Hormel Foods: This Stock Won't Hit $30 Again

Christopher is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Hormel Foods (NYSE: HRL) is famous (or infamous, depending on who you speak to) for its Spam line of spiced ham and other packaged meats, and possesses a diverse product line that serves the many time-constrained consumers. Around 62% of meals cooked at home in the United States are prepared in less than six minutes, giving Hormel Foods access to a large consumer base. However, recent consumer awareness and health consciousness has begun to lead many of Hormel Foods’ customers away in favor of healthier alternatives. Can Hormel Foods continue to compete in the convenience food market or was its slow growth in 2011 a sign of times to come?

Hormel Foods caters directly to the busy consumer who is constantly on the go with an assortment of prepackaged meals and canned meats that provide convenience at the sacrifice of nutritional value. Around 55% of its sales are of fresh meats — mainly sausages, bacon and other pork products. The rest of its revenue is generated through the sale of frozen dinners, microwavable meals and other precooked foods. It reported a record year in 2011 with revenue of $7.8 billion, but due to its cost of revenue and low gross margin, it only kept $474 million net profit.

Hormel’s leading competitors in the convenience food market are ConAgra Foods (NYSE: CAG), Tyson Foods (NYSE: TSN) and Kraft Foods (NASDAQ: KRFT), which all threaten the company in different ways. ConAgra has made steps to offer more health-conscious choices to its consumers, and its acquisition of Del Monte has allowed it to expand its business into canned fruits and vegetables in a market that is beginning to make a move toward health rather than convenience. Kraft Foods is the largest producer of packaged and processed foods in the world and provides numerous alternatives to Hormel’s frozen foods and precooked meals.  Tyson Foods offers competition in the frozen foods market and in fresh meat sales, but its reputation has been damaged recently due to a major recall of its beef in 16 states.

While Hormel Foods breaks sales records, it also struggles with rising costs and diminishing appeal for its products solely due to health concerns. Its gross margin is only 16.9%, which is well behind that of Kraft Foods, which operates on a gross margin of over 35%. Hormel Foods’ competition also outgrew the company over the last twelve months, with Kraft Foods seeing revenue growth of over 11%, Tyson Foods seeing gains of 9.4% and ConAgra experiencing growth over 8%. Hormel Foods’ record year in 2011 also reflects a trailing revenue growth of only 2%, indicating that the Hormel line of brands has been struggling against its competition for some time.

A recent poll indicated that consumers are beginning to place much more importance on health when making buying decisions in regard to their food. This places Hormel Foods at a severe disadvantage to competitors that possess a greater focus on healthy foods that cater to the growing number of health conscious consumers. Many families are beginning to move away from convenience foods entirely, choosing more time-consuming, but healthy options instead.

The rising cost of Hormel Foods’ revenue is an indicator of the increasing amount of effort the company must put forth in order to generate record sales in a diminishing market. In 2009, it spent $5.4 billion to generate revenue of $6.5 billion and it spent more than its gross revenue in 2009 on acquiring revenue in 2011. After grossing $7.8 billion, Hormel Foods only saw a net profit of $474 million after it spent more than $6.5 billion to earn the revenue. It then spent an additional $742 million on operating costs, effectively only taking home 9.5% of its cash flow for the fiscal year.

Hormel Foods’ inefficiency is the main contributor to my belief that the company is headed for a bad year in 2012. I believe that it will continue to be unable to generate sales without reining in its spending and its profit will continue to be hurt by the rising costs it is incurring. I’m not impressed at all with its record year in 2011 due to the fact that it only grew its revenue by 2% while its competitors all saw gains of 8-11%.

Its stock also reflects a lack of momentum, only rising $3 per share over the last year after gaining $5 a year in the previous two years. It moved from $15 per share to $28 over that time frame, with the majority of that growth happening in 2009 and 2010. Since it hit $30 in July of 2011, it hasn’t returned and I don’t think it will unless it can increase its margin by lowering its cost or providing more products that appeal to health-conscious consumers.

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