Hormel Foods (HRL): A Beaten-Down Dividend King That’s Worth a Closer Look

Hormel Foods (HRL) is one of the truly elite stocks when it comes to consistent dividend growth and shareholder value creation.

 

Thanks to 51 straight years of dividend increases Hormel is now a dividend king, a group of stocks that have historically been some of the most successful at growing investor income and wealth.

 

Best of all, this highly recession resistant, low risk stock, which has grown its payout by 10.8% annually over the last 20 years, has underperformed the market by nearly 20% over the past year.

 

Let’s take a closer look to see why Wall Street has become so negative about Hormel and if now could be a reasonable time for long-term investors to give the stock closer consideration as part of a diversified dividend growth portfolio.

 

Business Overview

Founded in 1891 in Austin, Minnesota, Hormel Foods has proven to be one of the most resilient food providers in the world. The company’s well known brands include Skippy peanut butter, SPAM meat, Dinty Moore stew, Muscle Milk protein drinks, Wholly Guacamole dips, Jennie-O turkey, and numerous Hormel-branded products.

 

The business operates under five segments:

 

 

Segments

Refrigerated Foods (49% of sales, 43% of profit in 2016): sells branded and unbranded pork and beef products for retail, foodservice, and fresh product customers.

 

Jennie-O Turkey Store (18% of sales, 24% of profit): sells branded and unbranded turkey products for retail, foodservice, and fresh product customers.

 

Grocery Products (18% of sales, 19% of profit): sells shelf-stable food products predominantly in the retail market (Wal-Mart accounted for 14% of company-wide sales last year).

 

Specialty Foods (10% of sales, 8% of profit): sells private label shelf stable products, nutritional products, sugar, and condiments to industrial, retail, and foodservice customers.

 

International and Other (5% of sales, 6% of profit): sales of HRL’s products in international markets such as China.

 

Business Analysis

Hormel Foods is a rare breed in consumer foods because it has managed to build a moat in a highly competitive industry. That’s courtesy of its strong focus on adding only top name brands to its portfolio over time and investing heavily in advertising.

 

For example, Hormel owns the #1 or #2 brands in 35 product categories thanks to a number of well-timed acquisitions and focused brand investments:

 

• $220 million purchase of Wholly Guacamole in 2012
• $700 million acquisition of Skippy Peanut Butter in 2013
• $450 million purchase of Muscle Milk in 2014
• $775 million bolt-on of Applegate organic deli meats in 2015
• $286 million for Justin’s organic peanut butter in 2016

 

However, Hormel’s ability to not just meet but exceed its ambitious long-term growth goals of 5% top line and 10% bottom line growth isn’t just a function of steady industry consolidation. The company has wisely chosen to invest in building its brands over time, in order to achieve strong organic growth.

 

 

Hormel is a big spender on R&D, what it calls “innovation investments,” to help launch new product offerings both at home and abroad. However, as one of the largest consumer-branded food and meat manufacturers, Hormel’s primary key to success is favorably altering customers’ perceptions of its products to gain loyalty and market share.

 

The company spent approximately $204 million on advertising last fiscal year, an amount nearly six times greater than Hormel’s spending on R&D.

 

With many of its brands dating back over 50 years (e.g. SPAM and Dinty Moore were introduced in the 1930s) and supported by billions of advertising dollars over the years, consumers know and trust many of Hormel’s products.

 

Investment Into Existing Brands

 

 

The company also benefits from economies of scale. As one of the larger players in the market, Hormel is able to achieve lower production costs than smaller rivals and squeeze more value out of each advertising dollar it spends by extending well-known brands into adjacent product categories. Extensive regulations by the U.S. Department of Agriculture also disadvantage smaller competitors.

 

Then there’s the company’s strong track record of cutting costs and growing productivity. Hormel’s corporate culture is all about long-term profit maximization, which has allowed it to generate strong, consistent, and growing margins and returns on shareholder capital over time.

 

 

Even more impressive is that Hormel’s profitability manages to keep growing when the company already boasts substantially above-average profitability relative to its peers.

 

 

This steady improvement in margins, combined with both organic and acquisition-fueled growth, is why Hormel has managed to achieve positive earnings growth with consistency that few other blue chips can match.

 

 

Part of what explains Hormel’s amazing track record is the company’s rare corporate culture.

 

Specifically, Jay C. Hormel, the founder of the company, believed that corporations exist to serve the interests of all stakeholders, not just shareholders. That’s why he founded the Hormel Foundation in 1941, which over the past 75 years has donated $229.2 million to worthy charities in the Austin, Minnesota, community.

 

Today the foundation owns 5.2% of outstanding shares but 48% of voting control in the company, ensuring that the company is always focused on growing long-term wealth to both enrich investors as well as its local community.

 

This largely explains why Hormel has such a well balanced capital allocation strategy, in which management spends the company’s cash flow on a good mix of organic growth, acquisitions, as well as capital returns to shareholders (including the Foundation), including its notable 51-year dividend growth streak.

 

 

This long-term approach to running, growing, and optimizing the business has proven to be highly successful, generating total returns that have far exceeded its peers and that of the broader market over the last decade.

 

 

Management is confident that it can continue to improve margins going forward, which combined with an even higher dedication to R&D should allow Hormel to continue growing at a similar pace in the coming years, with top and bottom line growth of 5% and 10%, respectively.

 

 

If Hormel can realize this type of growth, its results will bode well for dividend growth investors, who can likely expect many more years and decades of consistent payout increases.

 

Key Risks

While Hormel’s dividend king status and continued strong execution make it a relatively low risk company to invest in, there are nonetheless still challenges the company will have to contend with in the coming years.

 

For one thing, while Hormel has done an admirable job diversifying away from traditional commodity meats and into higher margin value-added brands such as Jennie-O, Justin’s, and Applegate, 20% of its product mix is still in relatively commoditized meats. That means it’s harder for Hormel to maintain stronger pricing power, especially in an age of changing consumer preferences.

 

For example, today more and more consumers are avoiding the center of the grocery store (pre-packaged foods) in favor of the fresher, outer rim of the store.

 

In addition, while Hormel raises a lot of its own pigs and turkeys, which decreases its exposure to commodity prices, feed prices for those animals are still outside management’s control, as are pork and turkey prices. In fact, low turkey prices were a big reason for Hormel lowering its guidance recently, which sent shares plunging 7% in a single day.

 

Next, we can’t forget that 65% of of the company’s sales are derived from grocery stores, which means that Hormel doesn’t just have to deal with competing products from rivals, but also must deal with large grocery chains such as Wal-Mart (WMT), and Kroger (KR).

 

The risk here is that as disruptive e-commerce giants such as Amazon (AMZN) make a stronger push into America’s grocery market, large grocery chains could put increasing pressure on Hormel to lower its wholesale prices so that they can compete with Amazon’s ultra low prices.

 

This would make it ever more important for Hormel to squeeze out more and more efficiencies from its production lines in order to achieve the kind of growth management is targeting.

 

Which brings us to the final big risk, Hormel’s steadily increasing size. In order to move the growth needle, Hormel will likely have to accelerate the pace of its acquisitions in the future, either by purchasing smaller niche brands more frequently or buying larger, more established ones.

 

The problem is that at the higher end of the packaged food industry it’s often much harder to find good values, thanks to today’s cheap cost of capital and mega-caps such as Kraft Heinz (KHC) and Tyson Foods (TSN) bidding up the prices required to close such deals.

 

In addition, a lot of the success that Hormel has had in previous acquisitions is being able to buy brands such as Skippy Peanut butter, which despite being the #2 brand in America was suffering from mismanagement and underinvestment. That made it a great choice with plenty of low hanging fruit when it came to synergistic cost savings and strong brand building investment opportunities.

 

Going forward, Hormel may not be able to find enough high-quality brands available at a good value that fit management’s strict capital allocation criteria, resulting in slower EPS, FCF, and dividend growth in the future.

 

Hormel’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. HRL’s long-term dividend and fundamental data charts can all be seen by clicking here.

 

Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

HRL has one of the safest dividends investors can find with a dividend Safety Score of 100. That’s not surprising given its incredible 51 year streak of uninterrupted payout growth.

 

 

One of the biggest factors contributing to this highly consistent and secure dividend growth is management’s long-term discipline when it comes to maintaining highly conservative EPS and FCF payout ratios.

 

 

Hormel operates in the consumer defensive sector, meaning the sales of its popular food brands are recession resistant because people still need to eat (Hormel’s sales dropped by just 3% in 2009).

 

Combined with the fact that the company generally pays out just 30% to 40% of its earnings and FCF most years, this creates a very stable and large buffer to protect the dividend and keep it rising.

 

This is why Hormel was able to continue growing its dividend not just during the Great Recession, but also throughout numerous other economic shocks over the past half century.

 

The other major protective factor of Hormel’s dividend is the company’s squeaky clean balance sheet. A strong balance sheet is important because it provides Hormel with the financial flexibility to make opportunistic acquisitions of quality, undervalued brands while still funding the steadily growing payout.

 

 

Hormel’s balance sheet is one of the strongest in corporate America, with cash exceeding debt, a very strong current ratio (short-term assets/short-term liabilities), and a high interest coverage ratio. And when we compare Hormel’s debt levels to its peers, the soundness of its balance sheet becomes even more apparent.

 

That’s because the packaged food industry is highly capital intensive, with most of Hormel’s rivals having much higher leverage ratios and debt to capital ratios. By comparison, Hormel has barely any debt, granting it one of the industry’s best credit ratings and allowing it plentiful access to very low cost debt.

 

 

Overall, Hormel’s dividend is one of the safest in the market. The company has relatively low payout ratios, sells recession-resistant products, generates excellent free cash flow, and has a very healthy balance sheet.

 

Hormel’s Dividend Growth 

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

HRL’s dividend Growth Score of 79 indicates that the company has excellent dividend growth potential, far above the S&P 500’s 20-year median payout growth of 5.7%. That’s because Hormel has not just a solid track record of continuous dividend growth, but at a rate that few other dividend kings or dividend aristocrats can match.

 

 

Now keep in mind that Hormel’s current payout ratios are in its sweet spot, meaning they provide the optimal mix of dividend growth, security, and retained earnings and free cash flow with which to reinvest in the business. That means that going forward Hormel’s dividend growth is likely to closely match its EPS and FCF per share growth rate.

 

Given that management believes it can maintain 10% bottom line growth, investors could expect annual payout growth of about 10% over the long term, in line with Hormel’s 20-year norm.

 

Valuation

Over the past year Hormel’s short-term hiccups have resulted in substantial (17%) underperformance relative to the S&P 500. However, that weakness could potentially represent an appealing long-term buying opportunity.

 

That’s because prior to the past year, Hormel was arguably highly overvalued (HRL’s forward P/E ratio exceeded 26 in early 2016). However, Hormel’s current forward P/E ratio of 20.8 is much more in line with its industry median of 20.5, though still higher than its 13-year median of 17.8.

 

It’s also worth mentioning that Hormel’s dividend yield of 2% is somewhat higher than its historical norm of 1.8%. In fact, Hormel’s yield has only been greater than today’s 27% of the time in the past 22 years.

 

While Hormel’s stock doesn’t necessarily look like a bargain today, its valuation seems reasonable to me considering the company’s high quality (Hormel consistently earns a 15-20% return on invested capital), excellent balance sheet, portfolio of well-known brands, and outlook for above-average long-term growth.

 

Hormel has the potential to generate 12% long-term annual total returns (2% dividend yield + 10% annual earnings growth) if the future plays out as management expects, which would be a very solid return for such a quality company and a true dividend growth king.

 

Conclusion

When it comes to proven track records, quality management teams, and shareholder-friendly corporate cultures, it doesn’t get much better than Hormel Foods.

 

The recent correction in Hormel’s stock price appears to be driven by short-term fears (declining turkey prices, which are near a seven-year low) rather than issues that could affect Hormel’s long-term earnings power (Hormel’s other businesses remain stable to moderately growing, and management reaffirmed 2017 guidance).

 

While the share price still may not be a bargain at the moment and the turkey price issue could persist for another quarter or longer, I doubt it is an issue we will be talking about several years from now.

 

It’s hard to find a high-returning business like Hormel’s that also has a clean balance sheet and numerous opportunities for long-term growth. There’s a reason why Warren Buffett owns a number of consumer staples businesses in his dividend portfolio, after all.

 

Hormel’s current valuation seems reasonable enough to give it some consideration as part of a diversified dividend growth portfolio.