KHC - Hormel Foods - Not Too Delicious

Summary

• Hormel Foods Corporation was a growth darling in the 2010s, but it has suffered stagnating sales and earnings in recent years.
• A premium valuation for Hormel Foods amidst higher interest rates simply feels a bit too rich given the observation above.
• Still admiring Hormel Foods Corporation's strong dividend track record, albeit with a higher dividend payout ratio, makes me interested in the business, but I fear the current risk-reward set-up.

Hormel Foods Corporation ( HRL ) was quite a good performer, that is its shares and the operational business, in the 2010s. With shares trading around the $10 mark in 2010, they quadrupled in the decade which followed, being a $45 stock as the pandemic arrived.

This solid growth was driven by a strong capital allocation, which included quite a few M&A actions on the buy side. This has created long term value for investors, but after shares already hit the $45 mark in 2019, they have pretty much been range bound, trading between $40 and $50 ever since.

My last take on the business dates back to February 2021, when the company announced a substantial acquisition. The company acquired snacking activities from Kraft Heinz ( KHC ) , in a deal which looked a bit pricey, but made strategic sense.

A Recap

Traditionally, Hormel has been quite strong in meat and with the long term headwinds seen to that category, which tends to post volatile margins as well, management has long been embarking on efforts to diversify the business in terms of other product categories, while growing outside the core North American region as well.

The company has traditionally been a strong capital allocator, earning nearly $2 per share in 2018 on which it paid a $0.75 per share dividend with shares trading in the thirties. While the yield itself was not necessary very high, the company has hiked the dividend for more than fifty years in a row. Operating with limited leverage, the nearly $10 billion business was happily picking up some bolt-on assets from more leveraged peers.

The problem is that despite solid growth in the 2010s, performance has been lagging a bit in recent years. The company posted 2018 sales at $9.5 billion on which earnings of $1.86 per share were reported, around a billion. 2019 sales were essentially flat at $9.5 billion, with earnings per share down a few pennies to $1.80 per share. While 2020 sales rose to $9.6 billion, earnings fell further to $1.66 per share, as the company apparently did not benefit from the hoarding effect related to the pandemic. Retained earnings and no investments or deals made that the company has been increasing its net cash position again.

Trading at $48 early 2021, the 548 million shares valued equity of the firm at $26.3 billion, with a similar enterprise valuation, equal to 3 times sales, 20 times EBITDA and a near 30 times earnings multiple.

The company saved the money to announce a big deal as it cut a $3.35 billion deal to acquire Planters, the snack nuts portfolio of Kraft Heinz, albeit that tax synergies cut the effective value of the transaction to $2.79 billion. The $1 billion revenue contribution reveals a fair 2.8 times sales multiple been paid (accounting for tax synergies), with accretion seen at $223 million and earnings accretion pegged at $0.17-$0.20 per share.

The deal was substantial and would add to reduce reliance on meat, so that is good, but the deal was not necessarily a bargain. With pro forma earnings seen around $1.70 per share and leverage around 2 times EBITDA, I placed some sell limited orders around $50, with shares trading at a$48 as the valuation simply has been too full.

How Have We Fared?

Forwarding to early 2021, shares of Hormel have on a net basis not moved at all, in fact they are down about three dollar to $45 per share in the time frame of nearly two years.

In December 2021, the company posted its 2021 results which revealed a 19% increase in reported sales to $11.9 billion, driven by 14% organic growth which largely stems from higher prices of course. Margins took a small beating, yet adjusted earnings rose seven cents to $1.73 per share. With the Planters deal only contributing for part of the year, the company guided for 2022 sales to rise minimally, seen between $11.7 and $12.5 billion. This increase in the sales guidance is minimal (at the midpoint less than 2%) with earnings seen between $1.87 and $2.03 per share, as the company hiked the dividend payout to $1.06 per share.

After a solid first quarter, the company reduced the midpoint of the full year outlook to $1.92 per share, down three cents from the initial outlook provided for the year. Inflationary pressure was really seen over the summer, triggering the company to hike the midpoint of the sales guidance to $12.5 billion, a four hundred million increase. That was about the good news as the midpoint of the earnings guidance was cut by ten cents to $1.82 per share.

In November, Hormel raised the dividend by another 6% to $1.10 per share, marking the 57th year in a row in which earnings have been hiked, increasing the payout ratio to well over 50%, which is important given that the company has taken on some, but manageable debt with the Planters deal. After the dividend hike, the yield still only comes in at 2% and change, as it still can not compete with risk-free rates of course.

In November, the company posted full year sales up 9% to $12.5 billion, driven by 6% organic sales growth which relates largely to pricing of course. Earnings of $1.82 per share were up 5% from the year before, indicating rather stable margins. Net debt has fallen to about $2.2 billion here, excluding minimal net pension liabilities. EBITDA trends around $1.6 billion here, as leverage ratios have fallen from nearly 2 times to about 1.4 times.

For the current fiscal year 2023, the company offered a non-inspiring outlook. Sales are seen between $12.6 and $12.9 billion, which essentially shows that sales are not keeping up with inflation. Earnings per share are seen between $1.83 and $1.93 per share, at the midpoint up 8 cents from the year ago, as the company is still largely a meat and refrigerated foods business.

Based on the new guidance, the company trades at 24 times earnings. The reason for that is that shares have been trading flattish for years, but so have earnings, as the company has not been able to regain its mojo as it did late in the 2010s, as the Planters deal did not change the trajectory.

Still Cautious

With growth being lackluster and premium valuations still here, I am a bit cautious about Hormel Foods Corporation.

While Hormel Foods Corporation commits to its strong and growing dividend, the payout ratio has risen rather quickly in recent years. The underlying lack of earnings growth and a premium valuation makes me very cautious amidst all this.

Weighing it altogether, I see no reason to get involved with Hormel Foods Corporation again. After all, the new 2023 outlook in terms of earnings comes in lower than the initial 2022 earnings guidance!

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