Is Hormel a Turkey, a Pig or Just a Great Company?

TK All-Star posted on 11/08/12 at 12:42 PM

Should conservative investors consider Hormel?

Does your family eat turkey at Thanksgiving and perhaps ham on Christmas? If so, there is a reasonable chance that you may be a customer of Hormel (HRL), which is one of the country’s largest producers of turkey and pork products. While many people know the company for its famous Spam product, they may not be familiar with this unique food company.

I have been following HRL closely since the end of 2008. It had sold off with stocks in general despite having a very strong balance sheet, a good history of growth and a very reasonable valuation. On top of that, with the likelihood at the time of a shift away from restaurants towards eating at home, the company seemed likely to do well. I ended up adding it to my Conservative Growth/Balanced model portfolio and enjoying a nice jump in the stock over the next couple of years.

I visited the company’s headquarters in Austin, Minnesota in June 2010 and developed an even greater appreciation for the company, as I will describe below. Despite having confidence in the long-term outlook, I ended up selling it later that summer as I positioned the model more aggressively. More recently, I added it back to the model portfolio in September despite the ensuing rally. I try to look forward rather than backwards when making investment decisions, so I repurchased the stock despite the higher price after further evaluation.

Let’s take a look at what the company actually does. HRL divides their business into five different segments (and their contribution through Q3):

1.    Refrigerated Foods (50% of sales, 29% of profits)
2.    Jennie-O Turkey Store (20% of sales,32% of profits)
3.    Grocery Products (14% of sales, 22% of profits)
4.    Specialty Foods (11% of sales, 10% of profits)
5.    Other (5% of sales, 6% of profits)

HRL is broader than most of its peers. On the one hand, they produce a lot of meat, with half the profits coming from turkey and pork. On the other hand, they make a lot of packaged foods, representing the balance of profits. This includes things like spam and chili as well as frozen entrees. I like the multi-pronged approach, as it ultimately leads to a less volatile model than just a pork or turkey producer. HRL does an excellent job of managing its input costs and pricing its products appropriately, a major challenge for the industry.

Before I go on, let’s look at the long-term chart:

This picture tells a great story. Let me share with you my take. First of all, in the top panel, we see that over the past ten years, the stock has almost tripled. This has been at a time where stocks in general have struggled. We also see in that top panel the blue line that represents earnings. They have tended to rise and then plateau, never retreating too much. We are in one of those plateau periods currently, but the dashes in the lines reflect analyst expectations that growth will resume.

The middle panel indicates that the current forward PE is about 15X. Over the past decade, the stock has traded between 19X and 12X. As I previously mentioned it, I felt the stock was very cheap near the end of 2008 – that’s when it dipped to 12 PE. Even today, though, at 15X, I find that the stock is reasonably valued.

In the bottom panel, we see that the LT Debt has declined over the past decade from 27% of capital (Debt plus Equity) to just 8%. In fact, HRL now has more cash than debt, which is highly unusual for both the packaged food industry and food producers, where most companies have net debt of 25-50% of capital. At the end of Q3, the company showed debt of $250mm but cash of $33mm. This works out to be net cash of $283mm, or over $1 per share. Having a strong balance sheet provides both safety but also the potential to take advantage of opportunities to repurchase the stock or pursue acquisitions.

HRL is a conservative company, as is reflected in the balance sheet but also other aspects of its business, such as its acquisition and dividend strategy. Part of this is just its Midwestern culture, but it helps that the Hormel Foundation (family members) owns 48% of the company. Insiders own an additional 3%. The company has increased its dividend, which currently yields 2%, every year since the early 1970s. The payout ratio is a conservative 33%.

HRL’s year ended last month, and the company will report its results on November 20th, just in time for Thanksgiving. I think that HRL is an appealing stock for conservative investors, with the market overly concerned about the impact of the recent drought and also failing to appreciate the strength of the balance sheet.

Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator

Disclosure:  HRL is in one or more models managed by the author at Invest By Model

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Posted by TK All-Star on 11/08/12 at 12:42 PM


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