Not all related stocks are created equal, and HRL proves it

September 25, 2018

Not all related stocks are created equal, and HRL proves it

One of the regular themes of my posts for the last several months, as well as the trades I’ve been placing since the late winter and early spring months of this year, has been the need to focus on making my investment approach more conservative. That flies in the face of a lot of analysts and experts who have been using the market’s continual run-up to one all-time high after another as an argument to prove that since this bull market is different than other, the rules that govern your investment decisions also need to be different. That’s one way to look at things, and I’ll admit that if you’ve been working with the biggest growth stocks in the market for the last year, your results probaby beat mine. That doesn’t really bother me too much, though, because throughout my career as an investor I’ve come to understand and appreciate the fact that investing is neither a sprint nor a contest.

To be a successful investor, you have to decide what approach fits your style – your investment needs, your goals, your tolerance for risk, and your highly individualized personality. Once you find it, you have to be willing to stick with it, and avoid being distracted by other investors, whose approaches may not be bad, especially over any given period of time. The discipline to stay the course and not get distracted or drawn in by methods that might look sexier or hotter right now is an attribute that every investor needs to develop in order to be successful. It’s taken a lot of years and a mountain of hard-earned experience to drill that lesson into my head, but it’s something that helps me keep the kind of perspective that I need in mind so that the investment decisions I make, allow me to sleep easier at night. Diverging from that perspective, or away from the approach that I know works best for me usually just creates more stress and worry about things I can’t control and reduces my ability to make effective decisions when I really need them.



One of the things that helps me take that more conservative, and yes, cautious approach right now is focusing on stocks that I think are well-positioned as potential defensive plays. Value analysis is a big piece of that puzzle, in part because if a stock is already trading at a significant discount to its intrinsic value, it should experience less volatility than other, stocks that are trading at overvalued levels if and when a major market reversal comes. Another way to look at the “defensive’ picture is to focus on industries that generally maintain stable revenue and cash flows even when the economy takes a turn for the worse. That’s a big reason that while I’ve seen a lot of experts dismissing stocks in the Consumer Staples industry as being overvalued, I’ve been writing about a lot of them for quite some time now. Stocks like Kroger (KR), Newell Brands (NWL), Campbell Soup Company (CPB), Tyson Foods (TSN) and Pilgrim’s Price (PPC) are good examples of stocks that I think fit the undervalued, defensive bill.

The thing that you have to be careful, about however is buying into the idea that all stocks in a given sector or industry will offer the same kind of value opportunity. Even if an entire industry is deeply out of favor with the broad market, there are always companies that have a lot of really positive elements of their fundamental story. Fundamental strength doesn’t automatically translate to bargain pricing, however, and all else being equal, it usually won’t, because the market likes the idea that fundamentally strong stocks have built-in reasons to be priced higher. Hormel Foods Corporation (HRL) is a very good example of what I’m talking about. This is a company with a very solid fundamental proposition, but that is only a few dollars below its 52-week high and about 15% below its all-time high. The common temptation right now, with the stock dropping directly off of that 52-week high over the last week or so, would probably be to “buy the dip.” I think this is a very good company that isn’t yet trading at a nice price, however, so it frankly doesn’t meet my requirements as a good value-based play. Take a look.



Fundamental and Value Profile

Hormel Foods Corporation is engaged in the production of a range of meat and food products. The Company operates through four segments: Grocery Products, which is engaged in the processing, marketing and sale of shelf-stable food products sold for the retail market and health and also consists of nutrition products, including Muscle Milk protein products.; Refrigerated Foods, which consists of the processing, marketing and sale of branded and unbranded pork, beef, chicken and turkey products for retail, foodservice and fresh product customers; Jennie-O Turkey Store (JOTS), which consists of the processing, marketing and sale of branded and unbranded turkey products for retail, foodservice and fresh product customers; and International & Other, which includes Hormel Foods International Corporation, which manufactures, markets and sells the Company products internationally. HRL’s current market cap is $21.2 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings increased by almost 15% while sales increased by nearly 7%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; but it is also a positive mark of management’s ability to maximize their business operations. In the last quarter, the story shifted, with earnings declining a little over 11% while sales were mostly flat, increasing by a just barely more than 1%. The company operates with one of the healthiest margin profiles in the industry, with Net Income for the last twelve months a little more than 10% of Revenues. That number declined modestly in the most recent quarter to 8.9%, but is still higher than a lot of other stocks in the Food Products industry.
  • Free Cash Flow: HRL’s free cash flow is healthy, at more than $903 million over the last twelve months. The company also reported about $268 million in available cash and liquid assets as of the last quarter. That number has declined by more than 50% since mid-2017, but generally implies the company has a good financial base to work from.
  • Debt to Equity: HRL has a debt/equity ratio of .12. This is a very low number that suggests management is very conservative about its approach to debt. As of the last quarter, they reported a little less than $625 million in long-term debt, with 
  • Dividend: HRL pays an annual dividend of $.75 per share, which translates to yield of about 1.88% per year. That’s roughly inline right now with the average of stocks in the S&P 500.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for HRL is $10.12 per share and translates to a Price/Book ratio of 3.95 at the stock’s current price. Their historical average Price/Book ratio is 4.12, which suggests the stock is trading right now at a discount of only about 4.1%%, and that puts the stock’s long-term target at about $41.60 per share. That isn’t great as a value play, and the story gets worse if you apply Price/Cash Flow analysis, which shows the stock is trading almost 10% above its historical Price/Cash Flow ratio.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s long-term upward trend stretching back into 2017 to its high earlier this month at around $42 per share.The stock is almost $3 per share below that point now and over the last couple of days appear to be finding a little bit of support; but given the angle of the stock’s upward trend, I put its most likely current support right around the 38.2% retracement line at around $37.50 per share. That means that short-term momentum or swing strategies that emphasize bullish trades are pretty speculative right now, offering only about 1.5 times more opportunity than risk right now. A more dangerous price point is sitting at right around $36 per share, which is not quite $4 away from the stock’s current price right now; a drop below that point would mark a likely reversal of the stock’s long-term upward trend, which could easily push the stock to test lows in the $31 to $33 range.
  • Near-term Keys: The truth is that for a value investor, you probably want to see the stock break down a little more. It’s right around its “fair value” right now, and that isn’t a terrible thing for growth investors; but from a value perspective it offers limited upside compared to the amount of risk potential you have to be willing to accept. It also isn’t trading at a level right now that really favors any kind of specific short-term strategy. The stock really needs to break above its 52-week high, or drop back to around $37.50 before finding support and moving higher again to offer a high-probability short-term bullish trade using call options or buying the stock outright. A break below $36 could offer some potential for shorting the stock or working with put options, while the sweet spot for a value-oriented investor in this stock sit around the $33 level.