Hormel Foods: Stagnation

Summary

• Hormel Foods has seen a few tough years with stagnating sales and declining earnings.
• The company is off to a very soft start to 2023.
• The premium multiple, deserved during the 2010s, no longer seems deserved here.
• Lagging operating performance and higher interest rates make me cautious, despite continued share price stagnation.
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Justin Sullivan

Shares of Hormel Foods (NYSE:HRL) have come down further which does not really surprise me, as I called shares "not too delicious" in the final days of 2022.

In that article I concluded that Hormel was a growth darling in the 2000s, as the firm has seen stagnant sales and earnings in more recent years. This performance did not rhyme with a premium valuation being awarded to the shares, certainly not in a rising interest rate environment.

A Quick Look Back

A $10 stock in 2010 saw huge momentum as the company saw strong organic growth in the years which followed, accompanied by interesting M&A moves, causing shares to peak in the $40s already in 2016. After a temporary pullback, shares have traded in a $40-$50 range ever since. That valuation made sense in 2018, when the company earned nearly $2 per share, while it paid a $0.75 per share dividend, as a near $10 billion business looked to be in solid shape from an operating point of view.

What followed were stable revenues just below the $10 billion mark but earnings of nearly $2 per share had steadily come down towards $1.50 per share. What followed was a big deal in 2021, when Hormel acquired the snack nuts portfolio Planters from Kraft Heinz (KHC) at a $3.35 billion headline price.

Not necessarily being a bargain, the deal could boost pro forma earnings to about $1.70 per share, and add a bit of leverage, a combination which made me cautious. The impact of this deal was seen in the outlook for 2022, a year in which sales were originally seen between $11.7 and $12.5 billion, with earnings seen between $1.87 and $2.03 per share.

That decent outlook quickly dissipated as the company dealt with inflation during 2022. This made that the midpoint of the sales guidance was hiked to $12.5 billion throughout the year, but earnings were only seen at around $1.82 per share amidst margin pressure, as the company actually delivered upon these numbers.

As the company hiked the dividend for the 57th year in a row, the $1.10 per share dividend translates into very higher payout ratios. Fortunately, net debt has fallen to $2.2 billion (as of late 2022), and with EBITDA trending at $1.6 billion, leverage is very reasonable at 1.4 times.

With the company guiding for 2023 sales between $12.6 and $12.9 billion, that is basically an admittance that sales will not keep up with inflation as full year earnings are seen between $1.83-$1.93 per share, falling short compared to the original 2022 guidance, even as they suggest earnings growth in 2023.

This was not so impressive, as the company still traded at 24 times earnings at $45 in December, as this soft performance and reliance on meat makes me cautious, with risks seen to the 2023 guidance.

And Now?

Shares of Hormel have seen a tough first quarter as shares fell from $45 by year end to a low of $38 and change, with shares now trading at $40 per share. This is a substantial decline, certainly for a consumer staple.

On the corporate new front little news was seen, other than the release of tough first quarter results early in March. First quarter sales fell more than 2% to $2.97 billion, amidst declines in each of the three business segments: retail (about two thirds of sales), food service and the international business. While the latter was particularly impacted by the stronger dollar, the overall performance was lackluster. The lower absolute sales numbers are very soft, certainly in an inflationary environment, as the underlying volume trends have been much worse than the reported 2% fall in sales.

Amidst the deleveraging in volumes through the system, the company posted a 9% fall in operating earnings to $281 million, with quarterly earnings down four cents on an annual basis to $0.40 per share. Net debt came in at $2.7 billion which was quite a bit higher largely due to an investment made in December when Hormel acquired a 29% stake in Indonesian-based Garudafood. The size of the investment, the minority stake and the location raises some strategic questions of course. At a $411 million price tag, this is a relative large deal in dollar terms, equivalent to about 2% of the enterprise valuation.

The company continues to see 1-3% growth in sales for the year, with earnings now seen between just $1.70 and $1.82 per share as the company cut the guidance already by ten cents after a softer first quarter.

Tough Times Continue

After a tough start to the year, the company has seen a 24 times earnings multiple based on a midpoint of earnings of $1.88 per share come down to 22–23 times based on a midpoint of $1.76 per share by now. It is clear that momentum is soft, as I have some questions on the Indonesian acquisition as well.

The reality is that the company seems to have lost some of its touch which it saw in the 2010s, as the current multiples do not look compelling, not at all given the outlook. Given all of this I am extremely cautious here given higher leverage, continued growth disappointments and above 20 times earnings multiples.

The only upside which could be seen is that if momentum returns in terms of sales and higher margins as well, although margins historically only have come in a point or two higher than seen now. That has the potential to boost earnings power just above $2 per share, and even if that is achieved, which is a big if, shares still trade at an 18-19 times earnings multiple.

For me, Hormel remains not interesting, despite the lagging share price, fully explained by the lagging operating performance.

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.

Comments

[Real007]

Stagnation? Not really -- it's crumbled since Jim Cramer recommended it Nov 2022:

twitter.com/...

[Dr. Tan]

I like the concept of an acquisition in the Asian market. Even if it's starting as a minority interest.

[smadadet]

People always have to eat. Hormel is a safe stock in these uncertain times. Nothing China, Russia, the Fed, or bad weather does will have much affect on the company.