Company Description (from recent 10-k)
Hormel Foods Corporation (HRL) engages in the production of a range of meat and food products and the marketing of those products throughout the United States and internationally. The Company operates in five segments: Grocery Products, Refrigerated Foods, Jennie-O Turkey Store (JOTS), Specialty Foods, and All Other. Internationally, the Company markets its products through Hormel Foods International Corporation (HFIC), a wholly owned subsidiary.
Hormel Foods is a dividend aristocrat that has raised its dividend for 46 consecutive years.
A 10-year summary of Sales, Earnings Before Interest and Tax (EBIT), Earnings per share (EPS), yearly high and low stock price, corresponding high and low P/E (calculated by dividing the high and low price by the EPS for the year), and average P/E (average of high and low P/E) is shown below. Prices are adjusted for stock splits.
Key 10-year data for Hormel Foods
Year | Sales (in Millions) | EBIT (in Millions) | EPS | High Price | Low Price | High P/E | Low P/E | Average P/E |
2011 | 7900 | 718.84 | 1.74 | 30.3 | 24.8 | 17.4 | 14.3 | 15.8 |
2010 | 7220 | 624.55 | 1.46 | 25.9 | 19 | 17.7 | 13.0 | 15.4 |
2009 | 6530 | 528.15 | 1.27 | 19.4 | 14.9 | 15.3 | 11.7 | 13.5 |
2008 | 6750 | 460.67 | 1.04 | 21.3 | 13.2 | 20.5 | 12.7 | 16.6 |
2007 | 6190 | 469.84 | 1.08 | 20.7 | 16.8 | 19.2 | 15.6 | 17.4 |
2006 | 5750 | 430.54 | 1.03 | 19.2 | 16.5 | 18.6 | 16.0 | 17.3 |
2005 | 5410 | 406.73 | 0.91 | 17.5 | 14.8 | 19.2 | 16.3 | 17.7 |
2004 | 4780 | 367.6 | 0.83 | 16 | 12.5 | 19.3 | 15.1 | 17.2 |
2003 | 4200 | 289.33 | 0.66 | 13.5 | 10 | 20.5 | 15.2 | 17.8 |
2002 | 3910 | 293.97 | 0.67 | 13.9 | 10.4 | 20.7 | 15.5 | 18.1 |
From these data, we can plot Sales, EBIT, and EPS versus Year, as shown in the chart below.
Sales (in Millions), EBIT (in Millions), and EPS versus Year for Hormel Foods, 2002-2011
As evident from the chart above, HRL has demonstrated very predictable sales and earnings over the past 10 years, allowing us to predict EPS in the near future, say in five years (i.e. Year 2016), using the linear regression equation for EPS = 0.1083 (2016) - 216.24 = 2.0928.
A conservative average P/E estimate for the stock can be obtained as follows:
Signature P/E: A well established stock has a signature P/E, an average P/E it commands in the market based on its business. We calculate this by averaging the Average P/E over the past 10 years, excluding any outliers (data points that fall significantly beyond the other data points). There are no significant outliers, so we average the Average P/Es from the past 10 years to arrive at a signature P/E of 16.7.
High P/E estimate: a conservative high P/E estimate can be calculated by averaging the five lowest High P/Es of the 10 High P/Es from the past 10 years. Averaging the 5 lowest High P/Es from the past 10 years gives 17.6.
Low P/E estimate: a conservative low P/E estimate can be calculated by averaging the five lowest Low P/Es of the 10 High P/Es from the past 10 years. Averaging the 5 lowest Low P/Es from the past 10 years gives 13.4.
Average P/E estimate: this takes the average of the High P/E estimate and the Low P/E estimate, as calculated above, to give a conservative estimate of an average P/E for the stock we can expect. Averaging 17.6 and 13.4 gives us 15.5.
Target Price
Multiplying our EPS projection for 5 years hence by the average P/E estimate gives us a projected average price for the stock: $2.0928 * 15.5 = $32.44, which represents an annual stock price return of 2.8% from the current price = $29. When we add in the 2.1% dividend yield, the total return expected is 4.9% per year, which means an investment in HRL today is expected to double in 15 years.
Given a beta = 0.47 for HRL, a risk-free rate = 2% (using the yield on 10-year Treasury bond as a benchmark), and estimated risk premium of about 5% for the general stock market, we have a discount rate = 2% + 0.47*(5%) = 4.35%. Applying this discount rate of 4.35%, our projected price of $32.44 in 5 years translates to a target price = $26 in today's dollars, which is 10% below the current price of $29 for the stock, suggesting the stock is slightly overvalued right now. For a good margin of safety, investors are well advised to buy only if the current price is at least 20% below the target price, which means a buy price of $21.
Market Expectation
What is the market's expectation of HRL's growth rate given its current market price = $29? Since stock price = dividend * (1 + growth rate) / (discount rate - growth rate), we have growth rate = ((stock price) * (discount rate) - dividend) / (stock price + dividend). Plugging in stock price = $29, dividend rate = $0.60, and discount rate = 4.35%, we get growth rate = 2.2%. This seems low, given that HRL has grown its revenue by 6.6% annually over the past 5 years. While growth is supposed to slow down as a company matures, a 2.2% expected growth rate appears low and suggests the stock is undervalued.
Current P/E Compared with Signature P/E
We should also determine how the stock's current P/E compares with its signature P/E, since established stocks tend to revert back to their respective signature P/Es over the long term. The current EPS = 1.74, giving us a current P/E = 16.7. This is the same as the stock's signature P/E, suggesting the stock is fairly valued right now. To provide some margin for error, we should look to buy when the current P/E is 80% or less of the stock's signature P/E, which means a buy price around $23.
Hormel Foods's P/E Compared with Competitors' P/Es
It is helpful also to compare Hormel Foods's valuations with those of its competitors and peers in the food manufacturing industry. Normalized P/E, Current P/E and Forward P/E are tabulated below for the company and its competitors/peers. Normalized P/E is calculated using average earnings over the past ten fiscal years. Current P/E uses earnings during the last fiscal year. Forward P/E uses projected earnings in the next year based on analysts' consensus.
Stock | Normalized P/E | Current P/E | Forward P/E |
Hormel Foods (NYSE:HRL) | 27.08 | 16.66 | 14.94 |
ConAgra Foods (NYSE:CAG) | 20.96 | 15.41 | 13.68 |
Kraft Foods (KFT) | 26 | 21.1 | 15.32 |
Tyson Foods (NYSE:TSN) | 25.67 | 9.42 | 7.97 |
Smithfield Foods (NYSE:SFD) | 20.07 | 7.42 | 8 |
Sara Lee (SLE) | 29.58 | 50.54 | 18.77 |
Mean | 24.89 | 20.09 | 13.11 |
Median | 25.835 | 16.035 | 14.31 |
Compared to its peers, Hormel Foods appears slightly overvalued on all three measures. Sara Lee is significantly overvalued on all three measures. In contrast, ConAgra Foods, Tyson Foods, and Smithfield Foods appear undervalued on all three measures. To be fair, Hormel Foods is a better company than all its competitors, as its earnings are more stable and its dividend record is stellar.
Risk Index
Lastly, we calculate the Risk Index, calculated as (Current Price - Forecast Low Price)/ (Potential High Price - Forecast Low Price) to give an estimate of the risk: reward ratio. Risk index less than 20% is desired, which gives us +200% potential returns for every risk of 50% loss we assume.
The Forecast Low Price is calculated by multiplying the Low P/E estimate by the Forecast Low EPS, to give a conservative estimate of low price for the stock in 5 years, assuming zero EPS growth and low valuation. Forecast Low EPS is estimated by averaging the EPS over the past 5 years. For growth stocks with predictable earnings growth, EPS in 5 years should not be any lower than this conservative estimate. For HRL, the forecast low EPS is equal to 1.318, so the Forecast Low Price = 13.4 * 1.318 = $17.60.
The Potential High Price is calculated by multiplying the High P/E estimate by the projected EPS in 5 years, giving us a price target in 5 years should the stock command a high P/E. For HRL, this equals 17.6 * 2.0928 = $36.93.
Thus, the Risk Index = ($29 - $17.60) / ($36.93 - $17.60) = 59%. Since this exceeds 20%, the stock has an unfavorable reward to risk ratio at the current price. A pullback to $21.40 would give a risk index less than 20%.
Conclusion
Hormel Foods Corporation, currently selling around $29, has a target price = $26, suggesting the stock is slightly overvalued. The stock appears overvalued compared to its peers, and downside risk appears to outweigh upside potential at the current price. Nevertheless, at the current price, the stock is expected to return 4.9 percent a year, it is selling near its historic P/E, and its market expectations are low. Therefore, I rate the stock a HOLD at the current price. A pullback to around $21 would provide conservative investors adequate margin of safety to buy as a long term investment.
Disclaimer: Use this information as a starting point for your own due diligence, before buying any stock. If you do buy, be sure to read any annual reports (10-K) and quarterly reports (10-Q) to ensure that the fundamentals remain good and the stock is on target to reach its projected price. After holding for five years, repeat the analysis detailed in the article to decide whether to continue to hold, add, or reduce your position.
Disclosure: I am long KFT.