Hormel Foods Corporation — Q3 FY2018 Form 10-Q
Reporting period: Three and nine months ended July 29, 2018; comparisons are to the periods ended July 30, 2017 unless noted. Amounts below are in millions of dollars except per-share data.
Business context and results
Hormel manufactures and markets branded food and meat products across Grocery Products, Refrigerated Foods, Jennie-O Turkey Store (JOTS), and International & Other. Fiscal 2018 segment reporting reflects a realignment that moved Specialty Foods into Grocery Products. Three acquisitions—Columbus, Fontanini, and Ceratti—contributed to reported sales growth.
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Net sales | $2,359.1 | $2,207.4 | $7,021.0 | $6,674.9 |
| Gross profit | $459.2 | $452.4 | $1,458.0 | $1,491.6 |
| Operating income | $261.6 | $279.7 | $874.5 | $951.1 |
| Net earnings attributable to Hormel | $210.2 | $182.5 | $750.7 | $628.6 |
| Diluted EPS | $0.39 | $0.34 | $1.38 | $1.17 |
| Gross margin | 19.5% | 20.5% | 20.8% | 22.3% |
Q3 reported sales rose 6.9%, while organic sales were down 0.2%; nine-month reported sales rose 5.2%, with organic sales approximately flat. Q3 net earnings increased 15.2% and diluted EPS increased 14.7%, despite lower operating income. Lower effective taxes and higher equity-method earnings helped earnings; acquisition costs, higher freight, advertising, and input-cost pressures weighed on operations. The nine-month effective tax rate fell to 12.6% from 33.7%.
Segments and material changes
- Grocery Products: Q3 sales were essentially flat and segment profit rose 4.2%; core portfolio and MegaMex strength offset contract manufacturing and CytoSport weakness. Nine-month profit slipped 0.6%.
- Refrigerated Foods: Q3 sales rose 10.1%, primarily with Columbus and Fontanini contributions, but profit was essentially flat. Value-added growth offset an 88% decline in commodity profits, higher freight, and advertising. Nine-month profit fell 1.5%.
- JOTS: Q3 sales increased 7.9%, but profit fell 23.0%; nine-month profit declined 28.3%. Turkey oversupply and weaker whole-bird/commodity profitability, freight, and advertising pressured results.
- International & Other: Q3 sales and profit rose 11.1% and 9.0%, respectively, with Ceratti and China performance; tariffs reduced fresh pork export profitability.
- Overall Q3 gross margin fell 1.0 percentage point. For nine months, gross margin declined 1.5 points. Management cited lower commodity profitability, input-cost volatility, and higher freight.
Cash, debt, and capital allocation
- Nine-month operating cash flow was $743.2 versus $531.4 in the prior-year period. Investing cash outflow was $1,096.0, including $857.7 for acquisitions and $244.0 in capital expenditures. Financing provided $177.3.
- Cash was $269.0 at July 29, 2018, versus $444.1 at October 29, 2017; the cash-flow statement reports $633.3 at July 30, 2017.
- Debt at July 29 comprised $95.0 short-term and $624.8 long-term, or $719.8 total, versus $250.0 long-term and no short-term debt at October 29, 2017. Columbus financing included $375.0 under a term loan and $375.0 under a revolving facility; the company reported $280.0 paid down during the first nine months. It was in compliance with debt covenants.
- Capital expenditures were estimated at approximately $400.0 for fiscal 2018. Nine-month dividends paid were $288.5; the annual dividend rate was increased to $0.75 per share. Share repurchases were $44.7 in the first nine months; none were reported in Q3.
Outlook, risks, and unusual items
- Management expected a fiscal 2018 effective tax rate of 15%–16%. The lower rate reflects the Tax Act, including a provisional $84.8 tax benefit from deferred-tax revaluation and a $5.2 provisional deemed-repatriation charge. Tax accounting remained provisional, with finalization expected within the one-year measurement period.
- For Q4, management anticipated continued freight pressure; weakness at CytoSport and contract manufacturing; continued negative effects on JOTS from depressed turkey markets; and tariff-related pressure on pork exports. Refrigerated Foods and International & Other were expected to grow value-added businesses; International & Other also anticipated growth in branded exports and China.
- Advertising investment was expected to increase approximately 20% for the year. The filing does not provide full-year sales or EPS guidance.
- After quarter-end, Hormel announced a $30 million sale of its Fremont pork processing facility to WholeStone Farms, subject to customary conditions and expected to close in December 2018. The agreement includes a multi-year pork raw-material supply arrangement.
- Key exposures include commodity and freight costs, turkey oversupply, trade tariffs, food safety and livestock disease, acquisition integration, foreign currency and trade conditions, and labor, regulatory, litigation, environmental, and cybersecurity risks. Commodity hedging losses in accumulated other comprehensive loss were $11.9 before tax; most were expected to be recognized over the following 12 months.
- Ordinary-course legal proceedings were not expected, individually or in aggregate, to materially affect financial condition, results, or liquidity. The filing also disclosed $44.4 of standby letters of credit, primarily for self-insured workers’ compensation programs.
Important facts for investors to verify
- How much of reported growth and Refrigerated Foods performance is sustainable after separating acquisition contributions from organic trends.
- Whether freight, commodity volatility, turkey oversupply, and tariffs continue to pressure margins and segment earnings.
- Final Tax Act measurement-period adjustments and the extent to which the unusually low year-to-date tax rate benefits reported earnings.
- Debt repayment progress, liquidity needs, and execution of the approximately $400 million capital-spending plan.
- Completion and terms of the Fremont sale, including the operational and financial implications of the ongoing pork-supply agreement.