When a company says it is disappointed with its results, the first thing we should ask is, why? What happened? And how can you get back on track?
Hormel Foods (stock symbol HRL) recently announced its Q1 2023 earnings. The report didn’t make for a good read, and the shares have fallen by around 9% since the earnings release.
The numbers are covered in red ink
The numbers were not pretty:
- Revenues are down by 2% to $3 billion compared to last year’s first quarter
- Earnings fell by $43 million (around 8%) to $496 compared to $539 million in Q1 2023
- Gross profit margin fell by 100 basis points
- Selling, general, and admin expenses increased to 7.5% of net sales
- Operating income fell from $320 million to $289 million as operating margins dipped from 10.5% to 9.7%
- Operating cash flow collapsed to $204 million from $384 million last year
- EPS of $0.40 versus $0.44 a year ago
So, why the poor performance?
Here’s what Hormel’s Executive Vice President and Chief Financial Officer Jacinth Smiley said:
- Planned lower commodity pork and turkey volumes were the primary drivers of the decrease in net sales
- Gross margins fell because the impact from pricing actions was more than offset by unfavorable mix and persistent inflationary pressures
- Increases in expenses were driven by higher employee-related expenses and outside consulting fees
- The decline in operating cash flow was driven by lower net earnings and an increase in working capital
Chairman Jim Snee also mentioned:
- Elevated inventory levels
- Operating in a volatile, complex, and high-cost environment in which cost pressures remain high
- The impact of inflationary pressures on the consumer
- The pricing actions taken by the company still lag behind inflation.
Avian flu also harmed the company, and this remains a “significant risk facing the business” that continues to affect the company’s poultry supplies despite the last supported case in its supply chain being as long as December. With the migration season upon us, this risk is heightened – and, besides which, feed costs are high and turkey breast meat prices have declined.
The company has previously spoken about its inventory. As Jacinth Smiley said:
“We have this elevated inventory. What it does is also just delay us from recognizing and benefiting from some of the costs coming down. When we think about freight rates, markets coming down, we haven’t really been able to realize those, and that’s been delayed. We talked about it in the fourth quarter that we should see that relief here and those benefits showing up in our margins this quarter, and that’s been delayed as well and affecting where we’re sitting right now from a guidance perspective.”
Can Hormel get back on track?
An outcome that the market didn’t expect. Nor did the company. Snee remarked on the conference call, “these are not results that we expected”.
The Planters business has started this year below expectations, and the company is still battling avian flu. Inventories are high, and misaligned with demand. The company expected the inventory to clear, and it hasn’t.
“This has resulted in inefficiencies across the supply chain and higher operating costs when we think about product and warehouses and probably moving it more than we had expected,” said Snee.
The chairman also commented that, “we know what we need to do and probably said the most simple way possible is that after almost three years of chasing this unprecedented demand, supply caught demand and we needed to react sooner and we didn’t.”
What does the company plan to do to reverse the slide? Here’s a snapshot:
- Putting in place additional inflationary justified pricing actions in certain retail categories, effective late in the second quarter.
- Evaluating further price actions, though the company will remain highly focused on the long-term needs of the business and protecting the equity of our brands.
- Attempting to stabilize margin pressures through a combination of pricing actions, operational cost management, and supply chain cost savings initiatives.
- Beginning in the second quarter, shifting resources to drive consumption. This includes increasing promotional support and prioritizing peanut items and pack sizes aimed at value-seeking consumers.
- Introducing flavored cashews and several new corn nuts flavors.
- Investing in capital for higher-growth items that are relevant for today’s consumer.
- Investing in process automation.
Guidance fails to ignite investors
Despite the softness in the first quarter, the management expect to deliver full-year growth of 1% to 3% with diluted EPS of between $1.70 and $1.82. Jim Snee noted:
“Demand for our leading center store and refrigerated retail brands remains favorable. The Foodservice segment expects strong growth for the remainder of the year, and we anticipate the near-term challenges impacting the international segment to abate over the coming months. Compared to our expectations heading into the year, earnings are being pressured by inefficiencies across the supply chain, persistent inflationary pressures, and softness in the snack nuts category.”
The problem is that this is not a particularly confident forward-looking statement. And when you consider the company’s recent record of misguidance (for example, inventories to wind down in Q1), it is not surprising that investors haven’t looked beyond the disappointment of the first quarter’s numbers.
Should income investors buy HRL now?
In terms of the size of the business, HRL has grown rapidly during the last two years. A point that Hormel’s management were keen to repeat several times on the earnings call.
The question is, has it grown too fast?
Nine months ago, the company had spoken about issues with labor shortages, turnover, and not being able to meet demand from its production. Today, these problems may have been ‘over-fixed’. Now there is a real issue with too much inventory and a misalignment compared to demand.
“If we go back over the last three years, everything that we’ve been through and that — those different scenarios of not having people,” explained Jim Snee when asked about this.“And then when we were getting people, they were turning over. And now that we’re getting people, we’re keeping people. The plants are running more productively and more efficiently. And our goal is to make sure that we’re getting up to fill rates, and that we do have some production capacity. So, our plants have gotten better. And like I said, in some cases, they’ve out-produced demand, and that is definitely part of the problem.”
At the time of writing, HRL shares are trading at around $40. Around the same level as they were pre-pandemic and pre- the growth it has been keen to talk about. But that growth is in the past. The question now is, do you believe the company’s management can continue to steer it forward?