In Part 8 of the 54 Part Dividend Aristocrats in Focus series, we will look into meat and consumer food business Hormel (HRL, Financial). Hormel is the maker of various food products that are sold under recognizable brands like Skippy, Muscle Milk, Jenny-O, Hormel and Spam. To say the company has had a long run of success is putting it mildly; Hormel has increased its dividend each year for 48 consecutive years.
Source: Hormel Website
Business overview
Hormel operates in five segments. Each segment is shown below along with its percentage of total operating profits.
- Grocery Products – 15% of operating profits
- Refrigerated Foods – 40% of operating profits
- Jennie-O Turkey – 29% of operating profits
- Specialty Foods – 8% of operating profits
- International & Other – 8% of operating profits
The company’s refrigerated foods section is its most important, generating 40% of operating profits in the company’s most recent quarter. Hormel’s refrigerated foods section controls the company’s bacon and lunch meat products, as well as other refrigerated food items.
Hormel’s most recent quarter showed continued growth for the company. Sales were up 6% and earnings per share were up 21% versus the same quarter a year ago. The company realized most of its growth in its refrigerated foods segment and Jennie-O Turkey segment. The refrigerated foods segment managed to grow sales 12% versus the same quarter a year ago, and Jennie-O Turkey increased sales 4%. Operating margins were significantly higher in both segments due to an increase in the sale of value-added products. Recent success is in line with the company’s long term averages. Hormel has managed to compound sales at 8% a year over the last decade, and earnings per share at 11% a year over the last decade. The company has achieved impressive growth through its two competitive advantages.
Competitive advantage
Hormel generates strong cash flows from its sale of well-established branded food products. The company’s competitive advantage lies in its ability to generate cash from its established brands and use that cash to acquire up-and-coming brands. The company’s competitive advantage and future growth depend on its ability to generate strong cash flows from its existing brands.
The company currently has 30 brands with #1 or #2 market shares in their respective categories. Brands like Skippy peanut butter, Hormel Chili, Spam and Jennie-O Turkey generate strong cash flows for Hormel. The company has done an excellent job of reinvesting these cash flows into newer brands.
The most recent example is Hormel’s acquisition of CytoSport, makers of Muscle Milk. Muscle Milk is expected to generate about $370 million in sales in 2014. The acquisition will cost Hormel $450 million. The deal is expected to have no impact on this year’s earnings, and increase earnings per share in 2015 by around $0.05. Muscle Milk is a respected brand in the fitness industry, and is the industry leader in drinkable protein. The acquisition gives Hormel the number one position in the growing drinkable protein market. The company believes it can grow sales of Muscle Milk significantly faster than overall company growth over the next several years.
Over the past 12 years, Hormel has made many notable acquisitions to diversify its branded food portfolio. The image below shows many of the more successful brands Hormel has acquired since 2002.
Source: Hormel BMO Farm to Market Presentation
The more strongly branded food companies Hormel acquires, the more cash flows it generates. This in turn allows it to acquire more high quality food brands in a virtuous cycle that gives the company greater scale and bargaining power with grocers. The company’s competitive advantage rests with its strong portfolio of consumer food brands and its ability to identify and acquire up and coming food brands.
Growth potential
Hormel’s future growth will come from both acquisitions and new product innovations that leverage the company’s existing brands. The company has a goal of generating 30% of revenue from new products by 2016. Hormel currently generates about 26% of its revenue from new product sales. The company has had several recent successful innovations.
The company’s REV single serve meat, cheese and tortilla wraps are experiencing strong growth. Hormel has decided to expand the product line into breakfast with its new REV A.M. wraps. Another example of recent innovation success at Hormel is the company’s new line of Skippy Singles; single serving peanut butter cups that are more convenient than traditional jars of peanut butter. Hormel’s focus on products that resonate with busy consumers on the go who demand prepackaged and convenient foods is working well for the company.
In addition to the company’s continuous food innovation, Hormel is focusing on international growth. The company is attempting to market its Spam products throughout Asia to capitalize on consumer preferences for pork products in Asia. The company is also leveraging its acquisition of Skippy to better reach international markets. Skippy has strong market penetration and distribution internationally which gives Hormel the opportunity to expand its products to new markets more efficiently.
Hormel has a long growth runway ahead from innovation, acquisitions and international expansion. These three factors together should give the company all the momentum it needs to continue growing earnings per share in high single digits or low double digits for the foreseeable future.
Dividend analysis
Hormel has grown its dividend at a strong 12% a year over the last decade. The company currently has a dividend yield of only 1.6% and a payout ratio of 33%. The company has raised its dividend at a slightly faster pace than overall company growth over the last decade. I expect this trend to continue because the company’s payout ratio is so low. Hormel does not provide a large amount of current income, but will likely reward long-term shareholders with dividend growth in the low double-digits for the next several years.
Valuation
Hormel has a current P/E ratio of about 23, reflecting its strong growth potential and relatively low-risk business model. The company trades at a significant premium to meat product competitors Pilgrim’s Pride (PPC, Financial) and Tyson (TSN, Financial); each of which have a P/E ratio under 14. Hormel also trades at a premium to packaged food product competitors General Mills (GIS, Financial) and J.M Smucker (SJM, Financial) which both have P/E ratios under 19. Historically, the company has traded for a P/E ratio of around 16 to 19 which I believe is fair give the company’s history of rewarding shareholders and strong growth potential. Overall, Hormel appears to be somewhat overvalued, but not terribly so. Investors should expect a modest amount of P/E multiple reversion to the mean in Hormel, but long-term investors will likely be rewarded with years of growth.
Final thoughts
Hormel is ranked in the Top 20 based on the 8 Rules of Dividend Investing, which ranks over 130 businesses with 25 or more years of consecutive dividend payments without a reduction over several quantitative metrics which have historically improved returns to determine which dividend paying businesses are suitable for long term dividend investors. Hormel ranks highly due to its low volatility from its strong brands and business model in the slow changing food industry, its high growth rate, and its fairly low payout ratio. Hormel is slightly overvalued at this time but still makes a solid investment for long-term oriented investors due to its relatively low risk business plan and long growth runway ahead.
