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Buffett-Munger Highlight Weekly Report – Hormel Foods Corp

April 25, 2011 | About:

Hormel Foods Corporation (NYSE:HRL) is engaged in the production of a range of meat and food products and the marketing of those products throughout the United States and internationally. The Company operates in five segments: Grocery Products, Refrigerated Foods, Jennie-O Turkey Store (JOTS), Specialty Foods, and All Other. Internationally, the Company markets its products through Hormel Foods International Corporation (HFIC), a wholly owned subsidiary. HFIC has a presence in the international marketplace through joint ventures and placement of personnel in foreign locations, such as Australia, Canada, the People’s Republic of China, Japan and the Philippines. On October 26, 2009, the Company completed the formation of MegaMex Foods LLC (MegaMex), a 50% joint venture, which markets Mexican Foods in the United States. Effective February 1, 2010, the Company completed the acquisition of the Country Crock chilled side dish business from Unilever United States Inc.

Market Cap: $7.6 billion

Business Predictability: 5 stars

Industry: Meat Products


A discussion on food stocks doesn’t offer much excitement. This group is most often seen as a defensive investment for rocky markets. However, Hormel Foods has demonstrated how a collection of powerful brands and strong execution can provide superior returns on your capital. The company’s focus is on packaged foods and further-processed meats (ok, that doesn’t sound very appealing), which carry higher margins than basic pork or turkey products. They are a clear leader in the industry — Hormel had 34 branded products that held the number one or two positions in their categories. This is truly a recession-resistant product line — Hormel's value-priced branded offerings, such as Dinty Moore and Spam, have performed well during the recent recession.

Converting commodity meats to value-added packaged products has allowed Hormel Foods to post above-average results compared with other meat processors. As previously mentioned, this value-added strategy has shown resilience during the recession. The most significant challenge facing the company currently is the threat from rising input costs which create highly volatile profit margins. It can be very difficult for the company to pass along higher prices in a rapidly changing environment. The company is broken down into two main divisions — consumer products and meat packing. Hormel has developed a brand identity for pork and turkey products in what has traditionally been a commodity-driven business. Hormel was a pioneer in leading the current industry trend of focusing on branded products, which garner wider and more consistent margins than basic meat offerings because of their higher prices.

In the meat-packing division, they have better operating leverage compared with traditional meatpackers. While they are still impacted from commodity price swings, it is more muted. Animal feed (grains) is the single-largest input cost for raising livestock, which has the biggest impact on Jennie-O’s Turkey Store segment (18% of fiscal 2010 revenue). Operating margins experienced significant declines from 12.5% in 2005 to 6.2% in 2008 as corn and other grain prices ran up considerably. Feed grain prices represent about 75% of the total cost of raising turkeys and can significantly affect profits in the Jennie-O division, which raises about 70% of the turkeys needed for its products. The competitive landscape for further-processed branded meats continues to intensify as Smithfield and Tyson pursue growth strategies for their value-added meat brands. Once again, we are seeing rising input costs, and it is expected that supply constraints and increased demand for commodities in developing markets will prevent this pressure from subsiding anytime soon.

On the branded side of the business, there is always the risk that spending-conscious consumers will trade down to private-label goods. However, Hormel's resilience in its categories is very impressive, in part because it owns many value-priced brands, such as Dinty Moore and Spam. It is quite possible that the firm may soon need to raise prices to offset profit pressure from higher input costs such as hog prices. Hormel is not fully vertically integrated in pork and buys live hogs from other producers such as Smithfield. There is a real risk that producers are in the process of reducing stock due to higher input costs, thus reducing supply, which means hog costs will probably continue their upward trajectory. Whether the company is able to pass along those costs remains to be seen. In addition, the competition with private label offerings is fierce at the store level. Despite these challenges, Hormel's profitability has remained very stable through many ups and downs during the past decade. The firm’s competitive advantages are very strong — leading to impressive returns on invested capital.

Valuation is something to consider with a possible investment. While the business provides consistency and profitability, growing a mature brand lineup will be a challenge in the future. If investments in product innovation and marketing support for core brands resonate with consumers, sales growth in the firm's value-added offerings will accelerate. By increasing its sales mix to include more of its top brands, as well as maintaining an intense focus on cost efficiency, it is reasonable to assume that Hormel should be able to offset some of the inherent volatility from commodity costs. Furthermore, strategic acquisitions have complemented organic growth. If they are unable to execute as planned, valuation multiples will surely contract.

Hormel's established stable of brands and above average capital allocation have sustained very high returns on capital and solid free cash flow. The company has successfully built shareholder wealth as book value per share has nearly tripled in the past decade. Normally, the average food company has very little sustainability due to thin, volatile margins, but Hormel has created a branded consumer product company. With more than $7 billion in annual revenue and operating margins in the high single digits, Hormel is not one of the largest or most profitable consumer product companies in the world, but by owning top brands in niche categories, such as shelf-stable packaged meats and chili, the firm is uniquely positioned relative to other meat companies which rely more on products where consumers tend to consider prices more than brands when making purchase decisions.


Ratios — P/E (ttm) 17.8X

P/S 1.02X

P/B 2.9X


Discounted Cash Flow Analysis —

10 year growth Margin of Safety
>15% 22%
10% 13%
<10% 5%


Book Value / Share Return on Equity Return on Assets
Oct 2010 $9.03 16.5% 9.8%
Oct 2009 $7.94 16.2% 9.3%
Oct 2008 $7.46 14.2% 7.9%
Oct 2007 $6.95 16.0% 8.9%
Oct 2006 $6.56 15.9% 9.4%
Oct 2005 $5.80 15.9% 8.9%
Oct 2004 $5.07 16.7% 9.2%
Oct 2003 $4.52 14.8% 7.8%
Oct 2002 $4.03 17.0% 8.5%
Dec 2001 $3.59 18.3% 8.4%


- Rising commodity costs

- Intensely competitive industry and pricing


The company’s shares trade at a premium valuation — most likely due to the highly consistent results of the past decade. However, volatile input costs threaten this stability. Consistent pricing power is important and, unfortunately, this industry is vulnerable. Therefore, one should seek a meaningful margin of safety to compensate. The Buffett-Munger screener is designed to find Buffett-type investments with extraordinary profitability, consistency, and future prospects. Our monthly Buffett-Munger Best Bargains Newsletter picks one stock from the screener. Our in-depth analysis shares with you why younger Buffett and Munger would like this stock. If you are a premium member, you can download it here. If you are not, we invite you for a 7-day Free Trial.

About the author:

Charlie Tian, Ph.D. - Founder of GuruFocus. You can now order his book Invest Like a Guru on Amazon.

Rating: 4.0/5 (24 votes)


Mcwillia - 6 years ago    Report SPAM
The stats here don't appear to bear out the 'impressive return on capital' claim compared to other competitors like Kellog or Campbells, who actually have stellar returns on invested capital.

Also, HRL's acquisition of Unilever's Country Crock unit shows that HRL is not looking for high ROA acquisitions...but Unilever certainly wants to ditch the lower margin businesses. Unilever is trying hard to move into higher margin businesses like personal care and hair, via purchases like Alberto Culver. P&G selling Pringles appears to be the same phenomenon, ditching a lower margin business to move into areas with more pricing power, better margins, etc.

HRL is a good solid company, but its ROA is only middling, and thus I wonder if they can compound their retained earnings at a satisfactory rate.

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