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Hormel Foods Corporation (HRL)

Hormel Foods (HRL) was founded in 1891 and has proven to be one of the most resilient food providers in the world. 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.

The business operates under five segments:
Source: Hormel Investor Presentation
  • Refrigerated Foods (48% of sales, 45% of profit in 2017): sells branded and unbranded pork and beef products for retail, foodservice, and fresh product customers.

  • Jennie-O Turkey Store (18% of sales, 19% of profit): sells branded and unbranded turkey products for retail, foodservice, and fresh product customers.

  • Grocery Products (19% of sales, 22% of profit): sells shelf-stable food products predominantly in the retail market (Wal-Mart accounted for more than 10% of company-wide sales last year).

  • Specialty Foods (9% of sales, 7% of profit): sells private label shelf stable products, nutritional products, sugar, and condiments to industrial, retail, and foodservice customers.

  • International and Other (6% of sales, 7% of profit): sales of Hormel’s products in international markets such as China, where the company is working to double its capacity.

Most of the company's products end up on retail grocery shelves, but a meaningful portion (27% of revenue) are sold to foodservice operators. Over 90% of Hormel's sales are made in North America, but the company is focused on increasing its international presence. 

Business Analysis

Few companies survive for more than 125 years. Hormel's competitive advantages are not about patents (Hormel only has 49) or innovation (the company only spent $34 million on R&D last year, or less than 0.4% of revenue). 

As one of the largest consumer-branded food and meat manufacturers, Hormel’s key to success is favorably altering customers’ perceptions of its products to gain loyalty and market share. The company routinely spends around $150 million on advertising, an amount nearly five times greater than Hormel’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 1930's) and supported by billions of advertising dollars over the years, consumers know and trust Hormel's products. 

As a result, more than 35 of Hormel’s brands have #1 or #2 market share positions in their respective categories. The company estimates that #1 or #2 brands represent approximately 60% of its retail sales. 

Beyond brand recognition, retailer relationships, and shelf space market share, Hormel also benefits from economies of scale. As one of the larger players in the market, Hormel 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.

Hormel's global distribution channels and economies of scale also help the company’s growth and diversification efforts. Hormel has made a number of large acquisitions in recent years to expand its business, for example:

  • $220 million purchase of Wholly Guacamole in 2012
  • $700 million acquisition of Skippy Peanut Butter in 2013
  • $450 million purchase of Muscle Milk in 2014
  • $775 million bolt-on of Applegate organic deli meats in 2015
  • $286 million for Justin’s organic peanut butter in 2016
  • $104 million for Brazilian meat processor Cidade do Sol in 2017
  • $425 million for food service business Fontanini in 2017
  • $850 million for Columbus premium deli meats in 2017

Hormel can sell these new brands and products to its existing customers and improve the cost profile of each acquired company once they are integrated. While meat-based offerings will always be core to the company, many of these deals expand Hormel's non-meat portfolio as well, helping to ensure that its products are located where the consumer is shopping. 
Source: Hormel Annual Report

Besides carefully selecting the brands and product categories it plays in to improve profitability, Hormel has a strong track record of cutting costs and growing productivity. Hormel’s corporate culture is all about long-term profit maximization, which has allowed it to generate strong, consistent, and growing margins and returns on shareholder capital over time.

This steady improvement in margins, combined with both organic and acquisition-fueled growth, is why Hormel has managed to achieve positive earnings growth with consistency that few other blue chips can match.
Source: Hormel Investor Presentation

Part of what explains Hormel’s amazing track record is the company’s rare corporate culture.

Specifically, Jay C. Hormel, the founder of the company, believed that corporations exist to serve the interests of all stakeholders, not just shareholders. That’s why he founded the Hormel Foundation in 1941, which over the past 75+ years has donated more than $225 million to worthy charities in the Austin, Minnesota, community.

Today the foundation owns around 5% of outstanding shares and 48% of voting control in the company, ensuring that the company is always focused on growing long-term wealth to both enrich investors as well as its local community.

This largely explains why Hormel has such a well balanced capital allocation strategy, in which management spends the company’s cash flow on a good mix of organic growth, acquisitions, as well as capital returns to shareholders (including the Foundation), including its notable 52-year dividend growth streak.

Management is confident that it can continue to improve margins going forward. When combined with an even higher dedication to R&D and more focused brand advertising, Hormel has reasonable potential to continue growing at a similar pace in the coming years, with top and bottom line growth of 5% and 10%, respectively.
Source: Hormel Investor Presentation

If Hormel can realize this type of growth, its results will bode well for long-term dividend growth investors, who can likely expect many more years and decades of consistent payout increases. As long as consumers need to eat, Hormel's well-known brands will be there for them.

Key Risks

While Hormel’s dividend king status and continued strong execution make it a relatively low risk company to invest in, there are nonetheless still challenges the company will have to contend with in the coming years.

For one thing, while Hormel has done an admirable job diversifying away from traditional commodity meats and into higher margin value-added brands such as Jennie-O, Justin’s, and Applegate, around 20% of its product mix is still in relatively commoditized meats. It’s harder for Hormel to maintain stronger pricing power in these areas, especially in an age of changing consumer preferences.

For example, today more and more consumers are avoiding the center of the grocery store (i.e. pre-packaged foods) in favor of the fresher, outer rim of the store. The company notes that approximately 40% of its total sales are in the perimeter of the store, which is better than many of its peers but could still create growth headwinds as consumer preferences continue evolving. 

In addition, while Hormel raises a lot of its own pigs and turkeys, which decreases its exposure to commodity prices, feed prices for those animals are still outside management’s control, as are pork and turkey prices. In fact, commodity price volatility is a big reason why Hormel has struggled in recent years. 

Next, it's worth mentioning again that 65% of of the company’s sales are derived from grocery stores. Hormel doesn’t just have to deal with competing products from rivals, but it also must work with large grocery chains such as Wal-Mart (WMT) and Kroger (KR).

As disruptive e-commerce giants such as Amazon (AMZN) potentially make a stronger push into America’s grocery market, large grocery chains could put increasing pressure on Hormel to lower its wholesale prices so that they can compete with Amazon’s ultra-low prices.

This would make it ever more important for Hormel to squeeze out more and more efficiencies from its production lines in order to achieve the kind of growth management is targeting.

Which brings up the final big risk, Hormel’s steadily increasing size. In order to move the growth needle, Hormel will likely have to accelerate the pace of its acquisitions in the future, either by purchasing smaller niche brands more frequently or buying larger, more established ones.

The problem is that at the higher end of the packaged food industry it’s often much harder to find good values, thanks to today’s cheap cost of capital and mega-caps such as Kraft Heinz (KHC) and Tyson Foods (TSN) bidding up the prices required to close such deals.

In addition, a lot of the success that Hormel has had in previous acquisitions is being able to buy brands such as Skippy Peanut butter, which despite being the #2 brand in America was suffering from mismanagement and underinvestment. That made it a great choice with plenty of low-hanging fruit when it came to synergistic cost savings and strong brand building investment opportunities.

Going forward, Hormel may not be able to find enough high-quality brands available at a good value that fit management’s strict capital allocation criteria, resulting in slower earnings, cash flow, and dividend growth in the future.

Closing Thoughts on Hormel

When it comes to proven track records, quality management teams, and shareholder-friendly corporate cultures, it doesn’t get much better than Hormel Foods.

While short-term headwinds, such as declining turkey prices and record-high input costs, have weighed on the business in recent years, these issues do not seem likely to affect Hormel's long-term earnings power. The company also owns a more on-trend product portfolio compared to many other food giants, positioning it better to deal with consumers' increasing tastes for fresher, healthier, and organic offerings. 

When combined with Hormel's solid balance sheet, numerous opportunities for long-term growth, recession-resistant portfolio of iconic brands, strong returns on capital, and impressive dividend growth track record, this seems like a business that will almost certainly be around for a long time to come. 

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