Hormel Foods Corp (HRL) — Q4 2018 Earnings Call Transcript

Good morning. Welcome to the Hormel Foods conference call for the fourth quarter of fiscal 2018. We released our results this morning before the market opened around 6:30 AM Eastern. If you did not receive a copy of the release, you can find it on our website at hormelfoods.com under the Investor section. On our call today is Jim Snee, Chairman of the Board, President and Chief Executive Officer and Jim Sheehan, Senior Vice President and Chief Financial Officer. Jim Snee will provide a review of each segment’s performance for the quarter and our outlook for 2019. Jim Sheehan will provide detailed financial results and further assumptions relating to our outlook. The line will be open for questions following Jim Sheehan’s remarks. As a courtesy to the other analysts, please limit yourself to one question with one follow-up. If you have additional questions, you are welcome to get back into the queue. An audio replay of this call will be available beginning at 11:00 AM today Central Standard Time. The dial-in number is 888-254-3590 and the access code is 9962477. It will also be posted to our website and archived for one year. Before we get started, I need to reference the Safe Harbor statements. Some of the comments made today will be forward-looking and actual results may differ materially from those expressed in or implied by the statements we will be making. Please refer to pages 35 through 41 in the Company’s Form 10-Q for the quarter ended July 29, 2018 for more details. It can be accessed on our website. Additionally, please note the Company uses non-GAAP results to provide investors with a better understanding of the Company’s fourth quarter and full-year operating performance. These non-GAAP financial measures should not be considered a replacement for and should be read together with our GAAP results. Discussion on non-GAAP information in addition to reconciliations to GAAP results are detailed in our press release located on our website. We will refer to these non-GAAP results as organic net sales, organic volume, adjusted segment profit and adjusted earnings per share. I will now turn the call over to Jim Snee.

Thank you, Nathan. Good morning everyone. Throughout the year, we made significant progress towards our long-term vision as a global branded food company. With an emphasis on brand building, innovation, acquisitions, and intentional balance, our long-term approach allowed us to manage through difficult situations, such as commodity market volatility, increased freight, and global trade uncertainty. This year was marked by many milestones. We made the largest acquisition in our Company's history with the purchase of Columbus Craft Meats, and we also successfully integrated both Columbus and Fontanini into our supply chain. We reinvested a record amount of capital back into our company to increase capacity and improve efficiency. Major capital projects in 2018 included the Dold foods, pre-cooked bacon expansion and a highly automated Holberg facility. We also delivered many innovative new items to the marketplace, including Herdez guacamole salsa, Natural Choice snacks, Applegate Naturals products in the retail space, and Fire Braised Flank Steak for food service customers. From a financial perspective, we delivered record sales, earnings, and cash flows. 2018 also represented the 90th consecutive year of paying a quarterly dividend. Our strong financial results and confidence in the business allowed us to announce our 10th consecutive double-digit increase in the dividend for 2019, which will mark our 53rd consecutive year of dividend increases. By many measures, 2018 was a success. Refrigerated foods made impressive contributions to our performance with significant growth coming from value-added brands in retail, deli, and food service. However, there are areas of the business that did not meet our expectations. Jennie-O Turkey Store had another difficult year as they manage through continued oversupply in the Turkey industry. And CytoSport had a disappointing year with declines in powder and single-serve ready-to-drink product lines. We are taking appropriate actions in both businesses and expect a return to growth in 2019. Looking at the fourth quarter, we delivered record adjusted earnings per share of $0.51, a 24% increase. Many brands and product lines across all four segments drove growth. This effort was led by the success in refrigerated foods and overcame significant commodity headwinds to deliver impressive results in all parts of their business. Our international team also delivered strong growth in the quarter, led by exports of branded products. For the total company, sales increased 1% on a 1% decline in volume. The sales increase was driven by our MegaMex joint venture and growth of branded products in refrigerated foods. The Fontanini, Columbus craft meats, and Ceratti acquisitions met our expectations for the year and contributed to the increase for the quarter. On an organic basis, volume and sales declined 3% due to weakness in contract manufacturing and a lower commodity market. Refrigerated foods grew volume 2% and sales 6%. Products, such as Applegate, Natural and Organic Meats, Hormel Natural Choice products, Hormel Fire Braised meats, and Hormel pepperoni, all delivered excellent growth this quarter. Sales also increased due to the Fontanini and Columbus acquisitions. A reduction in hog harvest volume of 3% drove an organic volume decline of 2% and an organic sales decline of 3%. Pricing declined due to the lower pork market. Refrigerated food was able to deliver a 25% increase in profits even as commodity profits declined 31%. The team was able to offset higher freight costs and higher advertising investments. I am particularly proud of how the refrigerated foods team continues to shift the portfolio towards branded value-added products. International sales increased 7% on volume growth of 5%. We saw strong sales increases on branded exports of products such as SPAM lunch and meat and Skippy peanut butter. The addition of the Ceratti business in Brazil also drove the sales increase. International segment profit increased 7% in spite of lower fresh pork exports and increased freight costs. Lower SG&A expenses also contributed to improved earnings. Jennie-O Turkey Store volume and sales declined 4%, primarily due to whole bird sales decline. As we mentioned on our last call, a portion of our whole bird sales were shifted to the third quarter to minimize cold storage expenses. Sales of Jennie-O lean ground turkey and premium deli items showed sales growth this quarter. Segment profit declined 31% due to lower whole bird prices, increased freight, and higher feed costs. Grocery products sales decreased 4% as strong volume and sales growth of Herdez salsa and Wholly Guacamole dips did not offset declines in our contract manufacturing business. Adjusted segment profit decreased 6% on lower sales and higher freight expenses. This year, we made excellent progress on our path forward that I laid out at our 2017 Investor Day. This included becoming a broader food company, expanding and accelerating food service, becoming a more global company, reducing volatility, divesting non-strategic assets, and modernizing our supply chain. We will continue to execute against these initiatives in 2019. I anticipate a combination of external factors will impact our business this year. On one hand, we expect to benefit from lower pork input costs and a return to more normalized fundamentals in the Turkey industry. On the other hand, we expect continued inflationary pressure in addition to commodity market volatility. Our team's ability to focus on the controllable elements of the business will help us manage through these challenges. The quality and speed at which we are bringing innovation to the marketplace will be even better than it was in 2018. Our pipeline of innovative products will help us achieve our 15% by 2020 challenge. We made progress toward this innovation goal in 2018 as more than 14% of our sales came from products innovative in the last five years. In 2019, we expect continued growth from innovative products such as Bacon 1 fully cooked bacon, Fire Braised Meats, Natural Choice snacks, taps and wraps, and Herdez guacamole salsa. The start of fiscal 2019 is also the official beginning of our new Hormel Deli Solutions division, which combines all aspects of our deli brands and businesses into one group within refrigerated foods. As we outlined at CAGNY in February, this new division delivers an unmatched array of high-quality deli and prepared foods offerings marketed and sold through a direct sales organization. We are excited to help retailers create the deli of the future. Looking at the segments for 2019, we expect all four business units to show sales and profit growth. The fundamentals in the Turkey industry are showing slow improvement with declines in placements and cold storage stocks. For the first time in over two years, we are seeing signs of consolidation within the industry. While we are encouraged by these factors, we continue to take proactive steps to restore the growth of this business. Our expectation this year is for a modest recovery in the turkey industry and earnings growth from Jennie-O Turkey Store. Commitments to control costs, optimize the supply chain, and investments in the Jennie-O brand will be important in 2019. Similar to 2018, we expect an increase in branded value-added sales and profits in refrigerated food. Growth will be led by our teams in food service, deli, and Applegate. Gains in our value-added businesses are expected to once again offset a reduction in commodity profits. International is expected to have a strong year. Exports of branded products and gains in China and Brazil will offset continued declines in fresh pork exports. We see sales and earnings growth in grocery products coming from established brands such as Spam and Skippy, in addition to emerging brands such as Justin's, Wholly Guacamole, and Herdez. We also expect a meaningful contribution from the Muscle Milk brand. Our supply chain is complex and for many years we were able to capture incremental savings through grassroots projects, known internally as Best of the Best. Since reorganizing our supply chain teams into one structure at the beginning of 2018, our teams have been thinking differently about ways to optimize procurement, manufacturing, and logistics. In 2018, the team was able to capture over $70 million in savings through a focus on in-sourcing production, better asset utilization, and more automation in our manufacturing facility, all while managing the sale of our Fremont plants and dealing with higher freight costs. These results speak to our culture of corporate and personal accountability. For 2019, our cost savings target is $75 million. Areas of opportunity cover the entire spectrum of our supply chain. We plan to use the savings to help offset inflation, reinvest into key brands, and contribute to earnings growth. One macro factor we are continuing to watch closely is freight. We saw a double-digit increase in 2018, and we expect another large increase in 2019. We remain focused on finding mutually agreeable solutions with our customers and if necessary, increasing prices. Taking all these factors into account, we are setting our full-year earnings guidance at $1.77 to $1.91 per share and our sales guidance at $9.7 billion to $10.2 billion. This guidance reflects pretax and segment profit growth across all of our business units, driven by strong retail, food service, deli, and international performance. As a reminder, we had a significant tax benefit in 2018 due to tax reform. At this time, I will turn the call over to Jim Sheehan to discuss our financial information relating to the quarter and key assumptions for fiscal 2019.

Thank you, Jim. Good morning, everyone. Fiscal 2018 was a record year for sales and earnings per share, operating cash flow, and dividends. Our financial strategy is aligned with our vision for the company. The balance sheet is strong and capital allocation decisions support the long-term growth strategy. Volume for the fourth quarter was 1.3 billion pounds, a 1% decrease compared to 2017. For the full year, volume grew 1%. In the fourth quarter, sales were $2.5 billion, a 1% increase. Sales for 2018 were $9.5 billion, a 4% increase. Net earnings for the fourth quarter were $261 million, up 20% compared to last year. Full-year earnings were $1 billion, also a 20% increase. Adjusted earnings per share for the full year were $1.89, a 20% increase. In the quarter, we recognized a non-cash impairment of $17 million or $0.03 per share associated with the CytoSport business. The impairment was recorded in the grocery product segment. For the full year, SG&A excluding advertising was 7.2% of sales compared to 6.8% last year. The impact of acquisitions drove the increase. In 2019, we expect SG&A as a percentage of sales to decline as the company continues to focus on funding efficiencies throughout the organization. For the year, advertising was $152 million compared to $136 million last year. We continue to shift investments between advertising and trade to attain the highest return. In 2019, we plan to use advertising to support such brands as SPAM, Hormel pepperoni, Hormel Natural Choice, Columbus, and Jennie-O. General corporate expenses increased in 2018, primarily due to higher employee-related expenses, including the universal stock option grant for all employees. For the full-year operating margins were 12.6%, 140 basis points lower than 2017. Higher freight in all segments and whole bird declines at Jennie-O contributed to the decrease. We expect operating margins to improve in 2019. The full-year effective tax rate was 14.3% compared to 33.7% in 2017. The decline was due to the Tax Cuts and Jobs Act passed December 2017. The effective tax rate for 2019 is expected to be between 20.5% and 23%. In 2018, we generated cash flow from operations of $1.2 billion compared to $1 billion last year. The primary use of cash was CapEx, the acquisition of Columbus, and dividends. Capital expenditures for the year were $390 million, including the expansion of value-added capacity at Dold and a highly automated whole bird facility. We anticipate capital expenditures to be $350 million in 2019. Major projects include the expansion of value-added capacity, investments to improve efficiencies, and expanded automation in our plants. We paid our 361st consecutive quarterly dividend effective November 15th at an annual rate of $0.75 per share. We also announced the double-digit dividend increase. This was the 53rd consecutive year we have increased the dividend and the 10th consecutive year we have increased the dividend at a double-digit rate. We repaid the remaining short-term debt associated with the Columbus acquisition in the fourth quarter, ending the year with $625 million in total debt. We remain in a strong financial position to fund other capital needs given our low level of debt and consistent cash flow. Share repurchases for the full year totaled $47 million, representing 1.4 million shares. We will continue to repurchase stock to offset stock option exercises and based on our internal valuation. We continue to monitor supply and demand in the hog industry. We expect hog supplies to increase next year. Near-term volatility is heavily dependent on the progress of the new plants ramping up to full production. Domestic pork prices have declined due to an abundant supply of protein on the market. We expect this to continue into 2019. Lower protein prices benefit our value-added businesses. We expect exports to be up 3% to 4% in 2019. However, the African swine fever outbreak in China could impact U.S. pork exports. Input costs for the fourth quarter were generally lower. Product prices were 16% lower than last year and well below the five-year average. We expect slight increases to hog prices next year. USDA composite values declined 9%. We expect USDA composite value to be lower in 2019. In 2019, our hog purchases will decline approximately 30%, reducing the exposure from the volatility of hog prices. When the Fremont sale is final, we will be purchasing all hogs from the facility based on the USDA composite value. Included in our guidance is a decline in commodity profits due to the reduced harvest level and lower industry margins. Deli markets declined 11%, finishing below the five-year average. Overall, we expect modestly lower deli prices and continued volatility in 2019. 72% pork trim prices were 14% below last year. We expect trim markets to be lower in 2019, especially in the first half. 50% beef trim was 9% higher. We expect beef trim prices to be flat next year, compared to 2018. Feed costs were higher driven by soy meal. We expect feed costs to be higher in 2019. Industry data shows turkey pull placements down 3% over the last six months, cold storage of breast meat is 12% below 2017 but higher than the five-year average. Despite improvements in both key drivers, recovery remains low. Turkey commodity prices, including whole birds, pressured Jennie-O results in 2018 despite higher breast meat prices. Whole bird prices were 15% lower than last year. The multiyear lows will persist through this calendar year. Whole bird prices next year will be impacted by Thanksgiving volume. Breast meat prices were 33% higher. We expect higher breast meat prices in 2019. As Jim discussed, we created a new deli division within refrigerated foods. As a result, beginning in 2019, we will report Jennie-O deli results within the refrigerated food segment. Actual deli sales and profits, including an allocation of supply chain profits, will be transferred from Jennie-O to refrigerated foods. The size of the deli business moving from Jennie-O to refrigerated foods is approximately $300 million in sales with margins in line with the Jennie-O segment. The Company will restate the segment results beginning in the first quarter of 2019. The sale of the Fremont plants to WholeStone Farms is scheduled to close in December. We will incur approximately $12 million of expenses in the first quarter to build value-added equipment out of the facility and for various pension-related expenses. In 2018, the team demonstrated an ability to manage through various market factors and volatility. We are confident in the plan for 2019 and our strategy for delivering long-term value to shareholders. At this time, I'll turn the call over to the operator for the question-and-answer portion of the call.

Can you clarify a little bit how we should think about the supply chain savings? You've talked about $75 million, but it doesn’t seem like it includes any bigger more restructuring-type savings. Is that something that should likely come down the road or what's the right way to think about that?

I think the best way to think about it, Michael, is we started off the year saying the thing that we had to get right was the structure and the process, and making sure that we could identify, capture, validate, and strategically reinvest the savings. So the team is thinking differently as we look to optimize procurement, manufacturing, and logistics. And certainly, 2018 had a keen focus on labor, overhead, and supply. Of course, let's not forget the fact that we put them in the middle of the freight increases and the Fremont divestiture. So they have a lot going on. In 2019, we'll have some of the things. But I will tell you that they're also starting to pivot towards the bigger and more structural things. So an example of that would be, as the baseline for freight has probably shifted over the long term, ensuring that we have the most optimized network possible. And so what does that look like for a distribution center, and how do we minimize travel over the long term? So, yes, we are getting to those bigger and more structural issues. But right now, it is a combination of some of the short-term and long-term things.

And your number for '19, could that have upside as you get into some of these projects later in the year or do you have a pretty good visibility and those will be further down the road?

Those will be a little further down the road. I mean for us, what is realistic so that we know disciplined and thoughtful, and we'll know more as we get closer.

The other item I would add, Michael, is that the $75 million we're talking about excludes any previously announced synergies that we have in our acquisitions.

I have a couple of questions regarding the guidance. The sales target seems quite ambitious, especially since the fourth quarter numbers fell short of expectations, particularly concerning pricing. Can you provide more details on how you arrived at these figures? Additionally, do you anticipate any price recovery in the commodity markets to help achieve these goals? Also, you mentioned that you expect hog prices to increase, but the overall composite would be lower for 2019. Could you explain the reasoning behind that assumption?

As we evaluate the various segments, we believe that the sales guidance is realistic. Considering the grocery products that came off a weaker fourth quarter, the main factor was that we had some additional sales in the fourth quarter of 2018 that we did not have in 2018, but we believe we are well positioned because the baseline for our grocery product business is strong. Therefore, as we enter 2019, we anticipate that this business will show mid-single digit growth. For refrigerated foods, we expect similar value-added growth and anticipate modest increases, projecting a low single-digit rise that we consider very attainable. Furthermore, our international growth on the top line aligns with our historical expectations of high single-digit growth. Overall, we believe the sales guidance is both realistic and achievable.

We expect the hog industry to be similar to the structural makeup of 2018, including the supply growth and the volatility based on the capacity coming online. Hog prices right now are low and we expect them to be up in the low single-digits. Regarding the spread, we expect the higher supply, the beef that will be available because of the additional capacity coming online will lower the commodity prices, including we expect deli and trimmed hog to be down in 2019.

And have you put any assumptions for China's hog herd disease issues, and what that might mean for American exports? Is that a positive or negative or too soon to tell?

It's really too soon to tell. And I would tell you, Rob, we have limited African swine fever risk assumed in this plan, because of exactly what you said. It's a risk to the China business but potentially an opportunity for our pork export business. We do believe that if it is a risk to China that we'll be able to take some pricing in line with the rest of the market, but it's really too early to tell. But we're watching and it's certainly on our radar like I’m sure it is everyone else's.

I just wanted to ask about the first quarter setup. In the past, you provided some commentary and insights around the call and how you’re seeing margins or EBIT overall trend across the different segments. I was hoping you could provide that here again on that first quarter setup?

Yes, so we haven’t really done so much by quarter. Last year, we talked a little bit about the commodity pricing just because of the very unique situation we were in and the recovery was heavily skewed to Q2. I would tell you or I would guide you to a couple of things that we have called out for Q1 that will impact the business as we did have the benefit last year of a mega tax credit. And then you heard in Jim Sheehan's comments the fact that we will have some Fremont closing expenses in Q1. So obviously, we're going to have that as a headwind early in the year.

And then just to follow-up on that on the Muscle Milk side, you mentioned meaningful contribution for the year. Is that both top and bottom? And can you maybe talk about what you're already seeing in that business in terms of its inflection?

So that would imply top and bottom line growth from the Muscle Milk business. And again, we've talked about several different components the part of the business that has grown throughout the year and continues to show growth is really the take-home or the multi-pack Tetra business. You've seen that in more food drug and mass as they expand out their sports nutrition category, that business has been healthy and will continue to be in 2019. We've seen recovery in the ready-to-drink space. So we saw growth in the back half of the year like we had said we would, and we expect that to continue in 2019. The area of the business that continues to be under pressure now is the powder business, and really the driver there is just that shift from the traditional brick-and-mortar specialty channel into more online business, and we have spent time and effort and resources building up that muscle for that digital competency that supports the e-commerce business.

I wanted to ask about the Turkey business. There have been some challenges from the industry and commodity pricing. Can you discuss the company-specific cost issues that you think you can address moving into next year? During a down cycle, I’m sure cost management becomes stricter. However, there were some specific cost challenges in your grow-out division. Can you help clarify the current state of Turkey, Jennie-O Turkey margins, and how much of the underperformance is due to industry factors versus company-specific issues?

I think the key driver in Jennie-O Turkey Store is that we need better fundamentals in the industry. I mean, that really is what is going to get us where we need the business to be. And so we've seen some of that happening, but we're still disappointed in the pace. And so we're looking into 2019, we are just projecting a modest growth. But in that modest growth, we know that we'll continue to outperform the industry. And so in some of the areas that Jim mentioned, Akshay, we continue to have a keen focus on securing our facilities to make sure we can avoid another avian influenza outbreak. We had talked about the work that we’re doing in the raise without antibiotics initiatives. And our team continues to make progress and they are making it more efficient and cost-effective. Clearly, they're impacted as much as anyone on the freight side of the business, and so that's not unique to them. And that’s really a company-wide initiative on how can we find those mutually agreeable solutions with consumers while still working in the long term to optimize our network. The other part is we see it as a business that continues to be on trend. We invested in the brands this year. We'll be reinvesting in the brand again in 2019, as we know, Turkey is on trend. And so we have to continue to outperform the industry, and we think the things we've done put us in a position to accelerate our performance, our outperformance versus the industry.

Akshay, one item that I would add is that we’re very excited about the new Melrose plant coming online in the spring. That’s a state-of-the-art plant that will really take our efficiencies to a new level. So that will, as Jim said, the business has outperformed the industry for a long time. This is going to allow us to increase that outperformance.

And just one follow-up on what Rob was asking about, but maybe in a different way. Looking through your segments, your business is so unique with the exposure to commodity meat prices that it's hard to really tell what's happening with full price. So can you at high level give us sense what you’re seeing pricing-wise as it relates to freight costs being up and overall food industry inflation has picked up? And so we feel like all the companies are talking about taking pricing. But what's your take on where we are in that cycle? Are you finding more success now than six months ago? Or how would you characterize the environment?

I think we’re no different than anybody else in that. We’re looking at all of these macro factors. So whether it's African swine fever, freight, tariffs, exports, it's clearly a dynamic situation. And we continue to look at it really on a category-by-category basis. And so refrigerated foods and Jennie-O Turkey Store are more market-based, closer to the market. And so you do have pricing that will move a bit more frequently. Grocery Products pricing really is less market-driven and impacted by the macro issues that we're talking about. And we took pricing obviously late '17 early '18, and we are looking at it on a category-by-category basis. And we don’t just look at pricing. We’re taking that holistic view of each of our brands in each of our categories, and understanding the levers in regards to trade, other revenue growth management initiatives, and obviously making sure we understand the corresponding projected elasticity. And I guess I would really look the fact that pricing has never been easy, never has been so, I think it ever will be. But the fact that we have number one and number two brands also puts us in a very solid position to make sure that we are taking those leadership roles.

And just one last housekeeping item, what is the guidance for next year's profits that will be impacted by the Fremont deal? Did you mention it was around $10 million? I understand the costs are $12 million, but what is the approximate profit contribution that will be missing from the P&L next year?

We mentioned in the script that commodity profits are expected to decline by 40% from this year, primarily due to the sale of the Fremont plant. Additionally, we anticipate that the margins on those hogs will also decrease throughout the year. Therefore, it seems to be a combination of both factors.

I believe I have the answer to this, but I want to clarify a bit. Regarding your question about guidance and the expenses you mentioned, which are likely to appear in the first quarter if the sale of Fremont occurs in December, could you tell me how much of those expenses are factored into your guidance? Is it accurate to assume that this is a GAAP number?

That's a fair assumption, Eric.

And then the second question, which I wanted to follow-up on here is, we saw the impairment charge for CytoSport in the quarter. I think Jim talked a little bit about the issue of sales moving more toward the e-commerce side of the business. But is this a business that you're still putting a fair amount of advertising support behind it? Is that the only fix that you need? Or what else in the powder side and I think it's also still widely competitive? But what else needs to happen for CytoSport to get back on track?

One of the things, Eric, that I called out was as those sales have shifted, we were behind the curve in terms of having the digital infrastructure that we needed. And so that has been a big initiative for us and we feel like we're in a position now where we have the appropriate content and sales infrastructure that we need. From an advertising perspective, the team that we have in place has reallocated some of those advertising dollars into slightly different messaging, which we're finding to be highly effective. And so I think those were really two of the bigger things that we had to get done and we're well-positioned for 2019.

I guess the first question in Jennie-O. I think you talked about modest profit improvement for fiscal '19. Can talk about the pass-through a couple of here? I mean it would look like some of the market indicators are moving in the right direction in terms of breast meat pricing being above $2 in terms of pulp placements being down, competitor potentially shutting down early in the new year. And I guess still only calling for modest profit improvement. Can you help us think about the path to getting back to those mid-teens margins this business did pre-avian flu?

I think you mentioned this. The fundamentals are definitely improving, but the main concern is the pace of that improvement. While full placements showed a downward trend last quarter, there was a slight increase in October. It's important for us to maintain focus on these fundamentals and encourage further acceleration. You're right about breast meat pricing, which we view positively, and we're seeing inventory levels decrease, which is also a good sign, although they're still historically high. We need to see this trend continue. As we've mentioned before, we will keep outperforming the industry, and the initiatives we are working on behind the scenes will support our ability to enhance this outperformance. However, to return to more normalized levels, we need to see greater acceleration in the fundamentals.

My second question is about refrigerated foods. The organic volumes in the quarter decreased by 2%, which you attributed to lower hog harvest levels. At what point does the organic volume trajectory in refrigerated foods diverge from hog harvest? I am also considering how Columbus and Fontanini might impact organic growth in the first quarter and beyond. At some point, you should need to grow this on the volume side with the new capacity you have added. Did that happen sooner than expected, or can you help us understand how the past will lead to organic volume growth?

I think 2019 is the year that you will see that where it will be the investments that we've made in those businesses that are driving volume, sales, and earnings growth. We see that across the board. We've been very intentional in terms of the investment to support value-added business and 2019 is a year that you will see that really connect.

Now a question on the deli business and you've mentioned you're going to move what you basically had within the Jennie-O Turkey up into the refrigerated foods segment. And you have nicely associated the sale volume, as well as the profitability. Now the question is for the whole restructuring and bringing that together. Are there any additional costs we should be aware of that you're going to encourage us by consolidating that business? And if you could share what is the size of the business if it's at some stage you would consider to actually spin it off from the refrigerated food segment and reported on a standalone basis just to get a little more magnitude of this business that would be my first question?

In regards to the deli business, we don't have any other expenses that we're expecting in 2019 and beyond as we've consolidated this business. For us, the bigger issues most of the work was done in 2018 really bringing all of these businesses together and integrating them behind the scenes; there was a lot of work that took place. And so as we've set off into fiscal 2019 really being able to stand up this organization and have them ready to go is exciting. In regards to the last part of your question, we've said it's about a $1 billion business and haven't really given any thought into splitting it and operating like that, because it is still closely linked and tied to refrigerated food. It makes perfect sense to have it there. And really the focus now is achieving and doing what we said we were going to do and making sure that it's A, our next growth engine and really helping retailers create the deli of the future and to capitalize on that opportunity.

So basically $1 billion that's what the $300 million that comes in from Jennie-O. Correct?

Yes.

And then lastly, regarding international sales, they were clearly strong. Could you provide an update on how the Brazil acquisition is performing, specifically with the Ceratti brand? How has your performance been and what is the competitive landscape like? I've noticed that some major competitors in the prepared food segment are relatively aggressive in raising prices. I’d like to understand your exposure to that situation and how you have been able to leverage it. Thank you.

So the Ceratti acquisition has met all of our expectations. And as we said, it's really given us a great entry point into the Brazilian market. In 2018, we did take some pricing down there as I think there’re some macro issues around inflation but we've been able to successfully pass along pricing, a reminder that the brand is a premium value-added brand very well recognized by Brazilian consumers. And so it mirrors a lot of what we have here in the United States in terms of being a premium authentic high-quality artisanal brand that resonates with consumers. And so the business is meeting all expectations. We're in the midst of continuing to make sure we're innovating and adding capacity to capitalize on the growth opportunities that are down there.

So just wanted to clarify on refrigerated foods guidance being up next year so just want to clarify, this includes the $15 million to $20 million in closing costs, which I think is what you estimated last quarter. It includes the estimated $10 million decline in commodity profits but it doesn't include the reconciliation of let's say $35 million, $40 million in Jennie-O Turkey Store business being reclassified into refrigerated food. So is your guidance implying that there's something in the range of $65 million to $75 million in organic operational improvements in fiscal '19?

I think it's fair to say everything that you've talked about is included in the growth that we're looking for in 2019. I think the $12 million is going to be in general corporate, but it's reflected in our overall number. But I think the other elements that you’re talking about really are reflected in refrigerated foods, and it will be another strong year for them. Jeremy, I guess if there's any more specific detail that you need certainly Nathan can be available to give you those answers.

But just want to make sure the Jennie-O reclassification is or isn’t included in your guidance, so refrigerated would have been up next year?

So that is now – the Jennie-O business has shifted into our deli organization, which is now included in refrigerated foods. So we are essentially rebasing refrigerated foods to reflect that.

And probably if you could expand on the pre-Fremont post-Fremont dynamic in refrigerate. I think you said commodity products would be down, hog harvest will be down but you’re getting your contract there would be no impact on volumes. So can you clarify what percentage of the tonnage that you will be buying from WholeStone under contract that will effectively be passed through, or in other words, the profit that you don’t turn into value-added, the green hands and their equivalents? Could you just quantify that if possible? And then within that, are there products that you're going to be entirely passing through and will there be products that you don’t necessarily add value on but you'll earn a spread, because you're locked into contract with a customer and you're getting capability there?

So we will take all of the meat coming off of Fremont line. Some of that meat will go into our value-added products. Some would be sold as fresh pork. We retain all margins on fresh pork sales. So we’re purchasing the meat at the USDA composite carcass value. So the spread between the carcass value and the sale and either the retail or the provisions market belongs to Hormel. So we’re taking down our harvest by 30% and as we see it, this is with the additional capacity coming online, this is exactly why we made the move to sell Fremont and de-risk the refrigerated foods business and that is the structure.

Lastly, regarding the 12% dividend increase in your guidance, it shows a significant rise in the payout ratio, which isn’t entirely unexpected considering your actions over the past decade. I'm curious about your reasoning for increasing the payout in 2019. Should we interpret this as a slight adjustment in your thoughts on potential M&A opportunities that may be available?

I think the biggest driver, obviously, is the strong cash flows of our business, strong cash flows and clearly our balance sheet remains strong for the organization. This is consistent with what we've done over the last decade, so the strong cash flows but the optimism that we have in our business going forward. So as we head off into 2019 and beyond, clearly the dividend is one of the levers when we think about capital allocation but we are in a very, very strong position to make any acquisition that we think is appropriate and strategic for us.

A quick follow-up on your comments about freight. Some other companies in the industry are saying they don't expect lower freight in 2019, but their outlook seems more cautious than yours. I'm curious if you're anticipating inflation on the freight side similar to what you experienced in 2018.

I think it's going to be a little lower than we saw in fiscal year 2018. We believe that there is still pressure but there's a bit more balance in the marketplace now that the freight lines have had time to work on, and certainly we've spent time working on it. So I guess I don’t want to overstate it but certainly it's a headwind in 2019. And again, it really goes back to this longer-term solution that our supply chain team is working on and what is the right network optimization for us.

You mentioned a 20% increase in advertising for 2018, but it ended up being less than that. You also noted a shift towards other types of promotions that proved to be more effective. Can you share your thoughts on advertising spending for 2019 in terms of year-over-year growth?

At the end of the first quarter, I mentioned that we planned to increase our advertising and promotional spending by around 20%. While our advertising showed a strong double-digit increase compared to last year, it did come in below that 20% target. However, our trained dollars exceeded our plans by a similar amount, allowing us to meet our expectations. Our spending on these dollars varies across different brands. The main takeaway is that we are actively managing our brand support to achieve the highest return on investment, focusing on revenue growth management, pricing, trade, and advertising. We are satisfied with our spending and anticipate a solid increase in 2019. Jim Sheehan mentioned some of the brands that will receive funding, including support for the SPAM brand, which recently had its fourth consecutive record year and has shown a positive response to advertising. We have also invested significantly in our Natural Choice brand and the Jennie-O Turkey Store business. Overall, we believe our investments, whether in advertising or trade, are yielding the desired returns.

Just a couple things to clear up. Frank, can you give us a sense of what the dollar inflation was in fiscal '18, just to get a sense of the headwinds just all in all. Second bellies, belly prices I think started pretty low in the quarter and were rising. Were you hedged on belly, did you get a really strong bacon margin in the quarter? And do you expect that to ease off in the first quarter, just because of the slope of the curve going higher. Maybe give us a little more clarity on what those bacon margins look like?

The freight was $0.06 to $0.08 in 2018, and belly markets as I said, we think that we will see volatility and we have seen volatility this year in bellies. We do not have a hedge on bellies right now. We still believe that they're going to be lower over the year. And I'll let Jim talk a little bit about the margins on the bacon.

Our bacon business was very strong, and it ties into my previous answer in terms of really where is the biggest ROI in terms of pricing or trade. And so we navigate through that. But I would tell you that we’re very pleased with bacon performance for the year, for the quarter, both top line and bottom line.

Last question, corporate expense it was like $60 million this year. I think it's twice as high as the year before. Should we expect it to be similar in fiscal '19? I didn’t catch that.

We will account for the $12 million from the closing of the Fremont sale in corporate expenses, which will increase the pressure on corporate expenses.

Great, thank you. On behalf of the team here at Hormel Foods, thank you to all of you for joining us today. To our team members listening in, thank you for all your tireless work that allows our company to be so successful in the marketplace. Your focus on delivering our key results and maintaining our culture of accountability will continue to make this company uncommon in the marketplace. Have a safe and happy Thanksgiving.