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Hormel Foods (NYSE:HRL) has performed well historically and expanded EBITDA every year since 2003 (a remarkable feat given the ubiquity of the great recession). While the current yield is low at 1.7%, the recent dividend growth more than makes up for it (15%+ compounded annual growth rate since 2009). Investors in Hormel Foods shouldn't be looking at the yield they are getting today, but they should be buying the stock for its yield years from now.

I. COMPANY OVERVIEW

Hormel Foods produces of a variety of meat and food products. The meat products are sold fresh, frozen, cured, smoked, cooked, and canned. The shelf-stable segment includes canned luncheon meats, microwaveable entrees, stews, chilies, hash, meat spreads, flour and corn tortillas, salsas, tortilla chips, and other items that do not require refrigeration. Other products include nutritional food products and supplements and industrial gelatin products.

II. HISTORICAL PERFORMANCE

20092010201120122013
Revenue$6,533.7$7,220.7$7,895.1$8,230.7$8,751.7
% Growthn/a10.5%9.3%4.3%6.3%
Gross Profit1,098.91,248.51,334.11,331.91,412.8
% Margin16.8%17.3%16.9%16.2%16.1%
EBITDA658.9768.8839.7845.5918.0
% Margin10.1%10.6%10.6%10.3%10.5%
Net Income342.8395.6474.2500.1526.2
Avg Diluted Shares271.0270.7271.9268.9270.2
% Growthn/a-0.1%0.4%-1.1%0.5%

Note: All figures are MM's (except per share data) unless noted otherwise

Hormel Foods has performed well over the past five years with EBITDA expanding each and every year. The company's revenue expanded every year since 2009 at a compounded annual growth rate of 7.6%. The gross margin has trended negatively staying within a tight 1.1% range over the past five years (bottoming at 16.1% and peaking at 17.3%). On the other hand, EBITDA Margins have expanded from 10.1% in 2009 to 10.5% in 2013 resulting in EBITDA expansion from $659MM in 2009 to $918MM in 2013 (39% expansion) over the five year period.

Per Share Data
20092010201120122013
Revenue$24.11$26.67$29.04$30.61$32.39
% Growthn/a10.6%8.9%5.4%5.8%
Gross Profit4.064.614.914.955.23
EBITDA2.432.843.093.143.40
Net Income1.271.461.741.861.95
Dividends0.380.420.510.600.68
Payout Ratio30.0%28.7%29.2%32.3%34.9%
Dividend Growthn/a10.5%21.4%17.6%13.3%

Note: Per share data based on weighted average diluted shares outstanding.

On a per share basis, there isn't much additional to identify. The company had relatively flat weighted average shares outstanding, only slightly decreasing from 271MM to 270MM over the period (a 0.3% decrease). EBITDA per share has expanded from $2.43 to $3.40 (a 40% increase as compared to a 39% increase at the Company level). The company's dividends per share have been growing, increasing from $0.38 per share in 2009 to $0.68 per share in 2013 (a 79% increase or a 15.7% compounded annual growth rate) while maintaining a stable payout ratio in the 30% range.

III. CAPITALIZATION

Market / Par ValueEBITDA Multiple
- Cash and Equivalents$4340.5x
+ Total Debt$2500.3x
+ Minority Interest$60.0x
+ Market Capitalization$12,08913.2x
Total Enterprise Value$11,91113.0x

Note 1: Based on TTM EBITDA of $918MM as of 10/27/13.

Note 2: Market Cap based on 263.7MM shares outstanding and a $45.85 market price as of 1/17/14.

Hormel Foods has an under leveraged (and over equitized) capital structure. The company is levered at 0.3x TTM EBITDA (totally covered by cash on hand) with a total enterprise value of 13.0x TTM EBITDA. Ideally, the company would incur a little bit of low cost debt to leverage their equity returns. Even with moderate leverage, the company would have a low cost of debt and maintain significant financial flexibility while enhancing returns to the equity holders.

IV. PROJECTIONS

20142015201620172018
EBITDA$1,060.5$1,141.4$1,198.8$1,198.8$1,198.8
% Growth15.5%7.6%5.0%0.0%0.0%
Interest Expense12.512.512.512.512.5
Taxes303.8327.3344.0344.0344.0
Capital Expenditures123.3132.7139.4139.4139.4
Dividends210.9210.9210.9210.9210.9
Addl' FCF$410.0$458.0$492.0$492.0$492.0

Note: All figures are MM's (except per share data) unless noted otherwise. Consensus Estimates only relate to EBITDA projections. All other assumptions are based on unadjusted LTM actuals.

The consensus estimates for Hormel Foods are aggressive, projecting a growth rate between 15.5% and 5.0% annually through 2016 at the EBITDA line (projections unavailable for 2017 and 2018). Under the consensus case, the company is projected to have significant additional free cash flow available to reinvest in the business, repurchase shares (always assumed for modeling purposes), or increase the dividend.

20142015201620172018
Addl' FCF$410.0$458.0$492.0$492.0$492.0
Share Redemption Price$52.73$60.64$69.73$80.19$92.22
Shares Redeemed7.87.67.16.15.3
Wtd Avg Diluted Shares262.4254.9247.8241.7236.4
Dividends Per Share$0.80$0.83$0.85$0.87$0.89
Dividend Growth18.2%3.0%2.8%2.5%2.3%

The share redemptions are assumed to be at a 15% annually compounded price. I believe that this is structured very conservatively. If the weighted average redemption price exceeded this threshold, the investor would have ample opportunity and time to re-evaluate their position and consider selling their position for a gain from today's price. The company's share redemption would allow for a 2% to 3% increase in the dividend annually from the share redemptions alone. Additionally, the company's payout ratio would decline as the dollar amount of dividends paid would not be increasing while the company's earnings (using EBITDA as a proxy) would be increasing.

If the company performs in line with the consensus estimates and pay dividends / redeems shares as outlined above, the company would achieve the IRR / Cash on Cash returns illustrated below based on the outlined terminal EBITDA multiples.

Returns Based on Terminal EBITDA Multiple
10.5x11.0x11.5x12.0x12.5x13.0x
IRR4.8%5.8%6.8%7.7%8.6%9.7%
Cash on Cash1.24x1.30x1.35x1.41x1.47x1.54x

V. RECOMMENDATION

Management has demonstrated that they can execute well in the food space. EBITDA has expanded every year since 2003 and at a remarkable rate. The company has a history of growing the dividend every year for the past 48 years and most recently (since 2009) at a 15%+ CAGR. Further, the company has only expanded its payout ratio slightly from 30% to 35% providing evidence that the growth rate is sustainable into the future which isn't the case for all dividend growth investments (P&G - Slower Growth). Hormel isn't one of those companies that you buy for its yield today, it's one you buy and put away for awhile, then amaze yourself as you look back and say, "I only paid that much?"

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in HRL, over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Hormel Foods: Dividend Growth To Envy