Hormel Foods Corporation.
/ (HRL-NYSE) / $30.67Note to Readers: This report contains substantially new material. Subsequent editions will have new or revised material highlighted.
Overview
Hormel Foods Corporation is primarily engaged in the production of a variety of meat and food products, and the marketing of those products throughout the United States. HRL’s products primarily consist of meat and other food products. The meat products are sold fresh, frozen, cured, smoked, cooked and canned. The Poultry category is primarily composed of Jennie-O Turkey Store (JOTS) products. The Other category primarily consists of nutritional food products and supplements, sugar and sugar substitutes, salt and pepper products, dessert mixes and industrial gelatin products. During the fiscal year ended October 30, 2004, the Company sold Vista International Packaging, Inc., acquired the assets of Concept Foods Inc. (Concept) in October 2004, and acquired Clougherty Packing Company in December 2004. Clougherty is a privately held Southern California pork processor and creator of the Farmer John brand of pork products. The Company is emphasizing the manufacturing of branded, packaged items versus pure commodity meats. HRL has five main segments: Grocery Products (18% of sales), Refrigerated Foods (48%), Specialty Foods (8%), Jennie–O Turkey (22%), and Other (4%). Well-known brands include Spam, Hormel chili and Dinty Moore stew. Hormel is also growing its ethnic foods business, which markets a variety of Mexican, Asian, Mediterranean and other regional specialties. Its headquarters is in Austin, Minnesota.
HRL is transforming itself from a commodity-oriented company to a branded value company. Continued improvement in commodity meats will drive the earnings momentum. HRL is growing faster than the commodity markets; yet, it has remained less volatile than its industry peers. HRL reported a strong 1Q05 with growth in all segments.
Analysts have identified the following issues as critical to an evaluation of the investment merits of HRL:
Strengths/Opportunities / Weaknesses/ThreatsTransition to Value Added Branded Company – HRL is transitioning from being a commodity meat producer to becoming a supplier of value-added branded products. Analysts believe HRL is a leader in the growing market for fully prepared meats. A return to a more normal protein market will also benefit HRL. / Global Meat Producer is Exposed to Political Issues – Political and trade issues such as the Russian chicken ban and the Canadian border closure created periodic disruptions to HRL’s business. Rise in commodity costs like beef and pork will continue to pressure margins.
Turkey Cutbacks – The turkey business had adversely affected HRL. Recently, both HRL and Pilgrim’s Pride cut back turkey production which contributed to market stability and more normalized pricing. . / Rising Commodity Input Costs – The rise in commodity costs like beef and pork will continue to pressure margins.
International Market Opportunities – The Mexican and Russian export markets are very strong; China has lifted its earlier ban on HRL’s products. / Need to Focus on Shareholder – HRL has historically placed acquisitions ahead of share buybacks while utilizing cash, thus disappointing shareholders and analysts.
Decline in Crop Harvests – Latest reports show a decline in corn and soybean harvests, hurting hog contract profitability.
Additional information is available on the company’s website, www.hormel.com.
HRL’s fiscal year ends October 31.
Sales
1Q05 sales increased 12% year-over-year. Volume increased 4% year-over-year. Grocery Products (15% of Net Sales) dollar sales increased 5%, but volume declined 1% due to weaker sales from DINTY MOORE canned products. Double-digit growth was reported for the SPAM family of products, HORMEL and STAGG chili, HORMEL bacon bits, CARAPELLI olive oil and HERDEZ Mexican products. In Refrigerated Foods (51% of Net Sales) dollar sales increased 19% (up 12% without Clougherty Packing) and volume increased 9% year-over-year. Leading the growth within this segment were double-digit volume performers HORMEL sliced pepperoni, HORMEL fully cooked bacon and HORMEL fully cooked entrees. Jennie-O Turkey Store (20% of Net Sales) increased 10%, primarily driven by new distribution of existing products and new product introductions. Volume increased 2%. Value-added products reported 4% growth, led by double-digit growth in the deli channel. Strong results were also contributed by JENNIE-O TURKEY STORE rotisserie turkey breasts, tray pack, bacon and marinated tenders. Specialty Foods (9 % of Net Sales) dollar sales decreased 2% to $110 million, with weaker sales in the sports nutrition and managed healthcare channels, volume declined 2% year-over-year. Other (5% of Net sales) rose 1% with a decline in volume of 1% on a year-over-year basis.
One analyst (Deutsche Bank) opines that the acquisition of Mexican Accent will help HRL continue to expand its ethnic business. With the addition of $25 million in sales from Mexican Accent and its Manny’s tortillas and other Hispanic items, Hormel’s ethnic portfolio now totals about $200 million in annual sales. Management indicated that Asia is an important area for HRL as well. Management reiterated that acquisitions remain HRL’s leading priority for the use of free cash flow. One analyst (Legg Mason) anticipates that the addition of Clougherty packing will boost Refrigerated Foods by about $380 million during the last three quarters of FY05 and, similarly, the addition of Arriba foods will increase Grocery products net sales by nearly $30 million.
Margins
HRL’s 1Q05 gross margin expanded 60 bps year-over-year. HRL’s operating margin was 8%, up 60 bps year-over-year. 1Q05 grocery products’ operating profit increased 2% year-over-year. Weaker sales from DINTY MOORE canned products offset a large portion of the profits from the categories reporting growth. Operating profits from Refrigerated Foods and Jennie-O Turkey increased 20% and 55% respectively, but Specialty foods declined by 25% year-over-year. All Other’s operating profit decreased 32% due to Vista’s removal from the portfolio.
One analyst (CSFB) thinks that HRL’s strength in meat was highlighted in the recent quarter with profits up over 20%, primarily driven by hog contracts that are based on cutout value. The analyst believes that the new contracts will lead to more consistent packing margins. One analyst (Merrill Lynch) opines that HRL has a superior operating margin compared to its competitor, Tyson, and expects it will become stronger as year unfolds. Another analyst (Wachovia) expects raw material costs to remain high this year as cattle are in short supply.
Earnings per Share
HRL reported 1Q EPS of $0.46, up 24% compared to $0.37 year-over-year.
Management expects 2Q05 EPS to range from $0.38 to $0.44. For FY05, they expect EPS to range from $1.70 to $1.80. Most of the analysts are raising their EPS estimates for FY05.
Target Price/Valuation
Out of the 9 analysts covering HRL, 2 gave a positive rating and seven gave a neutral rating.
Analysts’ target prices for HRL range from $29 (Wachovia) to $34.50 (Piper Jaffray). One analyst (D.A.Davidson) is taking 19x FY05 EPS estimate of $1.77, while another analyst (Piper Jaffray) is taking 19.7x CY05E, 22% premium to historical 10 year median P/E multiples for the same. The digest average is $32.29. One analyst (Piper Jaffray) raised FY05 EPS estimates.
Long-Term Growth
Analysts are projecting long-term growth in the range of 7% to 12%.
Analysts see a continuing secular shift toward value-added pork and turkey products. The company believes it is the leading and fastest growing player in fully prepared meats – currently worth nearly $500 million. HRL believes that their international business has strong growth opportunities with volume up 25% in the fiscal year just reported. Adding to this, there was double-digit growth from China. Due to opportunities in the Philippines, HRL just opened a second plant there. Management continues to consider acquisitions to expand its portfolio of branded products.
One analyst (CSFB) opines that the commodity environment looks attractive for the balance of 2005 with very rational supplies of turkey. Overall protein demand remains strong with low carb dieters continuing to have an interest in meat. However, this strong demand is expected to keep hog input costs at high levels which is causing profit pressure at other processed meat companies. Management reiterated its long-term financial targets of 5%-6% sales growth and a 30 to 50 bps annual improvement in operating margins as the company continues to increase its mix of value-added items, which should translate into 10% + annual EPS growth. One analyst (Piper Jaffray) believes that Hormel will continue to strengthen its long-term position with continued focus on innovation, processing, and strategically sound acquisition.
Individual Analyst Opinions
POSITIVE RATINGS
Merrill Lynch– Buy ($34.50): Report Date 2/23/2005
Piper Jaffrey- Outperform ($33.50): Report Date 2/24/2005
The analyst maintains his Outperform rating with a target price of $33.50. The analyst believes that HRL’s transformation from a commodity-oriented company to a branded value-add company will be translating to higher margins.
NEUTRAL RATINGS
CSFB – Neutral ($31): Report Date 2/24/2005
D.A. Davidson – Neutral ($34): Report Date 2/23/2005
Deutsche Bank – Hold ($33): Report Date 2/23/2005
Legg Mason – Hold: Report Date 2/23/2005
The analyst rates the stock Hold. The analyst believes that the addition of Clougherty Packing strengthens Hormel’s presence in the southwestern U.S., expands penetration into Hispanic markets, and increases export opportunities especially to Japanese market.
Prudential – Neutral Weight ($31): Report Date 2/24/2005
SunTrust Robinson Humphrey – Neutral: Report Date 2/22/2003
The analyst reiterates his neutral rating but believes that the stock will be a solid long-term holding in the packaged food sector. The analyst is concerned about the high inputs costs, but is encouraged by the continuous margin expansion.
Wachovia – Market Perform ($28-$30): Report Date 2/22/2005
“We believe Hormel’s relatively low debt levels & increasing value-added and branded products imply that the company enjoys more earnings stability than its agricultural peers and is more comparable to the packaged food companies.”
NEGATIVE RATINGS
None.