Hormel (HRL) released new quarterly earnings results and updated its 2017 guidance this morning.
The company’s earnings grew for the 15th consecutive quarter to reach a new record, and adjusted sales and volume increased by 3% and 5%, respectively. Not bad!
However, management lowered the company’s 2017 earnings per share guidance to $1.65 to $1.71.
Hormel previously expected full-year earnings of $1.68 to $1.74 a share, so the company’s updated guidance represents a 1.8% decrease at the midpoint.
Why the change? Turkey prices declined faster than expected, falling more than 60% from last year to hit a seven-year low.
The slump in turkey prices depressed profits in Hormel’s Jennie-O Turkey Store segment, which accounted for 24% of the company’s total operating profits last year.
The segment’s operating profit slumped 25% in the quarter.
Jim Snee, Hormel’s CEO, made the following comments:
“We are tempering our full year outlook for the Jennie-O Turkey Store segment given the shortfalls in the first quarter and the expected continuation of pricing pressure due to low commodity turkey prices. Improvements in our other segments are expected to offset some of the earnings headwinds from Jennie-O Turkey Store.”
Hormel’s overall earnings are still expected to grow in 2017, albeit very moderately.
Shares of Hormel sold off sharply on the news, dropping over 7% in early trading.
Hormel’s stock was trading at a forward P/E multiple of 21.8 prior to the earnings release, a meaningful premium to the S&P 500 Index’s forward P/E multiple of approximately 17.6.
Investors typically assign premium P/E multiples to companies that they perceive to be of higher quality and that possess the potential for strong and/or predictable long-term earnings growth.
The higher the valuation multiple (and expectations for the future), the more investors often punish a company’s stock price when management slips up.
The steeper-than-expected drop in turkey prices is certainly disappointing and looks like it will have some impact on Hormel’s earnings growth in 2017.
However, investors shouldn’t be quick to sell just because a stock’s price drops on earnings. Instead, they must decide if the news actually impacts a company’s long-term future or not.
If not, the drop in price is just another overreaction by the market to an event that really doesn’t matter.
Is This Noise or News?
Most of the time, an earnings report has very little to do with a structural change in a company’s long-term outlook. Hormel, for example, has been in business for more than 125 years.
Hormel has experienced many commodity price cycles and a slew of other issues that, while painful over the short term, never stopped the company from continuing its growth over longer stretches of time.
In fact, Hormel has even managed to raise its dividend for 51 straight years, making it a dividend king.
However, you never know when a real change could occur that actually does impair a company’s ability to profitably grow, potentially making it a value trap.
There are a number of examples in brick-and-mortar retail today, for example. E-commerce has fundamentally changed the ability of many retailers to continue growing, and they are under real, long-lasting pressure.
The key is to identify what is driving the stock’s price decline (falling turkey prices, in Hormel’s case) and use your best judgment to determine if the issue hurts the company’s long-term earnings power or not.
Essentially, has anything material really changed?
It’s not always easy to answer this question, but let’s take a closer look at Hormel’s exposure to turkey prices.
As previously stated, Hormel’s Jennie-O Turkey Store segment generated nearly a quarter of the company’s total profits last year. That’s certainly meaningful to the overall business.
Fortunately, Hormel’s other segments experienced stable or growing profits compared to the year-ago quarter. These divisions, which generated over 80% of Hormel’s profits last quarter, can help stabilize the company’s earnings even if Jennie-O continues its slump.
I would be more concerned about the turkey price issue if Jennie-O was a much larger contributor to Hormel’s bottom line (e.g. if Jennie-O generated 80% of Hormel’s profits).
Even still, Hormel could struggle if the decline in turkey prices proves to be a secular headwind.
What if consumer preferences have changed, and turkey consumption is set to steadily decline over the coming decade?
In that scenario, Hormel could really struggle to grow earnings, and its premium P/E multiple would be at real risk of contracting further.
Fortunately, that doesn’t seem to be the case here.
Turkey prices have always been volatile and unpredictable. As you can see below, the price of broilers (chicken and turkey) recently dipped to its lowest level since 2010-11.
However, the USDA expects prices to climb over the next decade to remain in line with long-term norms, driven by population growth and export demand increases.
Higher prices will be helped by steady-to-increasing turkey consumption trends. As you can see below, broilers pounds per capita has grown over the last 25 years, while per capita demand for beef has faded.
After ticking up slightly in recent years, broilers pounds per capita is expected to remain stable over the next decade. Consumers have shown an increased appetite for turkey because of its health benefits relative to other types of meat, and that trend seems likely to persist.
Essentially, demand for turkey seems here to stay. Excess supply has been the driver behind lower prices.
Investors might recall that the worst-ever U.S. outbreak of avian influenza destroyed about 8 million turkeys in 2015, resulting in a major supply shortage, sky-rocketing prices, and a slump in exports (foreign countries restricted U.S. poultry imports).
Turkey inventories have since recovered, bringing prices back down to earth. Turkey prices are also being held down by low feed costs (a major input in raising turkeys) and excess supply of beef and pork, which temporarily makes turkey a relatively less attractive meat for some cost-sensitive buyers such as retailers and restaurants.
Overall, I don’t think investors shouldn’t be worried about the recent plunge in turkey prices. I suspect they will eventually recover over the next year or so, especially as export demand continues coming back (the USDA projects exports to rise 21% over the next decade). The long-term demand trajectory remains up and to the right, and supply will eventually normalize.
Therefore, I view Hormel’s stock price slump as noise rather than news.
Closing Thoughts on Hormel’s Earnings Report
Hormel now trades at a P/E multiple of 20.6 based on management’s updated 2017 earnings guidance. While the stock still trades at a premium to the market, Hormel’s superior business quality and intact long-term growth opportunities make its valuation more reasonable, in my view.
While turkey price headwinds could persist or even intensify over the coming quarters, perhaps further weakening the stock, I view such events as buying opportunities for long-term dividend growth investors. Hormel’s long-term earnings power is unchanged, in my opinion.
Hormel’s dividend remains very safe with double-digit annual growth potential, and investors interested in learning more about the company can read my full thesis on Hormel here.