Hormel Foods Corporation — Q2 FY2016 Form 10-Q
Reporting period: Second quarter and six months ended April 24, 2016. Fiscal 2016 is a 53-week year, with the extra week in the fourth quarter. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions where appropriate.
Business context and performance
Hormel processes and sells branded and unbranded food products across five segments: Grocery Products, Refrigerated Foods, Jennie-O Turkey Store, Specialty Foods, and International & Other. Management reported record Q2 diluted EPS and growth in segment profit at four of five segments.
Key financial metrics
| Metric | Q2 FY2016 | Q2 FY2015 | Six months FY2016 | Six months FY2015 |
|---|---|---|---|---|
| Net sales | $2,300.2 million | $2,279.3 million | $4,592.9 million | $4,674.4 million |
| Gross profit | $526.4 million | $459.6 million | $1,084.4 million | $904.2 million |
| Gross margin | 22.9% | 20.2% | 23.6% | 19.3% |
| Operating income | $323.8 million | $277.7 million | $683.4 million | $543.7 million |
| Net earnings attributable to Hormel | $215.4 million | $180.2 million | $450.5 million | $351.9 million |
| Diluted EPS | $0.40 | $0.33 | $0.83 | $0.65 |
| Operating cash flow | Not separately reported for quarter | Not separately reported for quarter | $409.1 million | $445.7 million |
| Capital expenditures | Not separately reported for quarter | Not separately reported for quarter | $99.9 million | $55.0 million |
Q2 sales increased 0.9%, net earnings 19.5%, and diluted EPS 21.2% year over year. For the first six months, sales fell 1.7%, while net earnings rose 28.0%. Management also presented adjusted first-half FY2015 net earnings of $367.5 million and adjusted diluted EPS of $0.68, excluding prior-year Stockton plant closure and international joint venture exit charges; on that basis, first-half FY2016 net earnings and diluted EPS increased 22.6% and 22.1%, respectively.
First-half SG&A was $421.1 million, up 13.8%, reflecting Applegate expenses and higher advertising and employee-related costs. The effective tax rate was 33.6%, compared with 34.6% a year earlier. Cash flow from operations less capital expenditures was approximately $309.3 million for the first half; this is a simple calculation, not a company-defined free-cash-flow measure.
At April 24, 2016, cash and equivalents were $379.9 million, current assets $1,975.1 million, and current liabilities $937.4 million (current ratio approximately 2.1). Debt comprised $250.0 million of long-term debt and no short-term debt, versus $435.0 million total debt at October 25, 2015. Cash exceeded reported debt by approximately $129.9 million. The company was in compliance with debt covenants.
Material changes and segment trends
- Refrigerated Foods: Q2 sales rose 6.8% and segment profit 13.2%; first-half sales rose 4.1% and profit 37.5%. Applegate, acquired in July 2015, contributed to growth, alongside value-added products and strong pork margins.
- Grocery Products: Q2 segment profit increased 21.3%, supported by favorable input costs and plant efficiencies; first-half sales declined 1.7%.
- Jennie-O Turkey Store: Q2 profit increased 20.2% despite sales declining 3.5%; first-half sales fell 9.5%. HPAI-related flock losses continued to constrain volumes.
- Specialty Foods: Q2 profit rose 74.3%, aided by lower input costs, supply-chain synergies, and comparison with prior-year plant-closure costs. Sales declined 5.2% in Q2 and 7.3% for the first half.
- International & Other: Q2 sales fell 17.2% and profit 33.4%, pressured by weak exports and high pork costs in China. First-half profit increased 7.7%, partly reflecting a favorable comparison with prior-year joint venture exit charges.
Operating cash flow declined year over year despite higher earnings, mainly due to less favorable working-capital movements. Investing cash use increased, principally as capital expenditures rose. Financing cash use included repayment of $185 million of short-term debt and $142.9 million of dividends paid. The company raised its annual dividend rate to $0.58 per share, its 50th consecutive annual increase.
Outlook, risks, and unusual items
- Management expected FY2016 capital expenditures of approximately $250 million and a full-year effective tax rate of 33.5%–34.0%.
- Management anticipated continued profit improvement in Grocery Products and Refrigerated Foods, second-half sales and earnings growth at Jennie-O as turkey production normalized, and a second-half recovery in International & Other led by exports. Pork margins in Refrigerated Foods were expected to moderate as the year progressed.
- On May 2, 2016, Hormel agreed to acquire Justin’s for a preliminary $286 million; the acquisition closed May 26 and was funded with existing cash and short-term financing. Management cited an estimated $70 million net present value of tax-amortization benefits. It expected transaction costs and fair-value adjustments to offset near-term benefits, with benefits expected to be fully realized in FY2017.
- The company agreed to sell a portion of Diamond Crystal Brands; the sale closed after quarter-end. A $1.0 million goodwill impairment was recorded in Q2. The business held for sale was described as immaterial to annual sales, earnings, and EPS.
- Key exposures include food safety and product liability, commodity and feed-grain prices, livestock and poultry disease, consumer demand and competition, acquisition integration, international trade and currency conditions, regulation, litigation, environmental matters, and labor relations. Approximately 1,100 employees at the Vernon, California facility were covered by union contracts expiring in FY2016; negotiations had commenced.
- Unrecognized tax benefits, including interest and penalties, totaled $28.1 million; the IRS was examining FY2013 and FY2014. Standby letters of credit totaled $44.1 million, including $4.0 million of revocable guarantees for an affiliate. Management said known legal matters were not expected to materially affect financial condition, results, or liquidity.
Important facts for investors to verify
- Whether favorable pork and other input costs, value-added sales, and normalized turkey production persisted through the second half.
- How much of earnings growth reflects sustainable operating performance versus favorable input costs, acquisition effects, prior-year charges, and tax adjustments.
- Justin’s integration, actual transaction and financing costs, and realization of the projected tax-amortization benefit.
- The final financial effect of the Diamond Crystal Brands divestiture and the expected moderation in Refrigerated Foods margins.
- Working-capital trends, capital spending against the approximately $250 million FY2016 estimate, and liquidity after the Justin’s acquisition.
- Exposure to HPAI and other animal disease, commodity-price changes, export weakness, and unresolved tax and legal matters.