Hormel Foods Corporation — Form 10-Q
Reporting period: Third quarter and nine months ended July 30, 2017; filed September 8, 2017. Fiscal 2017 is a 52-week year, versus 53 weeks in fiscal 2016, whose extra week fell in the fourth quarter. Unless noted, figures below are in U.S. dollars and millions.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $2,207.4 | $2,302.4 | $6,674.9 | $6,895.3 |
| Gross profit | $452.4 | $475.3 | $1,491.6 | $1,559.7 |
| Gross margin | 20.5% | 20.6% | 22.3% | 22.6% |
| Operating income | $279.7 | $274.8 | $951.1 | $958.1 |
| Earnings before income taxes | $278.0 | $274.1 | $948.6 | $952.5 |
| Net earnings attributable to Hormel | $182.5 | $195.7 | $628.6 | $646.1 |
| Diluted EPS | $0.34 | $0.36 | $1.17 | $1.19 |
- Reported sales declined 4.1% in Q3 and 3.2% year to date. Company-adjusted sales, excluding the Justin’s acquisition and DCB and Farmer John divestitures, increased 1.4% in Q3 and 2.3% year to date; adjusted tonnage was down 0.9% in Q3 but up 1.5% year to date.
- Q3 operating income and pretax earnings increased modestly despite lower sales; management described pretax earnings as a quarterly record. Net earnings fell as the effective tax rate rose to 34.3% from 28.6%, partly because the prior-year quarter included a one-time foreign restructuring tax benefit. Nine-month effective tax rates were 33.7% and 32.1%.
- Q3 SG&A decreased 14.6% to $176.7 million, primarily on lower advertising and marketing costs. Nine-month SG&A fell 9.6%, also reflecting divestitures. Q3 equity earnings from affiliates declined 38.0%, including higher avocado costs at MegaMex.
Segments and material changes
| Segment | Q3 sales change | Q3 operating profit change | Key factors |
|---|---|---|---|
| Grocery Products | +5.7% | +10.2% | Growth in Wholly Guacamole, SKIPPY and Justin’s; lower advertising offset higher input costs. |
| Refrigerated Foods | -6.0% | +14.6% | Sales reflected the Farmer John divestiture; pork demand, value-added products and operational improvements supported profit despite higher costs. |
| Jennie-O Turkey Store | -8.6% | -19.9% | Lower commodity prices, competitive pricing pressure and higher operating expenses; reduced harvest tonnage also affected Q3. |
| Specialty Foods | -7.2% | -13.9% | Prior-year DCB business and lower Muscle Milk sales; contract-packaging pricing lagged input cost increases. |
| International & Other | +1.0% | -15.7% | Export sales supported revenue, while China results were pressured by high pork costs, Jiaxing startup costs and Shanghai facility closure. |
Reported sales and tonnage comparisons are significantly affected by the DCB and Farmer John divestitures. Farmer John was sold for $145 million cash on January 3, 2017; it had been included in Refrigerated Foods. DCB was divested in May 2016 and affected prior-year Specialty Foods comparisons.
Cash flow, balance sheet and capital allocation
- Nine-month operating cash flow was $511.5 million, down from $621.7 million, primarily due to higher working capital. Capital expenditures were $118.5 million versus $165.8 million; management estimated full-year 2017 capital expenditures of approximately $190 million.
- Investing activities provided $18.8 million, compared with $327.9 million used in the prior-year period. Fiscal 2017 included $135.9 million proceeds from the Farmer John sale; fiscal 2016 included $281.7 million for Justin’s and $110.1 million proceeds from the DCB divestiture.
- Financing activities used $311.6 million, including $256.3 million of dividends and $94.5 million of share repurchases. Dividends declared were $0.51 per share for the first nine months; the fiscal 2017 annual dividend rate was raised to $0.68 per share. The company repurchased 1.32 million shares in Q3.
- Cash and cash equivalents were $633.3 million at July 30, 2017, compared with $415.1 million at October 30, 2016. Current assets were $2,217.1 million and current liabilities $877.8 million. Long-term debt was $250 million, unchanged from fiscal year-end; the company reported compliance with all debt covenants.
- Management said operating cash flow is the principal source of liquidity and did not anticipate a significant near-term risk to it. Capital spending, dividends, business investment and potential strategic acquisitions remain uses of cash.
Outlook, acquisitions and risks
- Management expected a fiscal 2017 full-year effective tax rate of 33.25%–33.75%; the filing does not provide a specific full-year EPS forecast.
- For Q4, price increases were not expected to fully offset high raw material prices until late in the quarter. Management anticipated continued pressure on turkey results and China margins, ongoing lower Muscle Milk sales, higher Refrigerated Foods input costs, and a solid Grocery Products quarter with margin pressure. Specialty Foods expected flat earnings.
- After quarter-end, Hormel acquired Fontanini Italian Meats and Sausages on August 16 for $425 million, subject to working-capital adjustments, funded with cash and short-term financing. The transaction’s estimated net present value of tax amortization benefits was approximately $90 million. Hormel acquired Brazil’s Ceratti on August 22 for a preliminary $104 million, subject to adjustments, funded with cash. Management expected neither acquisition to add earnings in fiscal 2017; benefits were expected in fiscal 2018.
- Key exposures include volatility and availability of pork, poultry, beef, grains, avocados and other inputs; competitive pricing and consumer demand; livestock disease and food-safety events; acquisition integration; foreign-market and currency risks; regulation, litigation, labor, suppliers and cybersecurity. Management stated known legal proceedings were not expected to materially affect financial condition, results or liquidity.
- Standby letters of credit totaled $48.0 million and were not recorded as balance-sheet liabilities; this includes $4.0 million of revocable guarantees for an affiliate. Unrecognized tax benefits, including interest and penalties, totaled $20.3 million; the timing and amount of potential changes from state tax audits could not be reasonably estimated.
Investor verification priorities
- Confirm the drivers and sustainability of reported versus divestiture-adjusted sales, tonnage and segment profits.
- Track commodity costs, pricing recovery and margin trends, particularly in Jennie-O, Specialty Foods, Refrigerated Foods and China operations.
- Assess cash conversion and working-capital movements, capital spending, and liquidity after the Fontanini and Ceratti acquisitions, including the short-term financing used for Fontanini.
- Verify acquisition integration, expected fiscal 2018 benefits and the assumptions supporting the stated tax-amortization benefit.
- Monitor the tax-rate outlook, pension funding, commodity hedges, tax uncertainties and other disclosed contingencies.