Hormel Foods: The Headwinds Are Likely Temporary
Summary
- Hormel's profitability and efficiency have been gradually declining over the past years.
- On the other hand, the firm has remained strong from a liquidity point of view, as both the current and the quick ratios are above 1.
- The macroeconomic challenges, along with the recent outbreak of the avian flu, have been all negatively impacting HRL's financial performance lately.
- We, however, believe that these headwinds are temporary.
- For these reasons, we maintain our "buy" rating.
David McNew
Hormel Foods Corporation (NYSE:HRL) develops, processes, and distributes various meat, nuts, and food products to retail, foodservice, deli, and commercial customers in the United States and internationally.
This year, we have already published three articles on Hormel, rating the firm's stock as "buy" each time. The stock has not been performing particularly well, however, and it has declined substantially in March, after Argus downgraded the stock, due to a weak earnings outlook. They have also made references to the relative valuation of the stock at the current price levels.
Analysis history (Author)
Each time, our argument has been revolving around the firm's relative independence from consumer confidence levels and its safe and sustainable dividend payments, along with the latest quarterly results.
Today, we will be approaching Hormel's business from a different angle. Our focus will be on the company's efficiency and profitability, as well as its liquidity and leverage.
Net profit margin
One of the most commonly used profitability measures is the net profit margin. This measure shows, how much of the firm's revenue is left after accounting for all expenditures. It is essentially the ratio between the net income and the revenue.
The following chart shows, how Hormel's net profit margin has been developing over the past years. We can clearly see that since 2020, there has been a gradual decline. Ideally, we would like to see the net profit margin remain stable or increase.
The reason for the contraction is mainly the increase in costs, especially the increase in the cost of goods sold. At the same time, SG&A expenses have also increased, but not to the same extent.
The current macroeconomic environment, including elevated inflation levels, volatile energy prices, high transportation costs are all creating headwinds for HRL's business. However, we believe that these headwinds are temporary in nature, and are not only affecting HRL. In general, we have an optimistic view about the second half of the year. In our opinion, the macroeconomic conditions are likely to start improving towards the second half of the year, which could have a positive impact on the net margin and also on the stock price.
When comparing HRL's numbers with those of its competitors, HRL does not seem to stand out, in terms of net profit margin.
Comparison (Seeking Alpha)
Asset turnover
Asset turnover (= asset utilization) is an efficiency measure. It indicates, how effectively the firm is able to use its assets to generate sales. Just like with the net profit margin, here we would also prefer to see a stable or improving asset turnover. This is however not the case for Hormel. As shown in the following chart, efficiency has been gradually declining since 2019.
The reason for the decline is that the amount of assets has been growing at a faster pace than the sales.
If we look at the comparison table in the previous section, however, we can see that, despite the decline, HRL's asset turnover compares favorably to the efficiency of its competitors.
An important reminder: We have been elaborating on the reason for the sales decline in our previous article:
Jennie-O Turkey Store
Both volume and net sales fell substantially in this segment in Q4. The highly pathogenic avian influenza (HPAI) has been responsible for this decline. On the other hand, this segment delivered the highest profit growth year-over-year and contributed significantly to the margin expansions, higher commodity prices, and improved value-added mix.
Just like with the net profit margin, we also believe that the headwinds affecting the asset turnover are temporary. While this outbreak has been labeled as the "deadliest outbreak of bird flu that the US has ever seen", the Biden administration is working hard to contain the flu.
Leverage and liquidity
The following chart shows two widely used liquidity measures: the current ratio and the quick ratio. If these ratios are above 1, it means that the current assets are enough to cover the current liabilities. (The quick ratio excludes the inventory from the current assets.)
These two measures have been improving over the past 5 years.
These measures also compare favorably to HRL's peers and competitors, as most of them have current- and quick ratios lower than 1. As shown in the table, the amount of debt in the capital structure also compares favorably to that of its peers.
Comparison (Seeking Alpha)
We believe that in the current challenging macroeconomic environment, financial flexibility is of high importance. For this reason, we are glad to see that HRL remains in a strong position from a liquidity point of view.
Our take
On one hand, Hormel's financial performance, including its profitability and efficiency, has been declining gradually over the past years. The challenging macroeconomic environment as well as the recent outbreak of the avian flu have both been impacting the firm negatively. On the other hand, we believe that these headwinds are temporary.
Further, we still believe that HRL is an attractive investment for dividend- and dividend-growth investors. The company pays a safe and sustainable dividend, as they have done so in each of the last 21 years. They have also managed to increase their dividends each year.
For these reasons, we maintain our "buy" rating.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
Past performance is not an indicator of future performance. This post is illustrative and educational and is not a specific offer of products or services or financial advice. Information in this article is not an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. Expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. This article has been co-authored by Mark Lakos.
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Comments (4)
This year, we have already published three articles on Hormel, rating the firm's stock as "buy" each time. The stock has not been performing particularly well, however, and it has declined substantially in March, after Argus downgraded the stock, due to a weak earnings outlook. They have also made references to the relative valuation of the stock at the current price levels.
