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 strained health care systems and kept pressure on a variety of economic forces through all of 2021 – 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 and uncertainty that has been part of daily life for the last two years has given way in the last few weeks to the conflict and resulting devastation in Ukraine. That doesn’t mean that COVID isn’t a concern; recent increases in infections in China and Europe are starting to put health experts on this side of the pond for a comparable rise from the so-called “stealth omicron” variant. Put the geopolitical, humanitarian, and economic impact of war in Ukraine and global sanctions intended to isolate Russia from the rest of the Western world alongside COVID, and it seems likely that 2022 will continue to be driven by uncertainty in the marketplace.
All of the problems I just described may really seem to only exacerbate supply chain issues that have really become the biggest driver of an increase in inflation that analysts are saying hasn’t been seen in roughly 40 years. The Fed is widely expected to institute the first of multiple, planned interest rate hikes this week in an attempt to blunt inflation growth and slow things down. 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 tailwind 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 and 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 2021) 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 “sticky” 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. Since the fourth quarter of 2021, however, improving fundamentals helped the stock has picked up a significant amount of bullish momentum, pushing to a peak in the first part of this month at around $53 before dropping back again to its current price a little above $48 per share. 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 $26.6 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased 7.32%, while sales increased by 23.7%. In the last quarter, earnings declined by -13.73%, while sales were -11.88% lower. The company’s margin profile is healthy and stable; over the last twelve months, Net Income was 7.74%, and improved slightly to 7.87% in the most recent quarter.
Free Cash Flow: HRL’s free cash flow was a little over $939.35 million over the past twelve months and translates to a minimal Free Cash Flow Yield of 3.52%. It should be noted that Free Cash Flow increased from $771.73 million in the last quarter, and about $629 million a year ago.
Dividend Yield: HRL’s dividend is $1.04 per share, and translates to a yield of 2.11% at its current price. It is also noteworthy that HRL increased their dividend in 2020 and in 2021; it was $.84 per share on an annualized basis until the end of 2020 and $.98 prior to the last increase. HRL is on a select list of S&P 500 “dividend aristocrats,” having increased its dividend every year for the last 57 years.
Debt to Equity: HRL has a debt/equity ratio of 0.47. This is a conservative number that I think is a little misleading; more revealing is the fact that this ratio increased from 0.16 three quarters ago, coincident to the $2.8 billion acquisition of KHC’s Planters snack business. HRL’s balance sheet also shows about $846.63 million in cash (versus about $1.77 billion at the end of 2020, but $634.69 million in the quarter prior) and liquid assets against $26.9 billion 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 $48 per share. That suggests that the stock is fairly valued right now, with -1% downside from its current price, and with a useful discount price at around $39.
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 upward trend from from its low point in October at around $40.50 to its high earlier this month at around $53. It also acts as the baseline for the Fibonacci retracement lines shown on the right side of the chart. From that peak, the stock has picked up a lot of bearish momentum, breaking through support from previous pivot activity at around $50 in the last two days. Current support should be around $48, where the 38.2% retracement line sits, while immediate resistance is at around $50. A push above $50 should give the stock momentum to retest the $53 high, while a drop below $48 should find next support around $46.50, based on the 50% retracement line and a lot of pivot activity in February in that range.
Near-term Keys: HRL’s fundamentals have improved in the last two quarters, which is a big reason for the stock’s big push higher until earlier this month. Even with the recent drop, however, the stock is only fairly valued, which means that the best probabilities lie in short-term, momentum-based trading strategies, You could use a push above $50 as a signal to think about buying the stock or working with call options, using $53 as a near-term exit target for a short-term bullish trade. A drop below $48 could act as a signal to consider shorting the stock or buying put options, using $46.50 a practical, quick-hit profit target on a bearish trade.