Hormel: We’re Two-Thirds of the Way There (NYSE:HRL)

While we were not buyers of Hormel Foods Corporation (New York Stock Exchange: HRL) In any of our previous reviews of this work, we have typically labeled directional moves directly on this one. in In our last coverage a few months ago, we suggested that an exit for the bulls would be ideal. The high valuation, the stock’s return to its 200-day moving average, and the expectation of a slowdown in the earnings growth story were reasons we went for it at the time. Those who came out at that time will not be disappointed.

However, the majority of this decline was driven by the earnings release. We examine this for clues about the direction the company is headed.

Profits

Hormel has the end of October of the year, and the recently released results were for the second Fiscal quarter. The second quarter messaging began with Hormel telling everyone that the first half (not necessarily the second quarter) was strong, and that they had better than expected profits.

It’s always funny when a company and analysts work in tandem to lower expectations and then deliver a “better than expected” result. You can see how this year’s EPS forecasts have moved since November 1, 2023.

Lower the bar and enjoy the rhythm.

Despite the good setup, Q2 numbers on a standalone basis weren’t very interesting either. The 4% volume contraction leading up to the next slide likely produced a significant amount of disappointment. Interestingly, Hormel’s product mix changed little in the quarter meaning that price increases were not able to offset the decline in volume.

By all relevant metrics, we haven’t really reached the right recession point, and Hormel has shown a decline in operating income and declining margins.

Operating income: $252 million, compared to $296 million; Adjusted operating income was $276 million.

Operating margin: 8.7% compared to 9.9% last year. Adjusted operating margin 1 of 9.6%

You can see the problem when you break down the food service sector versus the retail sector. Food service profits rose 3% in the second quarter and 6% in the first half.

But the retail sector (which is the largest in sales) has performed very poorly, with the decline in profits accelerating in the second quarter. Sector profits decreased by 14%.

Net sales increased for several items, including Hormel® Black Label® bacon, SPAM® line of products, Applegate® natural and organic meats, Hormel® Square Table™ appetizers, and Planters® snack crackers. These gains were offset by higher year-over-year volume, lower prices for whole turkeys and lower net sales in the Convenience Meals and Proteins segment. Segment profit decreased due to lower sales and higher SG&A expenses, which included increased advertising investments.

Source: Second quarter earnings statement

International segment profits rose by a significant 70%, but the impact was very weak as this accounted for less than 8% of total operating profits. You can see in the following image this effect. You can also see that net unallocated costs (i.e. company-wide costs) rose by 82%.

Now, to be fair to the company, the investor presentation some time ago made clear the challenges they were facing and also prepared everyone for the high level of investment required.

Prospects

There has been a small adjustment to the annual guidance.

It reaffirms its expectations for net sales growth of 1% to 3%.

Updates its forecast for diluted net earnings per share to $1.45 to $1.55 (previously $1.43 to $1.57) and its forecast for adjusted diluted net earnings per share to $1.55 to $1.65 (previously $1.51 to $1.65 ).

Source: Second quarter earnings statement

The first half came in ahead by about 8 cents versus consensus estimates, so the above revision indicates further pressures in the back half. This is probably the reason for the short-term reaction in the stock. Investors became very excited after the latest set of quarterly results and were ready for an earnings upgrade cycle. This does not bear fruit. In the long run, this is just a slow process of adjusting to normal assessments. HRL was one of the most expensive consumer staples stocks a few years ago, and the journey to normal valuations takes time.

We have seen for some time that the 1.0X sales price was on its way. This trip looks about 60% to 70% complete. What happens next will depend on the broader markets. If we see a big bear market, Hormel will reach this multiple soon. If we don’t, it may take many years to get there. Of course, since the dividend yield is only 3.66%, almost any timeline you put in place to get to that multiple will mean really bad returns from here.

One miracle that would make us more bullish on the stock is if sales actually start growing strongly. By sales here, we are referring to actual volume numbers. Even outside of the specific pressures the company faced this quarter, volume growth was really weak. If that can be changed and the company can achieve 3% volume growth, you can have a slightly more optimistic bias with additional pricing additions of 2% to 4%.

As it stands, we don’t see any issues with Hormel trading at 12X-14X EPS. Even this may be optimistic. As you can see below, when competing with Kraft Heinz Co. (KHC), and Conagra Brands, Inc. (CAG) and Campbell Soup Company (CPB), Hormel has the lowest operating margins. It’s not even close.

It is trading at the most expensive valuation compared to those three.

So you will get there. It’s a matter of time. We stand by our previous suggestion that Hormel would only enter a buy range below $25.00 per share. We will avoid long positions outside of that.

Please note that this is not financial advice. It may seem so, it seems so, but surprisingly it is not. Investors are expected to conduct their due diligence and consult with a professional who knows their objectives and limitations.