For more than two years – even before COVID-19 became a global pandemic that collapsed economic and social activity for most of 2020 and that continues to strain health care systems and keep pressure on a variety of economic forces – I’ve been writing about the wisdom in being very selective about the investments you make. That includes taking a defensive approach by looking for industries and businesses whose operations aren’t as sensitive to the and ebb and flow of economic growth.
In the early stages of the pandemic, Food Products 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. Most of the pandemic-induced fear drove that initial surge has faded, even though the health crisis hasn’t abated, and variants of the virus have prompted new spikes across the globe. In the last few weeks, the general downward slope of unemployment claims has started to climb back up, with the unemployment rate still far above pre-pandemic levels and at rates that under any ordinary circumstances would continue to be a cause for concern. I think the continued need for vigilance and caution related on the COVID front, along with negative pressure from unemployment provides just two big reasons that economists continue to forecast steady demand for household goods, including pantry, fridge and freezer foods – which offers a headwind that makes this industry 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 and prolonged periods of uncertainty.
Prepackaged food stocks like Hormel Foods Corp (HRL), CPB, and 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, organic choices, with a specific emphasis on proteins. That also fits into related reports regarding China, which is increasing protein imports to make up for domestic supply shortages from the swine flu pandemic in 2018 that ravaged its pork capacity and still continues to impact that area. HRL specifically noted increasing orders for SPAM for China. This is a company that is also taking advantage of opportunities to diversify its business, as its recent, $2.8 billion acquisition of KHC’s Planters-branded snack business gives it a way to begin moderating some of the commodity-driven risk associated with its heavy emphasis on protein products.
A lot of prepackaged food companies have business segments dedicated to foodservice – primarily referring to supply to restaurants – and grocery. One of the interesting ways a number of companies in this industry were forced to adjust in 2020 was to de-emphasize foodservice channels, where forced shutdowns across the globe shuttered restaurants and social dining and focus more on grocery, where those same orders prompted an increase in food storage and consumption at home. The recovery of foodservice – which is progressing, though still below pre-2020 levels – provides a good potential tailwind that could work in HRL’s favor in the months ahead. Recovery in restaurant dining should benefit suppliers like HRL in a meaningful way. HRL’s fundamental profile has shown some signs of struggle in the last few quarters, and that is contributing to the stock’s current downward trend, which began at the end of 2020 from a high at around $52.50, but might have found a bottom in the last week or so. What does that mean for the stock’s value proposition? Let’s find out.
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 $22.8 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased 5.4%, while sales increased by 20.25%. In the last quarter, earnings slid -7.14%, while sales were 9.86% higher. The company’s margin profile is mostly healthy, but is showing some signs of deterioration; over the last twelve months, Net Income was 8.32%, and weakened to 6.3% in the most recent quarter.
Free Cash Flow: HRL’s free cash flow was a little over $410 million over the past twelve months and translates to a minimal Free Cash Flow Yield of 1.83%. It should be noted that Free Cash Flow was about $639 million in the last quarter, and $797.9 million at the end of 2020.
Dividend Yield: HRL’s dividend is $.98 per share, and translates to a yield of 2.34% at its current price. It is also noteworthy that HRL increased their dividend in 2020; it was $.84 per share on an annualized basis until the end of 2020. HRL is on a select list of S&P 500 “dividend aristocrats,” having increased its dividend every year for the last 54 years.
Debt to Equity: HRL has a debt/equity ratio of 0.49. This is a conservative number that I think is a little misleading; more revealing is the fact that this ratio increased from 0.16 in the quarter prior. HRL’s balance sheet also shows about $309.74 billion in cash (versus about $1.77 billion at the end of 2020) and liquid assets against $3.3 billion (versus $1.1 billion earlier this year) 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 $25 per share. In the first quarter of this year, this measurement was about $45 per share; I take the decline as a confirmation of some of the red flags outlined above. It clearly also means that the stock is overvalued right now, with -40% downside from its current price, with a useful discount price at around $20.
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 year. The diagonal red line traces the stock’s downward trend from from its high point in October 2020 at around $52.50 to its low in late September at around $40.50. It also acts as the baseline for the Fibonacci retracement lines shown on the right side of the chart. That low point marks current support, as the stock appears to be stabilizing around between $40.50 and $41 per share, with immediate resistance at around $42.50. A push above $42.50 should find next resistance between $44 and $45, where the 38.2% retracement sits. A drop below $40.50 could push the stock to lows not seen since before 2020 to find next support around $38.
Near-term Keys: HRL’s fundamentals have weakened quite a bit this year, which is a big concern when considered against the broad fundamental strength most stocks in the Food Products industry have demonstrated for the past couple of years. Given those weaknesses, the stock’s price performance doesn’t add to the value proposition. The best probabilities lie in short-term, momentum-based trading strategies; you could use a push above $42.50 as a signal to think about buying the stock or working with call options, using $44 to $45 as near-term exit targets for a short-term bullish trade. A drop below $40.50 could act as a signal to consider shorting the stock or buying put options, using $38 as a useful profit target on a bearish trade.