Hormel Foods Corp (HRL) — Q1 2016 Earnings Call Transcript

Good morning everyone. Once again, I’m Jon Feeney, CAGNY Conference Co-Chair. And once again, I have the pleasure of introducing Jeff Ettinger, Chairman and CEO, Hormel Foods. But first, I’d like to take this opportunity to thank Hormel for hosting lunch today, featuring many of their leading branded retail and foodservice items that’ll be immediately after this presentation. Hormel was nice enough to move up their strong earnings release this morning for this presentation, which you probably saw this morning, just like they’ve been nice enough to lead the industry in returns for the past 15 years and to grow dividends every year for the past 50. For 125 years, they’ve been the protein Company everyone else would like to be. And through the recent acquisitions like Skippy and Muscle Milk, they’re very quickly becoming the food and CPG company everyone would like to be. Today, their CFO, Jody Feragen will cover the highlights of their earnings in lieu of an earnings call first, while both Jeff and recently named President and COO, Jim Snee will follow up and focus on their long-term strategic efforts, of course followed by your questions. So, Jody, welcome. Thank you, and take it away.

Thank you, Jon, for that introduction. Before we get started this morning, I need to remind you that certain statements will be forward-looking and they are based on current conditions. I would refer you to the risk factors in our 2015 annual report. Additionally, 2015 results are non-GAAP numbers that exclude certain adjustments and those too are detailed in the annual report and also in the back of the presentation deck that you received when you walked in today. As Jon said, we did wait to deliver our record quarter for this morning, $0.43 per share, our 11th consecutive quarter of record earnings. We were pleased that four of our five business segments contributed to the growth. Now, sales were down 4% due to lower pork markets as well as the turkey harvest supply issues that we’ll talk about later. You’ll note that the earnings per share and all the earnings per share numbers in the presentation have been adjusted for the two-for-one stock split that our shareholders approved on January 26th and became effective on February 9th. So, taking a look at the segments, Grocery Products segment operating profit was up 26%, really benefiting from improved operational and supply chain efficiencies. In the first quarter of 2015, we rationalized our plant in Stockton, California, and moved that production into other facilities. So, they’re seeing a nice benefit from that and they’re also winning with favorable raw material costs. Sales were down 4%, as we saw some softness in the canned meats area but we were really pleased with the results of our HORMEL bacon toppings, our CHI-CHI foods products, and our Wholly Guacamole items. Refrigerated Foods had an outstanding quarter, segment profit up 65%. It was a great improvement, a great performance across all our value-added businesses as well as strong pork operating margins. This segment also benefited from the inclusion of the Applegate Farm operations, that was the business we acquired in July of 2015, and it continues to perform as we expected. I think you’ll hear a little bit more about that later in the presentation today. Sales were up 2% on a 5% volume increase as the higher sales were offset by those lower pork prices. We did see nice gains in our HORMEL refrigerated entrees, our HORMEL party trays in the retail side, as well as OLD SMOKEHOUSE bacon and FIRE BRAISED meats from the foodservice side. Jennie-O Turkey Store operating profit was down 2% for the quarter, really still recovering from the impact of highly pathogenic avian influenza that hit our farms in Wisconsin and Minnesota midway through 2015 last year. We are seeing improved performance, and we would expect that by the end of our second quarter, they should be back at normalized operations, providing we see no further widespread outbreaks of AI. They’ll also benefit from lower feed costs as grain prices have been lower. Sales were down 15%; volume down 23% and really that was just a supply issue, as we are vertically integrated in the turkey side of the business. Specialty Foods operating profit was up 44% on the 10% decline in sales. They too benefitted from favorable input costs and also some supply chain efficiencies as we look to rationalize the MUSCLE MILK production into some of our existing facilities. We were pleased with the growth of our MUSCLE MILK products, particularly the ready-to-drink items. But, we did see decreased sales of some contract packaging sports nutritional items that were at a low margin basis. International saw a 1% increase in operating profit on a 7% decline in sales. We were very pleased with the strong SKIPPY sales, both on an export basis as well as SKIPPY sales within our China operation, but they couldn’t offset softer pork exports as we continue to battle challenging market conditions. Our China results were lower year-over-year. First quarter 2015, we were able to import SPAM and sell that in the domestic marketplace in China; that’s no longer an option, so they are up against those difficult comparisons. But, we are fully looking forward to our plants that we are building in China to provide us the opportunity to sell SPAM to that marketplace. Some other financial metrics that we traditionally go over on our call, advertising spend was $48.1 million, up nicely from last year; we expect full year to be up in the low double-digits area. Our effective tax rate was 33.6% and we’re expecting approximately 33.5% to 34% for the full year. Depreciation and amortization was slightly under $32 million while our capital expenditures were $33.5 million. As a reminder, we guided at the end of our fourth quarter that we were expecting approximately $250 million in CapEx, and you’ll hear about some of the projects later in the presentation. From a market outlook perspective, we are expecting hog production to be up about 2%. While we benefitted from historically high favorable pork operating margins in the first quarter, we would expect those to moderate as the year goes on. Turkey production, assuming no widespread outbreaks of avian influenza, is expected to be up 5% to 6%. As that production increases, we should see prices moderate in the back half. Grains will be favorable year-over-year versus 2015. As a reminder, we traditionally look to hedge between 25% and 75% of our needs on a two-year forward looking. We have a very strong balance sheet. The $185 million of short-term debt that was on the balance sheet at the end of our fourth quarter related to the Applegate transaction was repaid. We now have $250 million of long-term debt on our balance sheet, which we believe gives us the opportunity to continue to look at all types of investments. I believe we could have $3 billion of additional debt on our balance sheet and still remain investment grade. Our excellent earnings results coupled with our disciplined capital model have allowed us to generate cash flows over the last five years of 21% growth rates. If you look at the trailing 12 months ended in the first quarter, we’re up over 65%, certainly generating nice cash flow. Our priorities have remained the same, pretty consistent year-over-year. We look to invest in our businesses as well as to return to our shareholders. We’ve invested about $2.8 billion in growing our business, some of that organic being capital investment. We’ll talk about adding capacity to meet some of the demand for our value-added products, and then about $2.1 billion in strategic acquisitions. The way we look at these investments is the same regardless of whether I'm adding internal capacity or looking at a strategic acquisition. We build the base case business model, we use a long-term cost of capital, and we do a discounted cash flow, and we believe that allows us to make the best decisions for our shareholders. Speaking of shareholders, we believe in returning our excess cash flow to our shareholders. Our share repurchase is a little more opportunistic given our ownership structure, but we certainly are pleased with our dividend results. As Jon referenced, 50 consecutive years of dividend increases. Our Board of Directors approved a 16% increase for 2016 and our average growth rate over the near term has been about 18%, in excess of the excellent bottom-line that we’ve been able to deliver, as we try to get a payout ratio and the dividend yield closer to our peers. So, excellent earnings results; disciplined capital allows us to put up a return on invested capital that’s in the top quartile of our peer group. With that, I’m going to turn it over to Jeff Ettinger.

It’s our pleasure to be with you this morning to share what was an outstanding quarter for Hormel Foods, and to be back at CAGNY after a few years hiatus to discuss what we’ve been up to and what our priorities are going forward in terms of our brands and our team. As Jon was nice enough to mention, we’re also hosting the lunch. We don’t have a formal Q&A session after this, but we’ll all be available including others of our team during lunch to take any additional questions you might have. One of the questions you could ask anybody in there is what does 5 and 10 mean to Hormel Foods? 5 and 10 have been our consistent goals within our corporation for the past 10 years; we strive to achieve 5% revenue growth each year and 10% earnings or operating income growth. These are among the most aggressive goals within the food industry and even in our past presentations here at CAGNY that Jody and I have done, you should have consistently seen that these were our goals at those sessions as well. Importantly, we’ve really done a nice job at achieving those aggressive goals. Our track record over the past five years on the topline is indeed at that 5% rate. We’re now a $9.3 billion company. In terms of earnings, we’ve actually been able to exceed our 10% goal with a 12% CAGR capping out last year. I want to share with you how we’ve done that and a little bit of our thinking behind some of the decisions we’ve made that have led to these types of results. We’ve grown our company on a topline basis and certainly significant profit contributions in three ways: Through M&A; through new product innovation; and by continuing to expand our traditional product portfolio. In the area of M&A, we had an active decade during the 2000s with a number of deals, somewhat smaller deals ranging from about $15 million to $200 million in deal value, over a broad spectrum of products. This array of deals enabled us to gain confidence in our ability to integrate and to look for new prospects, but as we headed into the most recent timeframe, we did make a couple of changes in our mentality toward acquisitions. We look for somewhat larger deals as our company’s getting bigger and to move the needle; we recognized we needed to look at bigger opportunities. Four out of the five largest deals in the company’s history have come in the past four years: Wholly Guacamole at a total deal value of north of $200 million counting earn-outs, Skippy which we completed in 2013, a $700 million deal, Muscle Milk in 2014 which was a $450 million deal, and most recently Applegate at $775 million. In addition to the deals being larger, we also looked critically at our portfolio and determined that, while we love many of the items that have been with us a long time, we recognized that our portfolio was very American dominated with traditional American food items. Neither SPAM nor bacon items will likely be accused of being health-oriented anytime soon. We recognized that consumers are more on the go, and our portfolio had become increasingly dominated by sit-down meal type items. So, all four of these acquisitions, Jim is going to give you more detail on these, aimed at making our portfolio more global, more multicultural to add elements of health, holistic attributes, and provide on-the-go solutions. Another decision you have to make when you acquire something is, how are you going to run this operation? We’re still headquartered in Austin, Minnesota, a small town, two hours south of Minneapolis. Indeed for some of these properties, particularly businesses or brands that we buy from another company or corporation, we tend to fold those in and run them in-house. This was true of the domestic Skippy business, it was true of the Lloyd’s barbecue line, and it was true of the Country Crock Side Dishes, which are now named Hormel Side Dishes. For some of these recent deals however, we’ve looked at those deals and decided that to really optimize the consumer connection and the uniqueness of some of these opportunities, we might need to run them a little differently. We still try to find ways to harmonize and gain synergies on a back room basis in every chance we get. But in terms of that direct to consumer connection point, for example, Skippy in China, it came at the plant in China from which we sell to most of Asia, and so we have a Chinese team that has been in place for over 15 years that’s taken on that business. Muscle Milk had a strong presence in Northern California, a vibrant market, and we wanted to maintain that, so we’ve left that team there supplementing with a few folks in the Hormel organization. MegaMex, into which we put the Wholly Guacamole acquisition, is a joint venture with two companies from Mexico, Grupo Herdez and Grupo KUO. So on a combined basis, we run that entity from Southern California, which is a hot market for understanding the Mexican food experience. With Applegate, this team and this business had a unique supply chain of organic and antibiotic-free natural products and also a very strong consumer connection. We wanted to make sure we preserved that connection. So in keeping with the theme of providing you with a little behind-the-scenes mentality of what we’ve been seeking to do, I want to share with you now a video that depicts what the Applegate experience is all about from the mouths of their team members.

Thank you, Jeff. First, since this presentation is doubling as our first quarter earnings call, I’d like to take this opportunity to update all of you on our outlook for the rest of 2016. During our fourth quarter conference call, we set our 2016 earnings per share guidance at $1.43 to a $1.48 per share. Those numbers are adjusted for the recent stock split. While sales growth will continue to be challenged, as we navigate lower pork markets and the reduced turkey volumes at Jennie-O, especially through the first half of the year, we do expect our earnings to continue to be favorable. Our strong earnings performance in the first quarter was led by Refrigerated Foods, Grocery Products, Specialty Foods, as well as improvements in our Jennie-O Turkey segment as we recover from the turkey supply pressures. This has given us the confidence to raise our guidance for the full year to $1.50 to $1.56 per share. That represents a 14% to 18% increase over 2015. While the Jennie-O Turkey Store business is still recovering from the impact of avian influenza last year, production volumes are expected to return to more normalized levels by the end of the second quarter. This expectation assumes that we do not have any new outbreaks of avian influenza in our operations, which are located in Minnesota and Wisconsin. We look for continued favorable input costs for our Grocery Products and Refrigerated Foods segment. Refrigerated Foods will also benefit from strong pork operating margins. However, we expect those pork operating margins to moderate as the year progresses. Specialty Foods should continue to benefit from an improved mix of higher value-added items as our Muscle Milk franchise grows and we shift away from some lower margin business in other areas. The team’s done a nice job capitalizing on operational efficiencies between our existing Century Foods business and the recently acquired CytoSport business. We expect Specialty Foods to continue to benefit from those efforts. We do expect our International segment to deliver improved results as the year progresses with improved export sales of both SPAM and SKIPPY. In terms of total company performance, one reason we’re able to consistently set and hit our aggressive long-term growth goals is the balance built into our business segments. Overall, our business model supports growth that exceeds the average for packaged food companies but is also inherently less volatile than our protein peers. In the first quarter, we’re pleased to post another record earnings which grew at a significant double-digit rate with four of our five segments delivering earnings growth, demonstrating our balanced model. The long-term success of this model is borne out over time, as we’ve delivered year-over-year earnings growth in 27 of the past 30 years. This financial consistency is due to the diversity across the business segments and the balance built throughout our business model. Our product offerings are both protein-centric and packaged foods, which has served us well over time. The deep investments we’ve made in our pork and turkey supply chains allow us to control the quality and consistency of our products while removing costs from our system. This is balanced by purchasing key inputs such as peanuts, avocados, and tomatoes from the outside; which reduces our exposure to potentially volatile growing cycles while minimizing capital investment. We have a strong presence in both the retail and foodservice channels, allowing us to serve consumers with meal solutions both at home and away from home. Our retail and foodservice businesses are strengthened by a dedicated sales force that concentrates exclusively on our family of brands. We maintain a strong sense of financial conservatism that serves the company well. As you saw earlier from Jody, we certainly have a strong balance sheet that provides great flexibility. This conservative nature is complemented by a relentless pursuit of innovation, which has allowed us to maintain relevance with consumers. This drives our success in both process and product improvement. This right balance allows us to prosper in various commodity cycles, and our diversified portfolio helps insulate the business from various market conditions. We have purposely prioritized our investments to expand the growth platform that positions our company for long-term growth, while complementing our existing portfolio of strong brands, ultimately creating a platform of foods that fit the many consumer needs. While we’ve seen faster growth in our International business, we acknowledge that our business is still primarily a U.S.-based business, but we continue to seek opportunities to expand our global footprint. We view multicultural items with new and adventurous flavors, such as those in our MegaMex portfolio, as a strong growth platform. We believe there are opportunities to expand our multicultural food offerings moving forward. Additionally, our innovation and acquisition efforts have focused on delivering foods that fit today’s busy on-the-go lifestyles, which are increasingly nutritious and have holistic attributes. Let’s take a deeper look at each of these platforms. Our International business has achieved significant top-line growth over the last five years, with a 15% compound annual sales growth rate. This segment is built on long-standing partnerships with Purefoods in the Philippines, CJ in South Korea, and a well-developed export business with iconic brands like SPAM and SKIPPY. In China, we’ve developed businesses in both foodservice and retail channels, leading to our decision to expand production capacity in that country. We broke ground in April on our new production facility in Jiaxing, China, which will be completed by the end of calendar 2016. This facility will produce refrigerated and frozen meat items and include in-country SPAM production for the first time in our history. This investment will provide much-needed capacity and allow us to meet the growing demand for our products in China from both consumers and foodservice operators. While we're pleased with the work our team has done to deliver organic growth, we continue to seek opportunities to increase our global exposure more meaningfully. I want to spend some time discussing specific brands in our portfolio supporting our growth platforms and the efforts made by our team to deliver innovation that meets today's consumer needs.

Thanks for taking the question. Congratulations on another great quarter. Can you talk a little bit about M&A? Obviously, your returns have exceeded any of your peers but your balance sheet is still under-levered; you mentioned $3 billion in dry powder. The last three deals on average have added I think 4% to your earnings growth on average. What do you expect M&A to add to your growth algorithm going forward?

We talk about 5% and 10% growth, but we’ve said that’s inclusive of M&A. Over a 10-year timeframe, M&A has contributed about 1 to 1.5% of the 5%. Over the last five years, it’s been a bit more robust as we have done bigger deals. We clearly have the financial capacity to tackle more acquisitions. If you look at recent ones, some are from corporations, like SKIPPY and Lloyds. Occasionally, companies change their portfolios, and we will look at items within those portfolios that make sense for Hormel. A number of our more successful acquisitions have been family-owned businesses, and we try to establish a relationship over the years to be a preferred buyer when those families decide to sell. We certainly have a number of hooks in the water and keep looking for the right opportunities. We know we can handle them financially and in terms of our company's capacity to integrate and manage those businesses.

Importantly, the disciplined model we put in place for our investments takes a long-term view because we do buy things that we intend to keep for the next 125 years.

We would probably keep those tied to the growth platforms I discussed. When we think about global multicultural, healthy holistic, and on-the-go, those will be key drivers for us in the future. It doesn’t mean we wouldn’t look at a business that adds scale to an existing portfolio, but we want to focus on those growth platforms ahead.

Results today highlighted the success of your allocation of raw material to the highest opportunity, particularly your Jennie-O Turkey Store had volumes that were down kind of 20% plus but your earnings were nearly flat. As you look forward, what more opportunity do you see in both turkey and pork going forward?

From a turkey perspective, clearly it’s exactly what you said. The team has done a great job allocating those raw materials. But as we get into the back half of the year, we will see a return to more normalized returns. We need to ensure our business and distribution return to pre-avian influenza levels, as there were some rationalizations that had to take place. The fundamentals of the Jennie-O Turkey Store business are strong. If we can put the supply on top of that, we believe we are well-positioned for future growth. On the pork side, pork operating margins could impact the back half of the year. However, across Refrigerated Foods, we include various meat products and foodservice; the impact is not uniform. We expect to be fine on the pork side.

Thanks. I thought what helped the quarter were bacon margins; deli prices were way down and bacon retail seemed really high. Was that a big driver of refrigerated margin in the quarter, and is that also sustainable given the volatility in deli prices historically?

That was a piece of it. Our portfolio includes Hormel pepperoni, bacon, and items within our foodservice group, which also has a bacon component. Our team does a great job of staying current on pricing, as there is volatility. I think the margin management and discipline of our team is commendable, and I would expect we would maintain that moving forward.

Industry-wide, turkey is unique as it's a niche protein. Even with the great job our Jennie-O brand has done proliferating in the marketplace and adding value-added items, it’s not the primary item retailers feature in their ads, except for Thanksgiving. The pricing model for turkey is quite consistent. As long as we build innovative items with unique selling points, we can maintain good margins. We will support that through advertising. It’s hard to predict from a macro standpoint. The industry will closely watch for further outbreaks in the upcoming spring. Cold storage stocks are rising, as some hold surplus items in anticipation of a potential challenge. We haven’t seen any recurrence in our region recently. There was a recent incident in Indiana but it was limited to a different strain. The AI dynamic will continue to affect the market at least through spring; a clean spring might change things next year.

I wanted to ask about your long-term targets; 5% sales, 10% earnings growth. This implies a decent amount of margin expansion over time. If we look at your specific segment margin ranges, you are already at the high-end or even above the high-end in some cases. Can you talk about where you expect to see that margin expansion come from over time?

We will look to leverage efficiencies on the corporate and G&A side of things, as Jeff mentioned. It’s really about focusing on what consumers are looking for and finding value-added products that fit our growth platforms. When looking at M&A or internal investments, we expect the margin profile of those investments over time to be accretive to their respective segments.

As Jon mentioned in his introduction, we certainly have sought to shift our portfolio to a more prepared foods player, but our aggregate margins still remain well below the average in that universe. We believe over time that we can migrate the total company margins northward to align with our goals.

Thank you all for your insights today. As a reminder, lunch is immediately after this. Hormel's management team will be available for your questions. Let’s take this opportunity to thank Hormel once again for what is sure to be a great lunch and for their support of CAGNY. We had a great presentation. Thank you.