Hormel Foods - Great Business, But Don't Pay This Current Great Price

Aug.26.14 | About: Hormel Foods (HRL)


Hormel Foods posted solid third quarter results.

Reported sales and earnings beat estimates on a lower than expected impact from higher input costs.

The company has a stellar track record and a strong financial position, yet the current valuation remains too high for me.

Investors in Hormel Foods (NYSE:HRL) were pleased with the company's third quarter results which the company released last week. Stronger than anticipated sales and earnings triggered enthusiasm among investors.

The company continues to be very well-led, reporting solid organic growth, making nicely accretive deals while operating with a very strong balance sheet. This has not gone unnoticed with competing investors who have been bidding up the shares, pushing up the valuation at levels which are no longer appealing in eyes. As such I remain a buyer on significant dips.

Third Quarter Highlights

Hormel Foods posted third quarter sales of $2.28 billion, a 5.8% increase compared to last year. Reported sales comfortably beat consensus estimates at $2.23 billion.

Reported net earnings to its shareholders have been up by 21.4% to $138.0 million, as earnings rose by nine cents to $0.51 per share on a diluted basis. This resulted in earnings coming in three cents ahead of expectations.

Looking Into The Numbers

Despite the solid reported increase in sales, overall volumes were down by 1%.

The company's biggest refrigerated foods business did well, posting 11.6% revenue growth on flat volumes to $1.19 billion. Strong pork pricing pushed margins with operating earnings doubling to $90.0 million. The retail and foodservice value-added products showed a healthy performance as well.

Sales of Jennie-O Turkey rose by 4.2% to $382.6 million, despite volumes being down by 2%. Margins of the turkey business expanded on strong turkey prices amidst lower feed costs, underlying a 41.9% increase in operating earnings to $64.8 million. This resulted in very comfortable operating margins of nearly 17%.

Weakness was seen at the grocery business, with sales being down by 2.9% to $359.5 million amidst a 3% fall in volumes. Canned meat and microwave meals suffered hard, also the result of higher input costs offset by a solid performance of Skippy and Hormel bacon toppings. As a result operating earnings were down by more than 36% to $33.8 million.

The smaller specialty food segments posted disappointed results, being largely the result of the expiration of the agreement with Diamond Chrystal Brands. International sales jumped by 18.3%, although total sales came in at just $133.7 million. This was amidst higher pork sales in China as well as the strong performance of Skippy in China.

Overall gross margins were up by more than 60 basis points to 15.9% of sales amidst higher meat costs and lower input costs in some key areas. At the same time the company demonstrated very strong operating cost control with expenses falling by nearly 30 basis points to 6.7% of sales, combined providing a nice boost to overall operating earnings.

A Look At The Valuation

At the end of the quarter, Hormel held about $530 million in cash and equivalents while debt of just $250 million results in a net cash position of about $280 million. With EBITDA of about a billion on a trailing basis, the company has the capacity and willingness to incur quite some leverage going forwards.

On a trailing basis Hormel posted sales of $9.0 billion on which it posted earnings of about $560 million. With 270 million shares outstanding at the moment at this point in time, and shares trading at $50 per share, equity is being valued at $13.5 billion. This values operating assets at about $13.2 billion after backing out the net cash holdings of the firm.

This values operating assets at 1.5 times annual revenues and 23-24 times annual earnings.

Solid Historical Growth, More Capacity To Do Deals

Hormel Foods has doubled its operations in terms of revenues over the past decade, which is quite an achievement given that the company turned a modest net debt position into a net cash holding at the same time.

Earnings have grown at a similar pace, as the company managed to reduce the outstanding share base by a tiny bit in the meantime, preserving the growth in its operations on a per share basis.

Earnings growth for this year is still seen within the $2.17 to $2.27 earnings per share range, although the company warned at the end of the second quarter that higher input costs might pressure earnings down towards the lower end of the range. Analysts have been forecasting earnings of $2.19 per share for this year. Momentum of Skippy peanut butter and snack wraps are expected to deliver solid results in the final quarter.

As stated before the company has enough balance sheet capacity and intentions to incur more leverage to buy other businesses to continue to grow the business in the future. These future deals should be consistent within the company's strategy to balance between protein, retail and pork while maintaining a solid financial position.

Recommendation For (Potential) Investors

Back in July, I last had a look at Hormel's prospects following the $450 million acquisition of CytoSport. With the acquisition of the ¨Muscle Milk¨ products, the company increased its reliance on protein, adding another $370 million in annual sales.

I applauded the deal which resulted in an improved growth profile, and earnings accretion, using some of Hormel's strong balance sheet power which the company still enjoys. CEO Ettinger furthermore re-conformed at the time that he feels comfortable racketing up the net debt position towards $2 billion, which allows the company to make a few more minor deals or even a bigger deal.

At the time I really liked the shares given the strong track record of profitably growing the business while having a lot of reserves in terms of the strong balance sheet. I furthermore was not really worried about comments about cost inflation, as these tend to be short term factors weighing on the performance.

I was and continue to hope for a $40-$45 potential entry point, valuing the business at about 20 times earnings. While this would still value shares at a 10% premium versus the wider market, I acknowledged the further potential to do deals in terms of financial firepower. This strong financial position and the very strong term track record of the business and its management are appealing in my eyes.

While shares have risen towards $50 in the meantime, I am committed to my disciplined target, cautiously awaiting any potential sell-off.

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.