Hormel Foods (HRL) was founded in 1891 by George Hormel in the small town of Austin Minnesota.

Today, Hormel has a market cap of $19.6 billion. The company has assembled a portfolio of well-known food brands. The image below shows many of the company’s most popular brands.

Source: Hormel BMO Capital Markets Presentation, slide 9

Hormel operates in the meat and packaged food industry. The idea that ‘people will always want convenient food’ isn’t particularly complicated.

Some of the best investments aren’t complicated. The inevitability of the packaged food industry makes it very stable. You don’t have to worry about industry obsolescence when you invest in Hormel Foods.

This stability has led to 50 consecutive years dividend increases for Hormel shareholders. This makes Hormel one of just 18 Dividend Kings.  Dividend Kings are stocks with 50+ consecutive years of dividend increases. They are the best of the best in terms of longevity.

This article takes an in-depth look at the investment prospects of Hormel.

Current Events

On August 18th, Hormel released its 3rd quarter results. The company posted positive numbers:

• Sales increased 5%
• Earnings-per-share increased 33%

The company’s CEO, Jeffrey Ettinger said the following about 3rd quarter results:

“We are pleased to announce exceptional results this quarter with three of our five segments delivering volume, sales and earnings growth.  This is also our thirteenth consecutive quarter of record earnings which is a testament to our balanced business model.”

As the quote above alludes to, Hormel operates in 5 segments. Each segment is listed below, along with the percentage operating income change in the most recent quarter versus the same quarter a year ago:

1. Refrigerated Foods – operating profit up 24%
2. Jennie-O Turkey – operating profit up 59%
3. International & Other – operating profit up 5%
4. Grocery Products – operating profit flat
5. Specialty Foods – operating profit down 13%

The Refrigerated Foods segment is the company’s largest; responsible for 44% of operating income in the most recent quarter. The excellent growth number above reflects the addition Applegate Organics to segment results. Hormel acquired Applegate Organics in July of 2015.

The Jennie-O Turkey segment is Hormel’s 2nd largest; it generated 20% of operating income in the company’s most recent quarter.  The 59% surge in operating profit in the segment was due to the recovery from avian influenza, which plagued the segment in the same quarter a year ago.

The International & Other segment generated just 7% of total operating profits in Hormel’s most recent quarter. The segment grew 5% on strong results from the Spam and Skippy brands.

The Grocery Products segment generated 19% of Hormel’s operating earnings in the most recent quarter. The segment did not grow operating income due to acquisition expenses related to the Justin’s Peanut Butter acquisition. Sales did increase 3% in the segment, however.

Finally, the Specialty Foods Segment – which generated 10% of total company operating income in the 3rd quarter of 2016 – struggled. Operating income declined 13%. Operating income declined due to lower contract packaging sales and the company’s divestiture of the Diamond Crystal brand.

Overall, Hormel’s quarterly results were better than expected. Management increased the company’s full year expected earnings-per-share:

• Old estimate range – $1.56 to $1.60
• New estimate range – $1.650 to $1.64

For comparison, Hormel generated adjusted earnings-per-share of $1.32 in fiscal 2015.

Competitive Advantage

Hormel’s 50 years of consecutive dividend growth – and continued growth today – show the company has a strong and durable competitive advantage.

The company’s success is due to its well-known brands.

30+ of Hormel’s brands hold the #1 or #2 position based on market share in their category.

Source:  Hormel CAGNY Presentation, slide 44

Most consumers goods companies spend 5% to 10% of their sales on advertising. This creates brand awareness.

What’s unusual about Hormel is the strength of its brands relative to its advertising spending. The company spends little on advertising compared to its peers.

• 2015 Advertising as a percentage of sales was 1.6%
• 2014 Advertising as a percentage of sales was 1.2%
• 2013 Advertising as a percentage of sales was 1.0%

Hormel’s brands have large market shares despite lower than average spending on advertising (as a percentage of sales). The company’s management recognizes increased ad spending will strengthen its competitive advantage. Advertising spending is increasing rapidly at Hormel.

Source: Hormel BMO Capital Markets Presentation, slide 12

Hormel doesn’t advertise as much as its peers because many of its brands are very well known.

Hormel’s management has shown the ability to reliably acquire and scale brands over the last several years. Acquisitions have led to rapid growth for Hormel.

Growth Prospects & Total Return

• Low debt for future acquisitions
• Low household penetration

Hormel has grown earnings-per-share at 11.1% a year over the last decade. Dividends have grown even faster at 15.2% a year.

Large acquisitions have fueled growth for Hormel. The company takes the proceeds from established brands like Hormel, Dinty Moore, and Spam – and reinvests the proceeds into faster growing brands like Wholly Guacamole, Justin’s Peanut Butter, and MuscleMilk. The image below shows the company’s acquisition history over the last several years.

Source:  Hormel CAGNY Presentation, slide 21

Hormel has plenty of ‘dry powder’ for large future acquisitions. The company has just $250 million in long-term debt on its balance sheet, and $380 million in cash. The company’s management says it has $3 billion in debt capacity, which it can use on future acquisitions.

Acquisitions are not the only way Hormel is driving shareholder value… The company’s current brands also have growth potential thanks to their low household penetration.

Source:  Hormel CAGNY Presentation, slide 46

Hormel’s increasing advertising budget will likely fuel greater household penetration for its existing brands.

As Hormel grows, it realizes greater economies of scale. The company strategically sheds non-core brands (like Diamond Crystal Brands) and invests in higher margin brands. The company integrates its new acquisitions and scales them. This creates increasing margins over time. Hormel’s operating margin has grown at 3.9% a year (from 9.9% in 2006 to an expected 14.5% in fiscal 2016).

I expect Hormel to continue generating strong growth for shareholders going forward. Earnings-per-share should continue growing at between 9% and 11% a year. In addition, the company pays a 1.5% dividend yield.

Hormel’s dividend yield combined with its expected earnings-per-share growth gives investors expected total returns of 10.5% to 12.5% a year, before valuation multiple changes.

Recession Performance & Dividend Safety

Hormel’s processed and packaged foods provide consumers with low cost (and convenient) meal options.

As a result, Hormel tends to perform well (relative to other types of businesses) during recessions.

The company’s results during the Great Recession of 2007 to 2009 are shown below to illustrate this point:

• 2007 earnings-per-share of $1.07 (new high)
• 2008 earnings-per-share of $1.04 (2.8% decline)
• 2009 earnings-per-share of $1.27 (new high)

Hormel is recession resistant and has a strong and durable competitive advantage. The company’s 50 year streak of dividend increases attests to this.

Hormel has a payout ratio of just 39%. The company’s combination of a low payout ratio, stable operations during recessions, and favorable growth prospects makes the company’s dividend very safe. It is extremely likely the company continues to pay rising dividends in the future.

Valuation & Final Thoughts

Over the last decade, Hormel stock has traded for an average price-to-earnings ratio of around 17. Viewed another way, the company has traded about in line with the S&P 500.

Hormel is currently trading at a price-to-earnings ratio of 26.6. This is quite a bit higher than I’d like to see. It does match these low interest rate times, however. The S&P 500 is currently trading for a price-to-earnings ratio of 25.1

Given its safety, slow-changing industry, growth potential, and double-digit expected total returns, Hormel should command a premium price-to-earnings multiple above that of the S&P 500’s.

Hormel is likely trading around fair value given today’s elevated market levels. On an absolute basis, it is overvalued. There’s no telling when interest rates will rise (and market valuations will fall), however.  Investors way want to get comfortable with low interest rates.

Is Hormel a screaming buy at current prices? No, it isn’t. But the company is certainly a hold given its growth history and growth expectations.

In fact, Hormel ranks fairly highly (just inside the Top 30) in spite of its high valuation using The 8 Rules of Dividend Investing.

That’s because the company scores high marks for growth, low stock price volatility of 19.6%, and a fairly low payout ratio of under 40%.

There’s no doubt Hormel is an excellent business with a shareholder friendly management. At current prices, it is a hold.

I would wait for a price-to-earnings ratio under 20 (and preferably under 17) to initiate or add to a position in Hormel. Hormel is an example of a great business trading at a price that does not warrant a buy.