Could This Meat Company Fall Prey to A Competitor?

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With the proposed acquisition of Smithfield Foods on the table, the attention now turns to which meat company could be next. Mario Gabelli got me thinking last week when he told CNBC that Hillshire Brands (NYSE: SLE) could be a takeover candidate:

This company sells at $32. I think you have a $45, $50 stock.

If he's right, that's not a bad return in an uncertain environment. He's not the only big name that likes the company. Richard Perry, John Paulson, Dan Loeb, Ken Griffin, and Israel Englander all have significant stakes in the company. All together hedge funds own more than 15% of the company.

What's so special about Hillshire Brands?

Hillshire Brands is really the former Sara Lee Corporation without the international coffee and tea business. The breakup occurred last year. Today, it's brands include Jimmy Dean, Ballpark, Hillshire Farm, State Fair, Sara Lee, Chef Pierre, Aidells and Gallo Salame.

The focus at Hillshire Brands is to innovate the processed meat business and keep the hedge fund owners happy before they agitate for change. The plan is to create new products to drive sales. Management's goal is to increase new product sales from 11% of total sales to between 13% and 15% by 2015. To drive sales, Hillshire Brands has hired the marketing expert from Newell Rubbermaid who revitalized the Sharpie pen brand.

The changes include a packaging makeover for Hillshire lunch meat; the Jimmy Dean brand is introducing flatbreads. For Ball Park, the plan is introducing precooked beef patties, sliders and brats wrapped in dough to appeal to consumers that want items quick and easy.

In terms of costs, Hillshire Brands has been working to reduce overall costs and improve supply chain inefficiencies. Last year, the company identified $65 million in cost savings. This year, Hillshire has identified an additional $35 million in cost savings that will be implemented by 2015.

By continuing to invest in its brands and reduce costs, Hillshire Brands is setting itself up for long-term growth. These are qualities a potential buyer would be interested in. The gross margin last year was 30%. The forward P/E is a reasonable 19. The company pays an annual dividend of $0.50 per share for a yield of 1.5%. The dividend payout ratio is 54%. Hillshire Brands has $949 million in debt, but has $416 million in cash. Operating cash flow last year was $571 million.

Potential buyers

The two companies most talked about in terms of buying Hillshire Brands are Hormel Foods (NYSE: HRL) and Tyson Foods (NYSE: TSN). Both are in the processed meat business and Hillshire brands would fit into each company's portfolio. Tyson is the larger of the two companies in terms of revenues, but Hormel has a greater market cap. Tyson last year had $33.50 billion in revenue to Hormel's $8.45 billion in revenue. Hormel has a current market cap of $10.89 billion compared to Tyson's $9.56 billion.

Hormel Foods last month lowered its guidance for the rest of the year. The company now says it will earn between $1.88 and $.96 per share compared to its prior estimate of $1.93 to $2.03 per share. The reasons behind this are lower than expected results from its pork operations, higher input costs and softer sales of its retail products in its refrigerated foods segment.

For investors in Hormel Foods, they're comforted by the fact that the company has paid a dividend every year since 1928. The annual dividend is now $0.68 per share for a yield of 1.7%. The dividend payout ratio is only 35%. On the balance sheet, there's $262.75 million in cash and $250 million in debt. Free cash flow last year was $359 million. By looking at its financials, Hormel has much more room to increase the dividend.

Hormel isn't afraid to make acquisitions to boost growth. This year Hormel bought the Skippy peanut butter business from Unilever for $700 million. Skippy is China's number one peanut butter brand and balances Hormel's portfolio with a non-meat protein. Hormel plans to grow its other brands in China with the Skippy distribution channels.

Hormel is not the only one making acquisitions. Last month, Tyson Foods announced that it was buying California-based Circle Foods, a producer of frozen and refrigerated handheld Mexican foods, uncooked tortillas and Indian flatbreads. Circle Foods has been in business for over 25 years and has over 600 full-time employees. The CEO of Tyson Foods, Donnie Smith, said of the acquisition:

We believe Tyson's robust sales structure, as well as our frozen and refrigerated foods distribution system, will enable this business to accelerate its growth.

Besides acquisitions, Tyson continues to innovate to drive growth. Most of its innovations come from a $45 million innovation lab that the company set up in 2007. This year the company plans to introduce roughly 90 new retail products. Some of these innovations include gluten-free products and products with no antibiotics ever. These products have higher margins as health-conscious consumers choose to pay-up for better quality items.

Foolish assessment

The entire meat sector has performed quite well since the acquisition of Smithfield Foods was announced. Analysts are speculating which company will be next. Hillshire Brands looks attractive to would-be buyers for its brands, financials and growth initiatives. The trend globally is towards a more protein-rich diet and there's strong demand for meat products. That trend is likely to continue and will benefit Hillshire Brands whether the company is acquired or not.

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