Hormel Foods Corporation — Q3 FY2019 Form 10-Q
Reporting period: Three and nine months ended July 28, 2019; comparisons are to the corresponding periods ended July 29, 2018. Amounts below are in millions of dollars except per-share data.
Business context
Hormel manufactures and markets branded food products through Grocery Products, Refrigerated Foods, Jennie-O Turkey Store, and International & Other. In April 2019, it sold CytoSport, including Muscle Milk and Evolve, to PepsiCo for $473.9 million, subject to working-capital adjustments. Fiscal 2019 segment comparisons were recast for internal business realignments.
Key financial results
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Net sales | $2,290.7 | $2,359.1 | $6,995.8 | $7,021.0 |
| Gross profit | $433.4 | $455.0 | $1,390.9 | $1,446.1 |
| Gross margin | 18.9% | 19.3% | 19.9% | 20.6% |
| Operating income | $256.7 | $256.7 | $875.3 | $860.4 |
| Net earnings attributable to Hormel | $199.4 | $210.2 | $723.3 | $750.7 |
| Diluted EPS | $0.37 | $0.39 | $1.33 | $1.38 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $572.9 | $743.2 |
| Capital expenditures | Not provided for quarter | Not provided for quarter | $154.2 | $244.0 |
Q3 sales declined 2.9% reported, principally reflecting the CytoSport sale; organic sales increased 0.2%. Nine-month reported sales fell 0.4%, while organic sales increased 0.7%. Q3 operating income was essentially flat, but net earnings and diluted EPS declined 5.1%. For nine months, GAAP diluted EPS declined 3.6%; adjusted diluted EPS, excluding the CytoSport-sale gain, declined 8.7% to $1.26.
Q3 SG&A fell 14.8% to $180.2 million; nine-month SG&A fell 14.5% to $543.8 million. Equity earnings of affiliates declined to $3.4 million in Q3 and $28.1 million year to date, largely due to higher avocado costs affecting MegaMex. The Q3 effective tax rate rose to 23.6% from 18.4%; the nine-month rate was 18.3% versus 12.6%.
Balance sheet, liquidity, and capital returns
- At July 28, cash and cash equivalents were $560.2 million, versus $459.1 million at October 28, 2018; short-term marketable securities were $14.1 million. Current assets were $2,246.0 million and current liabilities $1,073.1 million.
- Long-term debt, less current maturities, was $250.0 million, down from $624.8 million at October 28, 2018. The company repaid $374.8 million of long-term debt in the first nine months and reported compliance with debt covenants.
- Nine-month operating cash flow fell to $572.9 million, primarily due to higher working capital, especially inventory. Investing cash flow was $354.9 million provided, including $473.9 million in CytoSport sale proceeds; financing cash flow was $826.0 million used.
- Hormel repurchased $174.2 million of stock and paid $325.0 million in dividends during the first nine months. The annual dividend rate increased to $0.84 per share. Management estimated FY2019 capital expenditures of approximately $250 million.
Segments and material changes
| Segment | Q3 sales change | Q3 profit change | Management’s explanation |
|---|---|---|---|
| Grocery Products | -10.5% | -29.6% | CytoSport divestiture, higher avocado costs, and lower Skippy pricing weighed on results. |
| Refrigerated Foods | +1.0% | +13.1% | Value-added product profitability improved; lower operating costs and higher commodity profits also contributed. |
| Jennie-O Turkey Store | -5.5% | -8.7% | Lower retail and foodservice value-added sales; retail distribution remained affected by two voluntary recalls. |
| International & Other | +0.1% | +0.6% | China growth offset divestiture effects; exports and tariffs remained challenges year to date. |
For the first nine months, Refrigerated Foods profit rose 3.4%, while Grocery Products fell 5.7%, Jennie-O fell 17.4%, and International & Other fell 9.5%. Overall gross margin declined year over year, with lower pork commodity profits, higher freight, and weaker fresh-pork export margins cited for the year-to-date decline.
Outlook, risks, and unusual items
- Management expected FY2019 effective tax rate of 18.3%–20.3%, capital expenditures of about $250 million, and continued dividend payments.
- For Q4, Refrigerated Foods was expected to grow volume and sales but face lower commodity profits, higher input costs, and possible short-term margin compression. Grocery Products was expected to have lower volume and sales, with profit expected to improve slightly year over year. Jennie-O was expected to report lower earnings, and International & Other expected declines in volume, sales, and earnings.
- Management warned that African swine fever could contribute to rising, volatile pork costs; pricing actions may lag input-cost increases. Pork exports also face tariff and global-trade uncertainty. Other pressures include avocado costs, lower Skippy pricing, and lost lean-ground-turkey distribution.
- The CytoSport sale generated a pretax gain of approximately $16.5 million and a $17.0 million tax benefit. Hormel’s non-GAAP adjusted results exclude the resulting $33.4 million after-tax gain. Nine-month operating cash flow was also affected by elevated inventory.
- Other disclosed risks include food safety and livestock disease, commodity and freight volatility, consumer demand and competition, foreign-exchange exposure, regulatory and litigation matters, supplier disruption, cybersecurity and Oracle Cloud implementation, and labor negotiations. Contracts covering approximately 2,300 employees were due to expire in Q4 FY2019; negotiations were underway. Management said known legal proceedings were not expected to have a material effect.
Important facts for investors to verify
- Whether Refrigerated Foods’ value-added growth and pricing can offset pork-cost inflation and margin pressure.
- How long the Jennie-O distribution losses and Grocery Products pricing and cost pressures affect sales and segment profit.
- Whether working capital and inventory normalize sufficiently to support operating cash flow and planned investment, dividends, and repurchases.
- The realization of the expected FY2019 tax rate and the comparability of reported earnings with adjusted results following the CytoSport sale.
- Developments in African swine fever, export tariffs and trade conditions, and the outcomes of recall-related distribution effects and labor negotiations.