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 2020, 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 that now has some experts predicting COVID may never be “over” but will instead reach the “endemic” stage, putting it in the category of illnesses that simply become a consistent part of regular life, like seasonal flus by 2024. That is both good and bad news; bad in the sense that many of us have been hopefully looking forward to the end of a global crisis, and that now appears will remain as a constant presence, but good in the sense endemic mean that global populations have enough immunity – from either vaccines, prior infections, or both – to keep infections, hospitalizations and deaths under control.
On the economic front, COVID isn’t the only element analysts and investors are having to understand and put in to a proper context. Continued pressures on the supply chain – which have been exacerbated by the pandemic and the shortages that have been a result – have increased inflation to the point that the Fed is now planning at least interest rate hikes in 2022. Higher interest rates is one of the things to which the stock market has historically shown a significant amount of susceptibility and sensitivity, which I think means it could keep bullish investors on the sideline for the time being. I think these elements are among the reasons that economists continue to forecast steady demand for household goods, including pantry, fridge and freezer foods, as eating at home versus going out looks like the kind of thing that is becoming a habit resulting from two years of isolation and social distancing learned behavior. That could offer a headwind that makes the Food Products 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 has 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 (closed in June of this year) 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 focused more on grocery delivery. The recovery of foodservice – which, even though I believe eating at home is likely to be a permanent behavior, eating out will continue to see gradual recovery – 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 showed some signs of struggle in the first few quarters of 2021, and that contributed to a downward trend in the stock that didn’t find bottom until late September at around $40.50. After the latest earnings report, however, the stock has picked up a significant amount of bullish momentum, pushing about 20% higher to its current price around $48.50. What does that mean for the stock’s fundamentals and value proposition? Are they both improving enough to still make the stock a good buy, or has the stock moved past the point of useful value? 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 $26.4 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased 18.6%, while sales increased by 42.75%. In the last quarter, earnings grew by nearly 31%, while sales were more than 20.6% higher. The company’s margin profile is healthy, and showing signs of increasing strength; over the last twelve months, Net Income was 7.98%, and increased modestly to 8.16% in the most recent quarter.
Free Cash Flow: HRL’s free cash flow was a little over $771 million over the past twelve months and translates to a minimal Free Cash Flow Yield of 2.95%. It should be noted that Free Cash Flow increased from $410 million in the last quarter, and $797.9 million at the end of 2020.
Dividend Yield: HRL’s dividend is $1.04 per share, and translates to a yield of 2.16% at its current price. It is also noteworthy that HRL increased their dividend in 2020 and after the last earnings report; it was $.84 per share on an annualized basis until the end of 2020 and $.98 prior the last announcement. HRL is on a select list of S&P 500 “dividend aristocrats,” having increased its dividend every year for the last 56 years.
Debt to Equity: HRL has a debt/equity ratio of 0.48. This is a conservative number that I think is a little misleading; more revealing is the fact that this ratio increased from 0.16 two quarters ago, coincident to the $2.8 billion acquisition of KHC’s Planters snack business. HRL’s balance sheet also shows about $634.7 million in cash (versus about $1.77 billion at the end of 2020, but $302.74 million in the quarter prior) 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 $44 per share. That suggests that the stock is overvalued right now, with -9% downside from its current price, and with a useful discount price at around $35.
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 January at around $51 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. The stock started a gradual upward trend from that low point until the beginning of December; after the company’s last earnings announcement, the stock has picked up massive buying momentum, driving near to the 88.6% retracement line at around $49 before dropping back in the last two days to around $48.50. For practical purposes, I have current support expected at around $47 where the 61.8% retracement line sits, and immediate resistance at around $49. A push above $49 will find next resistance at around the stock’s 52-week high at $51. A drop below $47, on the other hand could have next support anywhere between $45 and $44.
Near-term Keys: HRL’s fundamentals have improved in the last quarter, and which is a big reason for the stock’s big push higher along with a general increase in momentum in the Food Products industry as broad uncertainty increases. Even so, the stock’s big rally in the last couple of weeks have pushed the stock into clear, overvalued territory, which means that the best probabilities lie in short-term, momentum-based trading strategies; you could use a push above $49 as a signal to think about buying the stock or working with call options, using $51 as a near-term exit target for a short-term bullish trade. A drop below $47 could act as a signal to consider shorting the stock or buying put options, using $45 to $44 as a useful profit target on a bearish trade.