deal, "The acquisition of Skippy peanut butter business represents a significant opportunity for Hormel Foods. It allows us to grow our branded presence in the center of the store with a non-meat protein product and it reinforces our balanced portfolio. The fast growing international line will also strengthen our global presence, and should be a useful complement to our sales strategy in China for the SPAM family of products."

Hormel expects that total sales will be approximately $370 million per annum, of which $100 million are international sales. The price tag values the business at roughly 1.9 times annual revenues.

The deal is expected to be accretive to full-year fiscal 2013 earnings per share. Accretion to full-year earnings for the fiscal 2014 could be between 13 and 17 cents per share.

The deal is subject to normal closing conditions, including regulatory approval in the US and other relevant jurisdictions.

Valuation

Hormel Foods ended its fourth quarter of fiscal 2012 with roughly $760 million in cash, equivalents and short-term investments. The company operates with $250 million in long-term debt, for a net cash position of $510 million, providing sufficient financial flexibility to close the deal. Hormel indicated the majority of the deal will be financed with cash at hand, and a small portion from existing credit lines.

For the full year of 2012, Hormel generated annual revenues of $8.23 billion. The company net earned $505 million for the year, or $1.86 per diluted share.

The market currently values Hormel at $8.7 billion. Factoring in the net cash position, operating assets are valued around $8.2 billion. This values the firm at 1.0 times annual revenues and roughly 16-17 times annual earnings.

On Wednesday, Hormel announced a two cent dividend hike. Consequently, the company pays a quarterly dividend of $0.17 per share for an annual dividend yield of 2.0%.

Some Historical Perspective

For the full year of 2012, shares of Hormel have traded in a tight trading range. Shares ended the year near the high end of the $27-$32 trading range, and are currently exchanging hands at $33 per share which is a fresh all-time high.

Shares rose from lows of $13 in 2008 to the fresh highs on improved operating performance. The company increased its annual revenues by roughly a quarter between 2009 and 2012. Earnings rose almost by half over the same time period.

Investment Thesis

Shareholders of Hormel applaud the deal with Unilever despite the fact that the price tag at 1.9 times annual revenues is a bit steep compared to Hormel's own valuation of 1.0 times annual revenues. Furthermore the price tag comes in far above analysts' estimates of $300-$500 million. The deal will increase annual revenues by roughly 4 to 5%.

Investors don't seem to mind that Hormel pays a premium on a revenue basis. The estimated $0.13-$0.17 per share earnings accretion for next year, translates into additional earnings of $34-$44 million. Most of the earnings accretion is the result of putting the low yielding cash balances to work.

Investors furthermore applaud the diversification move. Hormel's margins have been volatile on higher pork and beef prices as well as volatile grain prices. The peanut butter business should provide some margin stability across the board.

I think the deal is a net positive. The steep price can be justified given the significant accretion that Hormel expects and the diversification benefits. In August of 2012, I took a look at the prospects for Hormel, which at the time was trading around $28 per share. I expected shares to set new all-time highs later in 2012. Trading at $33 per share at the moment, shares have moved up too much to make the risk-reward attractive to my taste.

Source: Hormel - Addition Of Skippy Sends Shares To Fresh All-Time Highs