Stock Analysis: Hormel Foods Corporation

Hormel Foods Corporation (HRL) is a multinational manufacturer and marketer of consumer-branded food and meat products. The company sells its products through sales personnel, as well as through independent brokers and distributors. Customers include retailers, hospitals, nursing homes and marketers of nutritional products. HRL was founded in 1891 and is based in Austin, Minnesota.

HRL was the top ranked stock in the August edition of my 10 Dividend Growth Stocks series of articles on Seeking Alpha. The stock made the list again in the September edition, this time in second place. The stock is a Dividend Champion with a track record of 50 consecutive years of dividend increases and a 10-year dividend growth rate of 14.4%. HRL pays quarterly dividends of 14.5¢ per share in the months of February, May, August, and November.

To determine if a stock should be added to my DivGro portfolio, I look at the quality of the company and its ability to continue paying ever-increasing dividends. Because I prefer buying shares at a discount to fair value, I look at how the market prices the stock relative to the value of the company. Stocks that trade at a discount to fair value have increased upside potential, as gains can come from earnings growth and from the share price trending back to fair value.

Dividend History

At the time of writing, HRL traded for $38.46 per share, yielding 1.51%. Below is a 5-year yield chart of HRL. The yield topped out at about 2% in 2012 before dropping back to 1.5%. There it stayed for a few years, dropping to a level of about 1.25% earlier this year before recovering to the currently yield of 1.51%.

The following table presents HRL's dividend growth rates according to data available at tesselation.com:

HRL Dividend Compound Annual Growth Rate
1-Year	3-Year	5-Year	10-Year	25-Year
20.09%	20.64%	16.97%	17.07%	9.92%

Through the end of 2015, HRL has paid 156 quarterly dividends. So far this year, the company has paid 3 quarterly dividend of 14.5¢. Here is a chart showing all the quarterly dividends paid by HRL since February 2000:

Data source: gurufocus

The company has an impressive track record of paying and increasing dividends. Dividend growth has been remarkable, too. Below is a chart showing EPS (earnings per share) and FCF (free cash flow) along with dividends per share.

Data source: Morningstar

I like to look at payout ratio to gauge the likelihood of continued dividend growth. If the EPS payout ratio is below 60%, I consider the dividend to be sustainable with a good likelihood of future dividend increases. For the fiscal year ending in October 2015, HRL's EPS payout ratio was 38%. Presently, the TTM (trailing twelve month) EPS payout ratio is 37%.

Stock Performance

The main goal of dividend growth investing is generating a growing dividend income stream. Additionally, I'd like to see dividend growth stocks generate solid total returns in the long run. While past history does not guarantee future performance, I like to review the historical performance of stocks. Here is HRL's 10-year price history. The stock has outperformed the S&P 500 by more than 200% over the last decade.

Source: Scottrade

Below are the stock's total returns for 3 different periods, courtesy of longrundata.com. An investment in HRL 10 years ago would have returned 17.48% on an annualized basis with dividends reinvested. The stock performed even better over the last 5 years, with annualized returns of just more than 25%. Early investors in HRL would have done quite well, too! An investment of $1,000 in 1991 (25 years ago) would have turned into well over $23,000 (or 13.49% on an annualized basis). 


Stock Valuation

We can use some common valuation metrics to see if HRL is attractive at the current share price. The following table compares HRL's TTM (trailing twelve month) P/E (price to earnings), P/FCF (price to free cash flow), P/B (price to book), and P/S (price to sales) ratios to 5-year averages. 

HRL	Current (TTM)	5-Year Average	Relative Valuation		Industry Average	S&P 500 Average
P/E	26.5	20.8	27%		40.2	19.8
P/FCF	27.2	22.6	20%		26	41.2
P/B	4.7	3.4	38%		3.2	2.8
P/S	2.3	1.3	77%		2.1	3.7
Yield	1.5	1.6	6%		2.1	2.3

Data source: Morningstar

The relative valuation metrics point to HRL being overvalued compared to the 5-year averages. In fact, except for dividend yield, HRL seems to be substantially overvalued.

I've also done a discounted cash flow analysis for HRL, resulting in a fair value estimate of $33.24. I use a multi-stage DDM (dividend discount model) with proprietary adjustments to determine fair value. Generally, I set a required rate of return of 10% and use estimates of the annual EPS growth rate for the next 5 years. Thereafter, I taper the growth rate to a perpetual growth rate of 3% after 10 years. Adjustments to the calculated fair value are based on various factors, including an assessment of dividend safety.

For comparison, Morningstar's fair value estimate is $33.00 and S&P Capital IQ's fair value calculation is $36.10. According to TipRanks, based on 4 ranked analysts offering 12-month price targets for HRL in the last 3 months, the average price target is $40.75.

The fundamental analysis tools available at finbox.io provide a comprehensive list of stock valuation models and a quick way to view the average fair value estimate of several models with default settings. According to finbox.io, the average fair value of HRL is $33.48, implying a downside of about 13%. 

Finally, the following earnings and price correlated F.A.S.T. graphs chart for an 8-year period indicates an estimate price of $31.63 for the Normal P/E Ratio of 18.8 for HRL.

Excluding the highest and lowest of these fair value estimates and using the average of the remaining values, I get a fair value of $33.96. Recently, HRL traded at $38.46 per share, or at a premium to fair value of about 13%.

Key Statistics and Investment Thesis

The following table provides some key statistics for HRL. Data sources include the CCC spreadsheet and Finviz.

While I rate HRL highly as a dividend growth stock, I'm not willing to pay a premium of 13% to own shares. The premium price causes HRL to fail no fewer than 3 of my selection criteria:

• Dividend Yield: At least 2% but less than 8% (1.5%)
• Equity Valuation Multiple: Price to earnings ratio is less than 16 (25.0x)
• Fair Value Estimate: Price discount is at least 10% of fair value estimate (-13.3%)

On the other hand, the stock passes my other selection criteria with flying colors:

• Dividend Streak: At least 5 consecutive years of dividend increases (50 years)
• Dividend Growth: Median of 1-year, 3-year, and 5-year compound annual growth rates (CAGR) is at least 6% (18.9%)
• Dividend Payout Ratio: Ratio of dividend to earnings per share (EPS) is less than 60% (37.0%)
• Debt Ratio: Debt to equity ratio is below 60% (6.0%)

I would consider buying shares below $30.00, or about 12% below fair value. This means that HRL's share price would have to drop by nearly 22% from current levels. An alternative strategy might be to sell $30 puts and collect the option premium, while waiting for the stock to trade at more acceptable levels. 

Other Ratings and Rankings

The following table presents ratings of HRL from several sources:

For a description of the various stock ratings referenced in the table, please see my Ratings page.

Concluding Remarks

HRL has an impressive track record of paying and raising dividends. While the yield is too low for my taste at this time, the dividend growth rate is great! In fact, HRL easily passes the so-called Chowder Rule, which requires the sum of dividend yield and 5-year CAGR to be at least 12%. The company has a solid balance sheet, low debt, and a low payout ratio. The dividend seems very safe.

Last month HRL reported record third quarter results and raised full year guidance. The company reported EPS of 36¢ per share, up 33% from the year-ago quarter's EPS. This is the thirteenth consecutive quarter of record earnings for HRL. The company increased 2016 guidance to $1.60-$1.64 per share, up from $1.56 to $1.60 per share. It expects continued sales and earnings growth in 2017.

HRL seems to be firing on all cylinders and the market recognizes it! For now, I'll have to sit on the sidelines and wait for a more favorable entry point into this great stock.

Full Disclosure: I don't own any shares of HRL and I'm not planning on buying any shares soon.

This article first appeared on The DIV-Net on Wednesday, 14 September 2016. Active bloggers with sites that focus on Dividend Investing, Value Investing or a long-term buy-and-hold philosophy are invited to apply for associate membership.