Hormel (HRL) is the most recent dividend king to be crowned. The company recently raised its dividend by 16%, marking its 50th consecutive dividend increase.
Any company that manages such an accomplishment is worth becoming familiar with, and HRL is no exception. The company has one of the safest dividends around and has grown its dividend by 18% per year over the last five years.
While we don’t yet own HRL in our Top 20 Dividend Stocks portfolio, dividend investors might want to keep an eye on the company for several reasons.
Hormel Business Overview
HRL has been in operation for 125 years and is a multinational manufacturer and marketer of consumer-branded food and meat products. Some of the company’s well-known brands include Skippy peanut butter, SPAM meat, Dinty Moore stew, Muscle Milk protein drinks, Wholly Guacamole dips, Jennie-O turkey, and numerous Hormel-branded products.
Roughly 53% of HRL’s products are perishable (fresh meats, frozen items, refrigerated meals, sausages, hams, guacamole, and bacon), 19% are poultry (Jennie-O turkey), 18% are shelf-stable (canned luncheon meats, microwaveable meals, stews, chilies, hash, tortillas, and peanut butter), and 10% are miscellaneous (nutritional food products and supplements, sugar, dessert mixes, and drink mixes).
HRL’s Five Key Brand Segments
Grocery Products (17% of sales, 20% profit): sells shelf-stable food products predominantly in the retail market (Walmart accounted for 14% of company-wide sales last year).
Refrigerated Foods (47% of sales, 38% profit): sells branded and unbranded pork and beef products for retail, foodservice, and fresh product customers.
Jennie-O Turkey Store (18% of sales, 28% profit): sells branded and unbranded turkey products for retail, foodservice, and fresh product customers.
Specialty Foods (12% of sales, 9% profit): sells private label shelf stable products, nutritional products, sugar, and condiments to industrial, retail, and foodservice customers.
International and Other (6% of sales, 8% profit): sales of HRL’s products in international markets such as China.
Business Analysis
Few companies survive for 125 years. HRL’s competitive advantages are not about patents (HRL only has 63) or innovation (HRL spent $32 million on R&D last year).
As one of the largest consumer-branded food and meat manufacturers, HRL’s key to success is favorably altering customers’ perceptions of its products to gain loyalty and market share. The company spent approximately $145 million on advertising last year, an amount nearly five times greater than HRL’s spending on R&D.
With many of its brands dating back over 50 years (e.g. SPAM and Dinty Moore were introduced in the 1930s) and supported by billions of advertising dollars over the years, consumers know and trust HRL’s products. As a result, more than 30 of HRL’s brands have #1 or #2 market share positions in their category.
Beyond brand recognition, retailer relationships, and shelf space market share, HRL also benefits from economies of scale. As one of the larger players in the market, HRL is able to achieve lower production costs than smaller rivals and squeezes more value out of each advertising dollar it spends by extending well-known brands into adjacent product categories. Extensive regulations by the U.S. Department of Agriculture also disadvantage smaller competitors.
HRL’s global distribution channels and economies of scale also help the company’s growth and diversification efforts. HRL has made several large acquisitions over the last five years to expand its business further beyond meat products. It acquired sports nutrition products company CytoSport for $450 million in 2014, Skippy peanut butter for over $700 million in 2013, and organic meat company Applegate Farms for $774 million in 2015. HRL can sell these new brands and products to its existing customers and improve the cost profile of each acquired company once they are integrated.
With the company’s mix of higher-margin products increasing, HRL recently boosted its company margins guidance from 9-12% to 10-13%. As long as consumers need to eat, HRL’s well-known brands will be there for them.
Hormel’s Key Risk Factors
Over the near term, HRL’s results are strongly affected by the cost and supply of pork, a key raw material input. Retail prices of many of HRL’s products don’t fluctuate by more than a few percentage points each year, but its input costs are notoriously volatile.
A virus that kills young pigs sent pork costs flying in 2013-2014 and crimped HRL’s profitability (see the spike in the graph below, which shows swine prices over the last 30 years). However, pork prices have since plunged to reach levels last seen nearly 10 years ago. The price of corn, a key feedstock used in raising hogs, is also near its lowest level since 2010, which encourages hog farmers to expand their herds.
Source: IndexMundi
With stable retail prices and plunging pork costs, it’s no wonder that HRL reported 2015 profit growth of 18% despite a 1% decline in sales. The company’s stock also soared by nearly 50% in 2015.
In our opinion, this was driven primarily by luck, not skill. At some point, input cost trends will reverse again. However, with HRL’s stock trading at a forward P/E multiple of 26, investors could be in for a rude awakening whenever an input cost reversal occurs.
Beyond swings in commodity prices, one of the biggest risks facing HRL is shifting consumer preferences for healthier, natural, and organic foods. Walk through just about any grocery store today, and you will notice more organic products on the shelves. Consumers are becoming more aware of what they are eating and are reading more labels. They want to know how their food gets to their plates and how ethical its production process is, especially with meats.
In many cases, this shift is creating opportunities for new players to enter the market. The incumbents have brands associated with processed, unhealthy foods (e.g. SPAM, Dinty Moore). However, they do have size, massive marketing budgets, long-standing customer relationships, and shelf space.
Many incumbents are responding to this threat by acquiring new organic players, and HRL is no exception. For example, in May 2015, HRL bought Applegate Farms, the nation’s leading branded natural and organic meat company, for $774 million. This acquisition provided its Refrigerated Foods segment with a meaningful entrance into the high-growth natural and organic space.
Whether or not HRL can achieve success by acquiring and attempting to grow natural and organic brands is anyone’s guess. We would imagine that these businesses have very different cultures and processes, but it could turn out to be a successful capital allocation decision.
For now, we will continue watching HRL’s organic sales growth rate to see if the company can successfully adapt its product mix to meet consumers’ increased desire for healthier foods. The company already has exposure to some of the “healthier” areas of the market (e.g. turkey, natural peanut butter, perishables), but we estimate that the majority of its sales mix is neutral at best.
Dividend Analysis
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. HRL’s long-term dividend and fundamental data charts can all be seen by clicking here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
HRL has one of the safest dividends investors can find with a dividend Safety Score of 98.
Over the last four quarters, HRL’s dividend has consumed 41% of its earnings and 31% of its free cash flow. These low payout ratios provide plenty of safety and room for HRL to keep growing its dividend.
Over the last decade, HRL’s payout ratios have increased by about 10%. The company has grown its dividend somewhat faster than its underlying earnings, but not by much. If it wanted to, HRL could continue growing its dividend faster than its earnings because its payout ratio is still pretty low.
HRL’s high dividend Safety Score is further bolstered by the stability of the company’s business. HRL has recorded earnings growth in 27 of the last 30 years and saw its sales fall by just 3% during the financial crisis. The company’s stock also outperformed the S&P 500 by 15% in 2008. Even when times get tough, consumers still need to eat.
HRL has also been a free cash flow machine. Free cash flow per share has nearly tripled over the last decade, providing the firepower needed for acquisitions, dividend growth, and share repurchases. The best companies generate consistent free cash flow, and HRL is no exception.
HRL’s branding and efficient operations have also helped the company achieve extraordinarily high and stable returns on invested capital over the last decade. This is often a sign of a strong economic moat and a business that is creating meaningful shareholder value.
HRL’s balance sheet is also in excellent shape. As seen below, the company could cover its entire net debt with cash on hand and less than half a year’s worth of earnings before interest and taxes (EBIT). A healthy balance sheet enables HRL to continue searching for the right acquisitions to further growth the business.
HRL’s dividend is one of the safest in the market. The company has relatively low payout ratios, sells recession-resistant products, generates excellent free cash flow, and has a very healthy balance sheet.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
HRL’s dividend Growth Score of 85 indicates that the company has excellent dividend growth potential. HRL has paid dividends every year since 1928 and recently achieved its 50th consecutive increase, qualifying it for the exclusive list of dividend kings (companies with at least 50 straight years of dividend growth). Of course, HRL is also one of the dividend aristocrats.
As seen below, HRL’s dividend growth has accelerated over its last 10 fiscal years. The company’s dividend increase for 2016 is 16%, and we believe HRL can continue delivering double-digit dividend hikes for at least the next several years given its relatively low payout ratios and decent earnings growth.
Hormel Valuation
HRL trades at 26x forward earnings and has a dividend yield of 1.5%, which is below its five year average dividend yield of 1.7%.
HRL is no doubt a great business, but it’s really hard to justify the stock’s current valuation. At the end of the day, this is a business that seems unlikely to grow sales much faster than GDP and has significantly benefited from plunging raw material costs over the last year. Is that really worth paying 26 times earnings for?
With company margins at a 10-year high and bumping up against the top of HRL’s long-term margin guidance, fundamentals could be about as good as they will get. We plan on watching HRL from the sidelines and would become more interested if raw material cost trends reverse and the earnings multiple comes way down.
Conclusion on Hormel: Look to Other Dividend Stocks
HRL is a great company that will likely be around for a very long time to come, but its current valuation is hard to get comfortable with, especially in light of the raw material cost benefits it has enjoyed over the last year.
For now, we remain more interested in some of our other favorite blue chip dividend stocks.
