2023-12-11 08:22:19 ET
Summary
- A comparables analysis shows that the company is overvalued, but the multiples are lower than its 5-year average.
- The company's recent results show negative dynamics in return on net operating assets.
- Hormel Foods has to prove improving future perspectives so as not to be at risk for a further downgrade.
Despite the dividends, the consumer staples industry didn't perform well in general for the past 12 months, one of the companies, that caught my eye is Hormel Foods ( HRL ). It recently published its 4th quarter results, with missing profit and sales figures, it is trading now lower than its 5-year average multiples. This may sound like an opportunity, but with the peer's analysis and deep dive into its past and recent financial statements, I will prove that there is reason for these low expectations and show that it is an "underperform" now, providing my price target.
Comparison of 5-year Cumulative Total Return of HRL, S&P500, and S&P500 Packaged Foods and Meats (the company`s statements)
Company Overview
It is a US company with a long history starting from 1891 and iconic products in its portfolio. The company began as a meat processor and now operates in four segments: Grocery Products, Refrigerated Foods, Jennie-O Turkey Store, and International. Hormel Foods expanded through acquisitions, adding Planters in 2021 to grow its snacking business and in 2023 the company purchased Garudafood to add a presence in Southeast Asia and further support its business. The company didn't perform well for its shareholders for the last 12 months, providing Total Return. It has a "Hold" rating from both SA and Wall Street analysts and a "Sell" Quant rating. Earnings missed for the second consecutive quarter, and the recent dividend increase didn't cheer the cautious outlook.
Peer analysis
HRL | Sector Median | 5Y Average | |
P/E ((FWD)) | 20.25 | 17.52 | 25.86 |
EV/Sales ((FWD)) | 1.62 | 1.66 | 2.32 |
EV/EBITDA ((FWD)) | 13.98 | 11.07 | 17.38 |
P/S ((FWD)) | 1.4 | 1.15 | 2.24 |
P/B ((TTM)) | 2.22 | 2.37 | 3.66 |
1-Year Total Return | -32.26% | -19.05% | |
Dividend yield ((FWD)) | 3.60% | 3.81% | 2.20% |
Source: Author's calculations based on Seeking Alpha
From the table above it can be seen that the median Total Return for the past 1 year was negative for the industry, despite HRL trading with the premium to median numbers, except for P/B, confirming negative or cautious future expectations. I have to mention that the numbers are lower than its 5-year average, which may be for a good reason, let's move on to diving deeper into the company's statements. The company announced another dividend increase, and now it yields 3.6% significantly higher than the 5-year average and in line with the median number.
Latest Quarterly Results
The first thing that I want to mention is decreasing allowances for the receivables the company has used for the past 5 years, adding further pressure to its sales figures published.
Year | 2023 | 2022 | 2021 |
Allowances for depreciation | 0.52 | 0.50 | 0.49 |
Allowances for receivables | 0.0043 | 0.0040 | 0.0045 |
Source: Author`s calculations based on HRL statements
Return on net operating assets (RNOA), profit margin (PM), assets turnover (ATO), and spread dynamics (own calculations based on the company`s statements)
The company's return on net operating assets had negative dynamics for the past years, driven by decreasing profit margin and asset turnover. With the financial leverage growing, the spread between the return on net operating assets and net borrowing costs has become lower, deteriorating the effect of leverage and thus the company's operational performance.
Year | 2023 | 2022 | 2021 | 2020 | 2019 | 2018 |
Operating revenue | 100.0% | 100.0% | 100.0% | 100.0% | 100.0% | 100.0% |
Cost of sales | 83.5% | 82.6% | 83.1% | 81.0% | 80.2% | 79.3% |
Gross margin | 16.5% | 17.4% | 16.9% | 19.0% | 19.8% | 20.7% |
Operating expenses | ||||||
General and administrative expenses | 7.8% | 7.1% | 7.5% | 7.9% | 7.7% | 8.8% |
Other expenses, net | -0.4% | -0.2% | -0.4% | -0.4% | -0.4% | -0.6% |
Total operating expenses | 7.4% | 6.8% | 7.1% | 7.6% | 7.2% | 8.2% |
Core operating income (before tax) | 9.1% | 10.5% | 9.9% | 11.5% | 12.6% | 12.5% |
Tax on operating income | ||||||
Tax as reported | 1.8% | 2.2% | 1.9% | 2.1% | 2.4% | 1.8% |
Tax benefit from net interest expenses | 0.1% | 0.1% | 0.0% | 0.0% | 0.0% | 0.0% |
Total tax on operating income | 2.0% | 2.3% | 1.9% | 2.1% | 2.4% | 1.8% |
Core operating income (after tax) | 7.1% | 8.2% | 8.0% | 9.3% | 10.2% | 10.8% |
Other operating income (expense) (before tax) | ||||||
Impairment | -0.2% | |||||
Tax on other operating income | 0.05% | |||||
Other operating income (expense) (after tax) | ||||||
Currency translation gains (loss) | 0.0% | -0.3% | 0.1% | -0.1% | -0.1% | -0.4% |
Net hedging gain (loss) | -0.3% | 0.0% | 0.6% | 0.0% | 0.0% | 0.0% |
Pension and other benefits | 0.1% | 0.5% | 0.3% | 0.2% | -1.0% | 0.5% |
Equity method investments | 0.1% | |||||
Total other operating income (expense) | -0.1% | 0.2% | 1.0% | 0.0% | -1.1% | 0.0% |
Operating income after tax | 7.0% | 8.4% | 9.0% | 9.4% | 9.1% | 10.8% |
Financial income | ||||||
Interest expense | -0.6% | -0.5% | -0.4% | -0.2% | -0.1% | -0.2% |
Interest income | 0.1% | 0.2% | 0.4% | 0.3% | 0.3% | 0.2% |
Net interest Income (expense) before tax | -0.5% | -0.3% | 0.0% | 0.1% | 0.1% | 0.0% |
Tax benefit of debt | 0.1% | 0.1% | 0.0% | 0.0% | 0.0% | 0.0% |
Net financial income (expense) | -0.4% | -0.2% | 0.0% | 0.1% | 0.1% | 0.0% |
Comprehensive income (available to common) | 6.4% | 8.4% | 8.5% | 7.5% | 7.2% | 8.5% |
Source: Author`s calculations based on HRL statements
Sales were down with Retail and International segments contributing to the results
Besides the inflated cost of sales, affecting the gross margin, the company faced increased operating costs together with impairment charges resulting in lower operating income. Hedging losses contributed to the overall comprehensive income, as well as increased interest expenses. Also, increased brand investments decreased the profit, this gives hope for future improvements.
Risks
The company's performance is dependent on raw materials prices as well as transportation costs, further increases in prices may result in modest gross margin figures. A decrease in consumer spending affects sales, while the volatility in capital markets and increasing leverage increase the cost of borrowing. Despite the absence of operations in Russia and Ukraine, the company faces inflated fuel costs as well as supply chain shortages in case of escalating global conflicts.
Using hedging, the company may take losses that are not directly attributed to operations. This is the case for the latest results. Decreasing allowances creates risks for sales figures.
Impairment charges may arise, resulting in a lower profit margin.
From time to time, HRL acquires the businesses, which raises the risks associated with the transaction.
Valuation methodology
I used the same methodology as in my previous article. I forecasted the statements taking into consideration that the profit margin will improve at some point and the return on net operating assets will reach its average number. The required return is WACC-calculated , using the capital structure, current after-tax interest rate, and the company's beta. Balance inputs depend on the sales figures of the company. Sales figures are based on the company's outlook forecast and average 5-year sales growth rate.
Valuation inputs and results
The sales forecast is in line with the company's outlook provided and represents almost the upper bound suggested. The model takes into consideration improving the situation with the costs, and increasing margins.
2023 | 2024E | 2025E | 2026E | 2027E | 2028E | |
Income statement | ||||||
Sales | 12 110 010 | 12 459 000 | 13 081 950 | 13 736 048 | 14 422 850 | 15 143 992 |
Cost of sales | 10 110 169 | 10 403 265 | 10 923 428 | 11 400 919 | 11 970 965 | 12 569 514 |
Gross margin | 1 999 841 | 2 055 735 | 2 158 522 | 2 335 128 | 2 451 884 | 2 574 479 |
In thousands of USD
Next, I forecast the return on net operating assets. The continuing value growth rate is an average US GDP growth rate predicted.
Year | 2023 | 2024E | 2025E | 2026E | 2027E | 2028E |
Return On Net Operating Assets | 8.0% | 8.4% | 8.5% | 9.4% | 9.4% | 9.4% |
Residual Operating Income ((ReOI)) | 169481 | 218882 | 235987 | 343067 | 360221 | 378232 |
Cost of operations | 6.34% | |||||
Total Present Value (PV) of ReOI to 2023 | 1259667 | |||||
Continuing value ((CV)) | 8889980 | |||||
PV of CV | 6537687 | |||||
Value of operations | 15536340 | |||||
Value of common equity | 15526828 | |||||
Number of shares outstanding | 546599 | |||||
Value per share | $28.41 |
In thousands of USD, except per share amounts
Valuation risk
The growth rate is an average US GDP rate predicted for the coming years, even a slight change will affect the price. If the growth rate continues to rise this year, it will result in a higher price target. Due to accounting principles, some of the figures I used in my reformulation might be slightly off, but I tried to minimize their influence. The forecast is based on the fact that the return on net operating assets will improve at some point. Further continuing deterioration in this figure will result in a lower price target. WACC calculations are partly outsourced, but I made adjustments to match my own. Due to problems in forecasting effective tax rates, a 21% statutory tax rate is used.
Conclusion
Based on my calculations and analysis, I would label HRL as "Underperform", with further rating review and a price target of $28.41. The company has to prove that the decrease in return is short-run, and it will achieve its average figures in the future. A dividend increase just masks the fundamental issues with value creation.
The growth rate is an average US GDP rate predicted for the coming years, even a slight change will affect the price. If the growth rate continues to rise this year, it will result in a higher price target. Due to accounting principles, some of the figures I used in my reformulation might be slightly off, but I tried to minimize their influence. The forecast is based on the fact that the return on net operating assets will improve at some point. Further continuing deterioration in this figure will result in a lower price target. WACC calculations are partly outsourced, but I made adjustments to match my own.
Based on my calculations and analysis, I would label HRL as "Underperform", with further rating review and a price target of $27.95. The company has to prove that the decrease in return is short-run, and it will achieve its average figures in the future. A dividend increase just masks the fundamental issues with value creation.
For further details see:
Hormel Foods Is Underperforming