Wait For A Pullback In Hormel Foods

| About: Hormel Foods (HRL)

Summary

Company has been correctly working to strengthen its product portfolio, to benefit from a shift in consumer preference towards protein-rich diet.

Company solid balance sheet position allows it to look actively for strategic acquisitions to support growth.

Stock is currently trading at a high forward P/E of 21x, versus its peers average forward P/E of 18x.

Hormel Foods (NYSE:HRL) has been delivering healthy performance, and the momentum is expected to continue to in the upcoming quarters. The company in the recent years has supported its revenue and margins growth through strategic acquisitions. Also, a shift in consumer preference in the U.S. towards protein-rich diet will continue to support the company's revenue growth. Moreover, in the near future, the company's revenues will benefit from a recovery in turkey production. However, the company's turkey segment's margins could come under pressure in the second half of 2016, because of excess supply. I believe, the company will continue to look for strategic acquisitions in the future to support its top line growth and improve margins, given its strong balance sheet position; HRL has a low debt to equity ratio of 5%, versus Tyson Foods (NYSE:TSN) debt to equity of 65%. However, the stock valuation seems full, as the stock is trading at a forward P/E of 21x, in comparison to its peers average forward P/E of 18x; therefore, I recommend investors to wait for a pullback, before initiating a buy position in the stock.

Growth Catalysts

Consumer preferences in the U.S. have been shifting towards protein-rich diet, away from processed carbohydrates, which will support HRL sales volume in the future. The company has been working to strengthen its product portfolio and position itself to benefit from the shift in the consumer trend towards protein-rich diet. HRL generates almost 70% of its total revenues from perishable poultry and meat, which will benefit from the shift in consumer trend towards healthy eating. Also, the company's has correctly undertaken strategic acquisitions in the recent years to support its revenue growth, and I think, it will continue to strengthen its product portfolio in the future years, through undertaking strategic acquisitions, and selling non-core brands.

Moreover, the company's new product launches and packaging innovation will continue to support its revenue growth. The company has increased its focus to support its organic revenue growth by introducing 'on-the-go' single-serve packaging, consistent with consumer demands, for its core products, including Hormel Pepperoni Stix and Wholly Guacamole Minis. Moreover, the company is building a new R&D facility, which will support its product innovation efforts and future revenue growth; HRL has increased its capital expenditure for FY16 to $250 million, up from $125 million in FY15. Product innovation remains an important growth driver for the company, and it has a strong track record of product innovation, almost 25% of its total revenues in FY15 were generated from products introduced since 2000.

Furthermore, HRL's turkey business is poised to deliver record performance in the ongoing FY16, which will be supported by lower grain costs and turkey segment's operations fully recovering from the last year's avian influenza outbreak. Also, the fall in commodity breast meat prices will positively affect its performance. Moreover, the company's international segment will support its revenue growth in the upcoming quarters. The company's product innovation efforts, in China and Asia-Pacific, will support its revenue growth. The company's management expects its international revenues to grow by 10% in the upcoming years, ahead of its total revenue growth target of 5%.

The company is currently operating at above normal margins, mainly due to favorable commodity prices. HRL's vertically integrated turkey business and shift towards value-added products have resulted in margin expansion the recent years; HRL currently has an operating margin of 13%, versus its last five years average operating margin of 10%, and its peers average operating margin of 9%. The company's increased focus on value-added products will allow it to generate high-profit margins in comparison to its peers; however, increase in turkey supply and lower pork margins, could put pressure on the profit margins in the second half of 2016, which will weigh on the stock valuation. The stock is currently trading at a high forward P/E of 21x, in comparison its peers average forward P/E of 18x. I will recommend investors to wait for a pullback before initiating a buy position in the stock.

Moreover, the company should actively explore opportunities to strengthen its product portfolio and market position by undertaking strategic acquisitions, mainly focused on expanding its presence in the value-added protein space, and the potential acquisition targets could be Johnsonville Sausage and Jack Links. Also, the company's strong balance sheet position will support its acquisition plans; HRL has a low debt to equity ratio of 5%.

Summation

The company has been correctly working to strengthen its product portfolio, to benefit from a shift in consumer preference towards protein-rich diet. Moreover, the company's shift towards value-added products and product innovation will support its revenue and profit growth. Moreover, the company solid balance sheet position allows it to look actively for strategic acquisitions, to support its long-term performance. Despite the company's correct strategic decisions and healthy financial performance, I will recommend investors to wait for a pullback in the stock price before initiating a buy position, as the stock is currently trading at a high forward P/E of 21x, versus its peers average forward P/E of 18x.

Disclosure: I/we 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.