The narrow-moat firm will be threatened by its reliance on the center of the grocery store, which has seen rising competition.
has developed a portfolio of value-added protein brands, reducing its reliance on commodity products and building a narrow moat. The company’s health-friendly labels, such as Jennie-O Turkey and Applegate, are on-trend and should allow the company to expand distribution in previously untapped channels. Hormel’s Spam and Skippy brands have international appeal, offering the company a means of securing a foothold for those and other products abroad, a potential growth opportunity. That said, the sustainability of Hormel’s brand intangible asset is threatened by reliance on the center of the grocery store, which has seen rising competition even as consumers increasingly shop the perimeter (fresh products).
Zain Akbari, CFA, is an equity analyst for Morningstar.
Hormel has a history of strong return generation and a conservative balance sheet, which we expect to continue. Our forecast implies an average ROIC of 20% over the next five years, near the company’s 19% five-year historical average.
While management targets 5% revenue and 10% earnings growth annually, we believe Hormel will need to rely on acquisitions to achieve its objectives, as we forecast more modest respective paces of 4% and 5% over the next ten years (absent inorganic growth). Although the company has benefited from the availability of synergistic assets that suffered from inattention from their former owners (Skippy) or came available due to special circumstances (Applegate), valuations for on-trend, growing food manufacturers hit highs recently. These levels may anchor takeout price expectations, particularly for private companies.
Hormel’s performance is still influenced by feed- and hog-market conditions, as well as animal disease concerns, which have negatively affected the firm in recent years. Diverse product streams and brand strength limit the company's exposure to such considerations relative to other meat processors, but as the avian influenza outbreak affecting its turkey operations attests, Hormel is not immune. As such, we think the firm will need acquisitions to reach management’s EBIT margin goal (top quartile of peer group—currently at least 15%--by 2020, though we see this bar falling somewhat with normalizing commodity costs).
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