Hormel Foods - Beefing Up Its Protein Business

Jul. 2.14 | About: Hormel Foods (HRL)

Summary

Hormel Foods acquires CytoSport in a $450 million deal.

This deal follows a very successful string of acquisitions; more future deals are anticipated.

Strong momentum has pushed up the valuation a lot. Shares offer appeal on dips.

Hormel Foods (NYSE:HRL) announced yet another deal after making a string of acquisition in recent years. This time it acquired CytoSport, adding to its protein business in a move that will allow Hormel to report sales of $10 billion perhaps as soon as next year.

Hormel remains very well managed, and operates with a strong balance sheet. Yet shares have increased alongside the wider market, creating limited appeal in my eyes at current levels.

The Highlights Of The Deal

Hormel announced that it has entered into an agreement to acquire CytoSport Holdings, the producer of "Muscle Milk" products. Under the terms of the deal, Hormel is spending roughly $450 million to acquire the company.

CytoSport provides premium protein products within the sports nutrition category. This is a growth area, as athletes are not the only ones having Muscle Milk as part of their training schedule. Busy consumers are opting more often for meals they can drink quickly as part of breakfast or after lunch.

The deal is expected to be completed as soon as July of this year.

Strategic And Finical Rationale

The acquisition of CytoSport is in alignment with Hormel's focus on protein, mostly through beef products, while diversifying its portfolio. CytoSport will be a "growth catalyst" for the Specialty Foods segment, expanding into protein-rich foods, which appeal to younger consumers. With carbs being out of fashion along with the huge obesity challenges in the US, many consumers are choosing to add more protein to their meals. This allows Hormel to diversify from its still sizeable focus on meat products.

CytoSport was founded in 1998, and is the No.1 brand in the ready-to-drink protein beverage category, according to the press release. CytoSport generated sales of about $370 million for 2014, which implies a revenue multiple of about 1.2 times revenues. Including transaction costs, the deal will have no impact on Hormel's 2014 earnings, and limited accretion of about $0.05 per share is anticipated for the fiscal year of 2015.

Nothing has been mentioned regarding financial synergies of the deal. Hormel is likely to benefit from the employment of cheap debt to finance the deal, as well as potential back office cost savings to drive anticipated but modest accretion to 2015's earnings.

Recent Investor Presentation

Back in May, Hormel presented at the BMO Farm to Market conference. The producer of Skippy, Jennie-O, Hormel and Spam, among many other brands, commented on the guidance for the year.

Hormel is cautious for the second half of the year on higher beef, pork, turkey and advocado prices due to relative tight supplies. As a result, full year earnings are seen at the lower end of the $2.17-$2.27 earnings guidance.

To achieve long-term growth, Hormel will focus on innovation, leading brands and strategic acquisitions in growth categories. As such, the CytoSport deal fits perfectly within this framework. Hormel has a solid track record making numerous acquisitions over the past decade in a wide variety of segments of the food industry. For example, a few years ago the company made several modest acquisitions in the "Mexican" food business, in deals which paid off with increased demand for foreign cuisine.

Valuing Hormel

Back in May, Hormel released its second quarter results. The company ended the quarter with $499 million in cash and equivalents while having just $250 million in total debt, for a solid net cash position. Following the deal, Hormel will operate with roughly $200 million in net debt, which is a limited leverage position given the large size of the firm.

At this pace, annual revenues are anticipated to break through the $9 billion mark as earnings are anticipated to approach $600 million per annum. Note that this excludes any contribution from CytoSport, which will add a few percent to earnings and revenues.

At $49 per share, Hormel's equity is valued at roughly $13 billion. This values equity in the business at 1.4 times sales and roughly 21-22 times earnings.

Hormel's quarterly dividend of $0.20 per share provides investors with a 1.6% yield.

Takeaway For Investors

The deal appears solid with Hormel paying a fair revenue multiple and the acquisition being modestly accretive to earnings next year. Expected accretion of $0.05 per share implies an after-tax earnings contribution of $13 million after adjusting for financing costs. These are seen at roughly $15 million per annum on an after-tax basis, assuming all the funds will be borrowed.

As such, CytoSport is anticipated to earn about $28 million per annum after tax based on an unleveraged basis, which values the company at roughly 16 times earnings.

Note that this might not be the last deal. Hormel CEO Jeffrey Ettinger has indicated before that Hormel might incur up to $2 billion in net debt to do more deals. This is amidst a great consolidation efforts in the food industry driven, of course, by the battle for Hillshire Brands (NYSE:HSH).

Back in May, I checked out Hormel's prospects following the second quarter earnings release. I concluded that Hormel was a very well-led business with a rock solid balance sheet, yet food cost inflation was casting a shadow on the anticipated performance in the second half of this year. The solid past performance, driven by great acquisitions like the $700 million acquisition of Skippy as well as various other smaller deals, create appeal.

Unfortunately, shares have risen nearly 30% over the past year, being lifted alongside the general equity markets. I really like the shares, however, I am waiting for a better entry level, hopefully in the $40-$45 region. These levels would be a re-test of this year's lows and value shares at 20 times earnings. While that is still a modest premium to the market averages, Hormel has the capacity to add debt for making deals and has great management with a strong track record to do so.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.