Hormel Foods - Well-Led Food Business Warns For Food Cost Inflation

| About: Hormel Foods (HRL)


Extremely well-led food business with a rock solid balance sheet.

Reports solid results, but warns for food cost inflation.

Await a correction before making an investment at current levels.

Investors in Hormel Foods (NYSE:HRL) are not pleased with the company as management is foreseeing pressure later this year from food cost inflation on its margins.

While the company is holding onto its full year outlook, risks are emerging to the downside in combination with a ¨full¨ valuation for the company's shares.

Second Quarter Highlights

Hormel Foods reported second quarter sales of $2.24 billion which is up 4.3% on the year before.

Operating earnings improved by 15.3% to $213.2 million while net earnings came in at $140.7 million. Reported earnings came in at $0.52 per share, six cents higher compared to last year.

Growth Driven By Refrigerated Foods

Hormel's topline growth was driven by the refrigerated foods business which reported a 9.9% increase in sales, coming in at $1.11 billion. Segment earnings rose by 38% driven by higher pork operating margins.

International sales which rose by 22.7% to $144.0 million were the other bright spot. The sales performance of the unit was driven by sale of pork and Skippy peanut butter in China.

Sales of grocery products, Jennie-O Turkey Store and Specialty Foods were on the decline. In the latter segment, Hormel was pressured from the expiration of an agreement allowing Diamond Crystal Brand to sell sugar substitutes.

The company did a good job boosting its gross margins by 48 basis points to 16.87% of sales. The company did a great job at cutting costs, reporting a decrease in selling, general and administrative costs in actual dollar terms.

Food Cost Inflation Dominates The Outlook

Hormel Foods is seeing higher pork, beef, turkey and advocado costs driven by tight raw material supplies which will put pressure on margins, especially in the latter half of this year.

Despite these pressures, the company maintains the earnings guidance of $2.17 to $2.27 per share.

Operating With A Clean Balance Sheet

Hormel ended the quarter with $499 million in cash and equivalents while debt stands at $250 million, resulting in a solid net cash position.

At the current pace, Hormel is on track to generate revenues around $9.1 billion as revenues could come in around $575 million. Trading at $46.50 per share, equity is valued around $12.3 billion which values operating assets of the firm at $12 billion.

This values operating assets at roughly 1.3 times annual revenues and 20-21 times annual earnings.

The $0.20 per share quarterly dividend provides investors with a 1.7% dividend yield. The latest dividend marks the 343rd consecutive quarterly dividend paid by the company.

A History Of Shareholder Returns

Hormel has done extremely well for its shareholders in recent years. Shares traded mostly between $15 and $20 in the years ahead of 2010 when shares broke out towards the upside. Ever since shares have seen a big run-up, trading as high as $49 a few weeks ago.

Underlying this growth is a compounded annual growth rate of 6% for Hormel's sales between 2005 and 2013, accompanied by a 10% annual growth rate in earnings per share. The company's $700 million acquisition of Skippy last year appears to be a great move in hindsight. With the brand, Hormel owns the second largest US peanut butter brand behind Cif which is owned by J.M. Smucker (NYSE:SJM) while gives the company access to quick growth in China.

Despite this acquisition and addition of Mexican and Spanish based food brands in the years before, Hormel has a rock solid balance sheet, net holding cash of roughly $250 million.

I think the company's management is doing a great job and that the business is operating well, yet the valuation has outpaced all the operational achievements as Hormel's shares have been lifted just like the wider market.

As such I will not consider taking a position until a sizable correction takes place.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.