HORMEL FOODS CORP quarterly report, Q3 FY2011

Hormel Foods Corporation — Q3 FY2011 Form 10-Q

Reporting period: Third quarter ended July 31, 2011; nine-month period ended July 31, 2011. Comparisons are with the three and nine months ended July 25, 2010. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless noted. Prior-period per-share data reflects the February 2011 two-for-one stock split.

Financial performance

MetricQ3 FY2011Q3 FY2010Nine months FY2011Nine months FY2010
Net sales$1,910.6m$1,730.5m$5,791.2m$5,157.7m
Gross profit$297.9m$284.9m$998.1m$883.8m
Gross margin15.6%16.5%17.2%17.1%
Operating income$146.8m$140.6m$555.3m$453.9m
Net earnings attributable to Hormel$98.5m$85.4m$356.9m$274.4m
Diluted earnings per share$0.36$0.32$1.31$1.01
Operating cash flow——$319.4m$271.6m

Q3 net sales rose 10.4%, while tonnage was flat at 1.12 billion pounds. Nine-month sales rose 12.3% and tonnage increased 3.6% to 3.58 billion pounds. Q3 gross margin contracted year over year; nine-month gross margin was slightly higher. Calculated operating margins were approximately 7.7% for Q3 versus 8.1%, and 9.6% for nine months versus 8.8%.

Q3 diluted EPS increased 12.5%; attributable earnings increased 15.4%. Nine-month GAAP attributable earnings rose 30.0%. Management also reported adjusted nine-month FY2010 attributable earnings of $287.8m and diluted EPS of $1.06, excluding the prior-year plant-closure and tax charges; on that adjusted basis, FY2011 growth was 24.0% for earnings and 23.6% for EPS.

Balance sheet, cash flow and capital

  • At July 31, 2011, cash and cash equivalents were $497.4m and short-term marketable securities were $76.1m. Current assets totaled $1,977.1m against current liabilities of $701.0m.
  • Total debt was $250.0m, all long-term, versus $350.0m of current maturities at October 31, 2010. The company repaid $350.0m of senior unsecured notes and issued $250.0m of 4.125% notes due 2021. Long-term debt fair value was estimated at $265.3m.
  • Nine-month operating cash flow of $319.4m exceeded capital spending of $56.3m. Investing activities used $73.0m; financing activities used $217.0m. Cash increased $29.5m from fiscal year-end.
  • Inventory rose to $865.9m from $793.8m at October 31, 2010. The filing attributes part of the cash-flow comparison to working-capital changes, including higher inventories and reduced accounts payable and accrued expenses.
  • Nine-month dividends paid were $96.0m and share repurchases were $80.6m. The annual dividend rate was increased to $0.51 per share, the 45th consecutive annual increase. The company repurchased 1.568m shares in Q3 at an average $29.29 per share.

Segments and changes versus prior year

  • Jennie-O Turkey Store: Q3 sales increased 10.8% and segment profit 13.7%; nine-month profit increased 61.7%. Value-added sales and efficiencies helped, while rising grain costs are expected to pressure margins.
  • Refrigerated Foods: Q3 sales rose 10.1%, but segment profit fell 12.0%, principally because pork operating margins weakened. Nine-month profit increased 17.3%.
  • Grocery Products: Q3 sales rose 4.4% and profit 18.9%, supported by core products and stronger MegaMex joint-venture results. Nine-month GAAP profit rose 4.7%; comparison with adjusted prior-year profit was down 3.7%.
  • Specialty Foods: Q3 sales rose 10.7%, but profit declined 7.9%; high raw-material costs, particularly sugar and dairy, weighed on results. Nine-month profit fell 10.3%.
  • All Other: Q3 sales rose 35.4% and profit 66.8%, led by fresh-pork exports, royalties, currency effects, and improved international operations.

Overall, growth in sales and earnings reflected pricing, value-added products, turkey performance, export sales, improved affiliate earnings, and a lower effective tax rate. These benefits were partly offset by higher input costs and weaker Q3 pork margins.

Outlook, risks and unusual items

  • Management expected raw-material costs to continue pressuring margins and was monitoring the effect of pricing increases on demand. It expected Q4 pork margins to be below the prior-year level but above historical levels; higher grain costs were expected to weigh on JOTS.
  • For FY2011, management expected SG&A at approximately 8.0% of sales, an effective tax rate of 33.0%–34.0%, interest expense of $22m–$23m, and capital expenditures of $85m–$95m. No full-year earnings or EPS guidance was stated in the provided filing text.
  • After quarter-end, MegaMex completed its acquisition of Fresherized Foods, maker of Wholly Guacamole, Wholly Salsa and Wholly Queso. Hormel’s 50% share is expected to be included in Grocery Products equity earnings from the acquisition date.
  • The Q3 effective tax rate was 29.3%, versus 35.8% a year earlier. A $4.4m reduction in tax expense resulted from resolving tax matters; management cautioned that the lower rate reflected favorable discrete items. Unrecognized tax benefits, including interest and penalties, totaled $22.3m.
  • FY2010 included a $6.3m after-tax plant-closure charge and a $7.1m income-tax charge related primarily to Medicare Part D tax treatment. These nonrecurring items make adjusted comparisons different from GAAP comparisons.
  • Key exposures include food safety and product liability, animal disease, volatile pork, poultry and feed-grain prices, customers’ response to pricing, hedging effectiveness, investment-market volatility, regulatory and environmental matters, labor relations, and acquisition integration. Contracts covering about 3,300 employees at six facilities were due to expire in Q4 FY2011; negotiations had begun.
  • The company reported no material expected effect from currently known legal proceedings. It also disclosed a renewable $4.8m standby letter of credit for an affiliate’s workers’ compensation obligations, not recorded as a balance-sheet liability.

Important facts for investors to verify

  • Whether pricing actions and demand sustain sales volumes and recover elevated raw-material costs.
  • Whether Q4 pork margins, turkey input costs, and segment profit trends develop as management expected.
  • How much of earnings growth depended on discrete tax benefits, and the outlook for the effective tax rate.
  • The cash, earnings contribution, and integration progress of MegaMex’s Fresherized Foods acquisition.
  • Inventory and working-capital trends, planned capital spending, share repurchases, and dividend funding.
  • Commodity hedge positions and exposure to feed, hog, natural-gas, and investment-market volatility; labor negotiations at the identified facilities.