Hormel Foods: Free Trade Agreement With South Korea Offers Growth

| About: Hormel Foods (HRL)

American producers of the other white meat won an important victory in the recent free trade agreement with South Korea, one of the four largest importers of beef and pork in the world. Pork exports, which have increased markedly this year, will likely continue to provide revenue and profit growth for companies, such as Hormel Foods (NYSE:HRL).

The agreement phases out fresh pork import tariffs of 22.5% over ten years. Across the industry, United States pork exports climbed 43.6% in August from last year. Exports to South Korea, which has been wrestling to match supply and demand since its foot and mouth outbreak earlier this year, were up 146%. This trend in rising exports is likely to continue as US products become more competitive on prices.

At Hormel, international sales - which make up the company's "all other" segment and include exports to South Korea - rose 35.4% to $84.5 million last quarter from last year. Segment operating profit increased 66.8% on a 22% jump in volume. Such sales account for 4.4% of Hormel's sales, up from 3.6% last year, and are likely to improve, as US pork producers cut into other countries, like Canada's, export share. According to Dermot Hayes, an economist with Iowa State University, the approval of FTA's with Korea, Columbia and Panama may increase U.S. pork exports by $770 million annually.

Overseas strength helped Hormel's total sales increase 10% to $1.9 billion last quarter. Earnings came in at $0.36, up 13% from the same quarter last year. Increased clarity allowed management to guide the full year to $1.70-$1.75 per share in earnings, up from prior forecasts of $1.67-$1.73. In spite of Chicago hog prices hitting all time highs this year in part on Korean demand, Hormel has been able to boost the bottom line. Last quarter, operating margins expanded to 11.1% from 10% the prior year.

Next year will likely offer upside too. South Korea's herd will recover from 2011 culling, which could depress hog prices and offer margin upside for Hormel. At the same time, however, South Korea's appetite for pork imports, while down from 2011, is expected to remain high. The US may ship 170,000 tons of pork to South Korea next year, much higher than the 100,000 tons it was shipping prior to the foot and mouth disease outbreak.

The globalization of Hormel's products is one reason the company believes it will grow sales at a compounded rate of 5% through 2016. Since 2004, Hormel has been able to exceed this mark, growing 6%. At the same time, earnings have grown at a rate of 12%. And, earnings have grown at an impressive 11% annual rate since 1984. This growth has come not only from rising overseas sales, but also thanks to new products, expansion of its private label brands and joint ventures, such as Hormel's 50% stake in Mexican food company Megamex.

Healthy margins have boosted free cash flow, supporting dividend growth. Since 2006, Hormel's dividend payout has risen by a compounded rate of 13% annually and at current levels, the stock yields 1.7%. Earnings growth also fueled the buyback of 1.5 million shares last quarter and has helped the company reduce its debt. Even after the purchases, the company still has 6 million shares remaining on its buyback authorization. And, its debt level has dropped to $250 million from $350 million this past year, which has helped reduce interest expenses.

As the company continues to expand its footprint in emerging markets, leveraging rising demand in part tied to free trade, shareholders are likely to be rewarded. Particularly given the company's skill at navigating volatile commodity markets and launching new products. If hog prices stay high on export market demand, Hormel has proven it can grow earnings. If they fall, margins will support the bottom-line. This suggests investors will be rewarded regardless of which way the commodity basket trades in 2012.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in HRL over the next 72 hours.

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