Key Risks
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.
Hormel Foods Corp (NYSE: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.
