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Recession-Resistant Total Return Stock in the Packaged Foods Industry

- By Ben Reynolds

(Published by Nicholas McCullum on April 11)

The consumer staples industry has historically been one of the best-performing sectors of the stock market.

A large reason for this is the performance of these stocks during recessions. Consumer staples companies produce necessity products, and sales remain relatively constant during economic downturns.

One great example of a consumer staples stock with a robust dividend history and strong total return prospects is Hormel Foods (HRL). Hormel is well known for its household brands like Jennie-O Turkey and SPAM.

Hormel is a dividend darling with 51 years of consecutive dividend increases. This qualifies the company to be a member of the Dividend Kings, a group of stocks with 50-plus years of consecutive dividend increases - twice the requirement to be a Dividend Aristocrat.

You can see the list of all 19 Dividend Kings here.

Hormel ranked as a top 10 stock according to The 8 Rules of Dividend Investing in the most recent Sure Dividend Newsletter.

Business overview

Hormel's earliest predecessor was established in 1891 by George Hormel, who founded Geo. A. Hormel & Co. in Austin, Minnesota. The business' early growth was driven by robust consumer demand for Hormel's packaged pork products.

After less than 20 years in business, Hormel was already planning international expansion.

Hormel is a behemoth in the packaged foods industry. The company generated $9.5 billion of 2016 sales and has a market capitalization of ~$18 billion.

HRL We Are Hormel Foods

Source: Hormel Foods 2017 CAGE Presentation, slide 4

Hormel is currently divided into five operating segments:

  • Refrigerated Foods (49% of 2016 sales).
  • Jennie-O Turkey Store (18% of 2016 sales).
  • Grocery Products (18% of 2016 sales).
  • Specialty Foods (10% of 2016 sales).
  • International & Other (5% of 2016 sales).

A snapshot of each of Hormel's operating segments can be seen below.

HRL Business Overview

Source: Hormel Foods 2017 CAGE Presentation, slide 4

Hormel has an impressive history of delivering total returns to its shareholders.

The company has grown its earnings per share in 28 out of the past 31 years, which is a record matched by only four companies in the Standard & Poor's 500. Johnson & Johnson (JNJ) (the textbook example of a high quality business) is one of them.

HRL We Have Grown Earnings 28 Out of 31 Years

Source: Hormel Foods 2017 CAGE Presentation, slide 11

Hormel has a rather unique corporate structure. The company's founder (George Hormel) and his son (Jay Hormel, who eventually led the company) created the Hormel Foundation to ensure that their business would give back to the communities it serves for decades to come.

The Hormel Foundation currently owns ~48.5% of Hormel Foods Corp. and donated over $34 million to projects in the Austin, Minnesota area in 2016. Many of the directors of Hormel Foods are also directors of the Hormel Foundation, which helps align the interests of Hormel with those of its largest shareholders.

Growth prospects

Hormel drives its business growth by acquiring smaller food companies and scaling their operations. For example, consider the following sizable acquisitions completed by Hormel.

  • 2011: MegaMex Foods (a joint venture between Hormel and Herdez Del Fuerte, S.A. de C.V.) acquired Fresherized Foods, the maker of Wholly Guacamole, Wholly Salsa, and Wholly Queso, for an undisclosed amount.
  • 2013: Hormel acquires the Skippy peanut butter brand from Unilever (UN) for approximately $700 million.
  • 2014: Hormel acquires Cytosport Holdings Inc., the maker of Muscle Milk, for approximately $450 million.
  • 2015: Hormel closes the acquisition of Applegate Farms LLC, owner of the Applegate brand (the leading brand in the natural and organic value-added prepared meats category) for approximately $775 million.

This is only a portion of Hormel's historical acquisitions. I encourage you to read Hormel's full corporate history.

There is a definite trend here. Hormel tends to purchase the leading brand in a particular category and then improve its market position by scaling the product through Hormel's impressive distribution and advertising networks. The company devotes a substantial amount of money toward marketing - $52 million in the first quarter alone. Further, Hormel reported $128 million in accrued marketing expenses for first-quarter 2017.

These efforts have paid off. Hormel brands currently have a No. 1 or No. 2 market share in more than 35 categories.

HRL Our Brands Have a #1 or #2 Share in Over 35 Categories

Source: Hormel Foods 2017 CAGE Presentation, slide 17

It is nearly impossible to guess what company Hormel might acquire next. However, we can say with high certainty that Hormel will continue to be active on the M&A front for the foreseeable future.

Looking ahead, Hormel will also benefit from a changing secular trend in consumer tastes. Namely, turkey is gaining market share in the ground meats category, increasing its share of the ground meats market for seven consecutive years.

HRL Turkey's Share of Ground Meats

Source: Hormel Presentation at the 2016 Barclays Global Consumer Staples Conference, slide 19

Hormel's Jennie-O Turkey Store contributed 24% of the company's 2016 profits. Hormel is well-poised to benefit from this turkey trend.

Despite this positive trend, Jennie-O Turkey Store has been struggling as of late. This segment reported a 25% year-over-year decrease in earnings per share for the first quarter of 2017, which was driven by declining turkey prices, increase competition and increased expenses.

Considering that Hormel's turkey segment is expected to be a key contributor to future growth, this is worrisome. Each of the components causing this earnings decline will be discussed individually below.

Hormel's management stated on its first quarter conference call that this earnings decline in its turkey segment was primarily driven by a decline in turkey meat prices. The turkey markets are in a state of oversupply and have caused turkey prices to decline by 60% year over year. The price of turkey meat currently sits at a seven-year low.

The increased competition in Hormel's turkey segment has been caused by companies in Hormel's peer group trying to capitalize on the rising popularity of turkey products. Each of Hormel's three turkey channels (foodservice, retail and deli) have experienced this competitive pressure.

The higher expenses in Hormel's turkey segment have been caused by the company's continued investment in biosecurity. The company is aiming to avoid adverse events such as an avian influenza outbreak, and this has increased spending accordingly. Hormel's turkey segment is also investing heavily in facilities upgrades and new consumer trends like raised-without-antibiotics products.

Looking ahead, the weakness in Hormel's turkey segment does not change the company's compelling investment proposition. Management expects that declining turkey sales will be offset by strength in Hormel's other segments, particularly Refrigerated Foods (whose performance has been excellent recently).

In the long run, Hormel operates a very diversified business model, so weakness in a single segment will not materially harm the overall company. Once the company's turkey earnings grow, this will provide a tailwind for the cumulative Hormel business.

Competitive advantage and recession performance

Hormel Foods has a tremendous competitive advantage that stems from its robust portfolio of popular brands. The company has a healthy mix of cheap brands (SPAM) and expensive brands (Muscle Milk) that give consumers plenty of variety if they need to trim their spending.

Further, Hormel has a very profitable business. The company ranks sixth in its peer group for return on invested capital.

HRL Consistently High ROIC

Source: Hormel Foods 2017 CAGE Presentation, slide 14

Hormel's business is minimally effected by economic downturns because the company produces necessity products. People need to eat regardless of what the global economy is doing.

Hormel's recession-resistant business model was evident during the great recession in 2008-2009. The company saw only a very minor earnings-per-share decrease, which more than rebounded in the following year.

  • 2007 earnings per share of $1.07.
  • 2008 earnings per share of $1.04 (2.8% decrease).
  • 2009 earnings per share of $1.27 (22.1% increase).

Hormel also has a rock-solid balance sheet, which will serve it well in the next downturn. The company currently has no short-term debt and only a minimal amount ($250 million) of long-term debt. What little debt Hormel has is more than offset by its current reserve of cash and cash equivalents ($610 million).

This means the company will not be troubled by interest payments in the event that earnings decline. It also means that Hormel has the flexibility to leverage up and execute strategic acquisitions.

Hormel's recession resiliency is also evident in its stock price volatility. Hormel is one of the Dividend Aristocrats with the lowest stock price volatility, ranking 13th out of 51 Dividend Aristocrats.

Valuation and expected returns

Hormel's future returns will come from valuation expansion, dividend yield and earnings-per-share growth.

In the past 12 months, Hormel has reported adjusted earnings per share of $1.65. The stock is currently trading at a price-earnings (P/E) ratio of 20.8. For context, the S&P 500's current P/E ratio is 26.4, indicating that Hormel is currently a bargain compared to the rest of the stock market.

Hormel's current P/E ratio is also below its recent averages. The following diagram compares Hormel's current P/E ratio to its average P/E ratio over the past 16 years.

HRL Hormel - Valuation Analysis

Source: Value Line

Hormel's current P/E ratio is above its long-term historical average but still below its levels in recent years. This makes sense because rock-bottom interest rates are propping up stock valuations. Taking this into account, Hormel is a bargain.

Hormel's depressed stock price has also increased the company's dividend yield. The company yields 2.0% right now, which is higher than normal for this low-yield stock.

The rest of Hormel's returns will come from earnings-per-share growth. The company's long-term goal is 10% annual growth in diluted earnings per share, partially driven by 5% annual net sales growth.

HRL Achieving Our Long-Term Growth Goals

Source: Hormel Foods 2017 CAGE Presentation, slide 12

These goals are reasonable. For context, Hormel has compounded its earnings per share at an 11.2% clip since 2000. The company shows no signs of slowing down.

Putting this all together, Hormel appears capable of delivering double-digit total returns, composed of:

  • 2.0% dividend yield.
  • ~10% earnings-per-share growth.

Final thoughts

Hormel's price has declined recently among fears surrounding the Jennie-O Turkey Store. These fears are overblown, and Hormel is trading at an appealing valuation.

This company, which is typically a low yield dividend stock, is priced at a 2.0% dividend yield. This means investors can generate meaningful income from an investment in this incredibly high-quality business and benefit from its strong risk/reward profile.

Hormel was also ranked as a top 10 stock in April's edition of the Sure Dividend Newsletter. Accordingly, Hormel Foods is a buy.

Disclosure: I am not long any of the stocks mentioned in this article.

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