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Should you focus more on Food stocks like HRL with market uncertainty increasing?

Spikes in COVID-19 infections across the country have put the market on uneven footing in the last couple of weeks, with the major indices coming off of their most recent highs and sparking concern that a broader pullback, or more alarming, a fresh new correction could be looming. That uncertainty has been enough to push a lot of the most popular stocks in the market – tech stocks, healthcare, and others – off of their own highs, sometimes by -10% or more. I think that uncertainty is driven, at least in part by the increasingly clear reality that a full recovery, economic or otherwise, isn’t going to happen quickly. Coronavirus isn’t going away, and the ability of businesses in just about every sector to recover from the impact of broad, government-mandated shutdowns and isolation restrictions is something will take time.

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Uncertain economic conditions have proven to be a good time to think about stocks that most people tend to overlook because they’re “boring.” These are stocks that also tend to operate in counter-cyclical fashion. It’s been interesting – but not surprising – to see a bit of a resurgence in stocks in the Food Products industry, for example show a lot more resilience, and in some cases even go up in price while stocks in trendier industries are getting thumped.

In the early stages of the shutdown, these stocks were the clear winners, as consumers clamored to stock up on basic home supplies and other packaged, non-perishable food products, like canned food, prepackaged meat, and so on. The fear that we may see more of that theme come back into play, while dealing with already existing supply chain shortages in various foods, could be a reason that this industry could once again be a natural fit for anybody that wants to find places to invest that could represent “safe havens” within the market that aren’t as sensitive to economic downturns.

Prepackaged food stocks like Hormel Foods Corp (HRL), CPB, KHC have all been facing significant challenges over the last couple of years related to changing consumer preferences. HRL occupies a somewhat different niche than some of these other stocks, however because its products fit nicely into that shift towards healthier choices, with a specific emphasis on proteins. Recent news also seems to indicate the company’s products fit nicely into the pandemic-induced inclination to “hunker down” and get braced for the worst. Does the additional fact the stock has a strong fundamental profile mean that it is also a good value? Let’s take a look.

Fundamental and Value Profile

Hormel Foods Corporation is engaged in the production of a range of meat and food products. The Company operates through four segments: Grocery Products, which is engaged in the processing, marketing and sale of shelf-stable food products sold for the retail market and health and also consists of nutrition products, including Muscle Milk protein products.; Refrigerated Foods, which consists of the processing, marketing and sale of branded and unbranded pork, beef, chicken and turkey products for retail, foodservice and fresh product customers; Jennie-O Turkey Store (JOTS), which consists of the processing, marketing and sale of branded and unbranded turkey products for retail, foodservice and fresh product customers; and International & Other, which includes Hormel Foods International Corporation, which manufactures, markets and sells the Company products internationally. HRL’s market cap is about $26.3 billion.

Earnings and Sales Growth: Over the last twelve months, earnings declined -8.7%, while sales increased 3.31%. In the last quarter, earnings declined -6.67%, while sales managed to increase by 1.6%. The company’s margin profile is healthy; over the last twelve months, Net Income was 9.65%, and declined only slightly to 9.41% in the most recent quarter.

Free Cash Flow: HRL’s free cash flow was a little over $761 million over the past twelve months and translates to a modest Free Cash Flow Yield of 2.9%. It should be noted that Free Cash Flow was about $863 million a year ago – which means this important measurement has declined over the last year, but also improved from $619.5 million in the last quarter.

Dividend Yield: HRL’s dividend is $.93 per share, and translates to a yield of 1.91% at its current price. It is also noteworthy that HRL has increased their dividend; it was $.84 per share on an annualized basis as recently as October of last year.

Debt to Equity: HRL has a debt/equity ratio of .01. This is a very low number that is clearly representative of the company’s conservative use of leverage and its approach to debt management. In the last quarter, HRL’s balance sheet showed a little over $623 million in cash and liquid assets against $445 million in long-term debt.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $37 per share. That means the stock is overvalued right now, with -24% downside from its current price.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: This chart traces the stock’s movement over the last  two years. The diagonal red line traces the stock’s upward trend from July 2018 to its peak, which the stock hit in March at around $5. It also acts as the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock dropped from a peak around $46 in February with the rest of the market, but then rallied sharply by mid-April to its latest peak at around $50. Over the last month, the stock has settled into a consolidation range, with resistance at around $49 and support tightening to about $47 per share. A push above $49 could give the stock room to test its peak around $51, but the truth is that HRL would need to break above that high to really provide a reasonable, momentum-based forecast of any additional upside; until then, upside on the stock is likely to remain limited. A drop below $47, on the other hand could see the stock test next support around $45, near to the 38.2% retracement line, with additional downside to the 50% line at around $43.50 if bearish momentum picks up.

Near-term Keys: HRL’s fundamentals are solid, especially considering the challenging conditions just about every sector in the market has had to deal with for the last few months, but the stock’s big bullish move in the last two years means that there really isn’t a good value-based case to make for this stock right now. If you want to work with this stock, it may be more appropriate to focus on short-term strategies. If bullish momentum continues, and the stock pushes above $49, you could consider buying the stock or working with call options, with a top-end profit target at $51. A drop below $47 could act as a signal to consider shorting the stock or to work with put options with a target price between $45 and $43.50.

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