Morningstar | Our Outlook for Hormel Remains in Place Despite Tepid 3Q Results
A large change to our $36 fair value estimate for narrow-moat Hormel is unlikely after the third-quarter earnings release, despite diminished fiscal 2018 expectations. The changes to our near-term outlook are due to volatile commodity meat prices, and so our long-term forecast for mid-single-digit sales growth and 14% operating margin on average through fiscal 2027 endures.Year to date, Hormel posted 5% sales growth against about 150 basis points of operating margin degradation, to 13%. Management reaffirmed its $1.81-$1.95 fiscal 2018 diluted earnings per share guidance but cut its net sales forecast to $9.4 billion-$9.6 billion from $9.7 billion-$10.1 billion. Our preannouncement $1.86 EPS target is in line, but the new revenue range lags our $9.7 billion mark.
The grocery unit (about 20% of sales) continues to struggle, but we are seeing signs of recovery at the main culprit, CytoSport (which includes Muscle Milk). Management indicated progress in the food, drug, and mass channels, particularly in ready-to-drink multipack offerings. Distribution challenges remain, especially in convenience stores, but we expect recovery, leading to segment sales growth moving from a fairly flat year-to-date performance toward our 3% long-term average forecast.
Results in refrigerated foods (about half of sales) were strained by sharp pork price declines, with commodity operating profits down 88% in the quarter as trade concerns and cheap competing meat left supplies high. Management sold a pork processing plant earlier this month, reinforcing our positive view of its capital-allocation prowess, which has earned an Exemplary stewardship rating. The price received was a modest $30 million, but the deal avoided over $80 million in capital expenditures that would have been needed for an undifferentiated business. With a supply contract in place with the buyers, the deal reduces Hormel's reliance on commodity sales and the associated risk, in our opinion.
Hormel Foods is primarily engaged in the production of meat and food products and the marketing of those products throughout the United States and internationally. The company's segments are: Grocery Products, which consists of the processing, marketing, and sale of shelf-stable food products; Refrigerated Foods, which consists of the processing, marketing, and sale of branded and unbranded pork, beef, chicken, and turkey products; Jennie-O Turkey Store, which consists of the processing, marketing, and sale of branded and unbranded turkey products; and International and Other, which includes Hormel Foods International Corporation that manufactures, markets, and sells the company's products internationally.
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