Hormel’s Brand-Based Moat Helps Offset the Volatility That Comes From Its Raw Meat Business

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Retail

Foodservice

International

Grocery Products

Refrigerated Foods

Jennie-O Turkey Store

International & Other

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Hormel Foods has long been on U.S. shelves, with strong meat-centric brands like Jennie-O, Spam, Dinty Moore, and various Hormel-branded goods. These brands tend to hold number one or two share in their categories. To keep pace with evolving trends, Hormel has expanded its focus through acquisitions of non-meat protein brands like Skippy and Planters and branded meat products like Applegate. It has also entered ethnic and emerging food with Wholly Guacamole, Herdez, and Happy Little Plants. Concurrently, Hormel has reduced its commoditized farming footprint, increasingly relying on third-party farmers. Taken together, we think these moves stabilize its competitive standing and improve profitability in the competitive packaged food arena.

But selling food isn’t easy, with inflation, avian flu, and supply chain bottlenecks as some recent headwinds. Hormel has increased prices and cut costs to offset these risks. Though we expect these challenges to ebb and flow over time, resulting in our stable long-term outlooks for sales growth and adjusted operating margins (about 2.5% and 11%, respectively), near-term volatility can still be drastic. For example, in 2021, organic revenue growth of 14% amid strong demand was offset by a 160-basis-point contraction in operating margin within surging input cost inflation.

In 2023, Hormel reorganized toward the customer channel (retail, food service, and international) rather than by product to streamline sales and improve cross-selling. Customers will now deal with one salesperson. However, we think this may lead to reduced transparency of performance at a detailed level and potential internal tension among product teams.

Retail is about two thirds of revenue at high-single-digit operating margin. Much smaller but more profitable, food service is about 30% at a midteens margin. We see low-single-digit sales growth for both, with retail leveraging brands and food service capturing untapped markets. Additionally, we think the two together create demand diversification, as seen when the pandemic hurt food service but greatly benefited retail, and a proving ground for testing innovation within food service that can be taken to retail.

Business Strategy & Outlook

We assign Hormel Foods a narrow economic moat rating based on intangible assets stemming from its strong brands and entrenched relationships with retailers and food-service companies. Leading brands include Spam (claiming the top spot with 50%-plus market share in the $2.4 billion shelf stable meat market versus just 9% share for private label), Applegate Farms and Jennie-O (number three and number four brands, respectively, with a combined 5% share in the $8 billion chilled processed poultry market dwarfed by the 11% share for private label), Skippy (number two with 18% market share in the $2.8 billion nut- and seed-based spreads market consistent with the 18% share held by private label), and Planters (which boasts leading branded share at 17% in the $8.1 billion nuts, seeds, and trail mixes market, though this is eclipsed by the 33% share private label has amassed).

The moat is evident through its returns on invested capital including goodwill consistently exceeding our estimate of its cost of capital. Even in 2021 and 2022 when avian flu struck and input cost inflation rose before the company could adjust its prices, it still earned double-digit returns. With price increases having now taken effect, we expect economic returns to migrate back to the low-double-digit range, lower than the 20% range that the company has historically earned but still well above our estimate of its cost of capital of about 7%.

As anecdotal evidence, we performed some channel checks to measure potential pricing power. Spam sells for 15% higher than private label, Planters peanuts sell for 25% higher (likely capturing the premium end of the market given its high price and lower market share than private label), and Skippy peanut butter for 21% higher. Admittedly, this isn’t perfect evidence of pricing power, but we think it indicates willingness to pay higher prices among end-customers.

Hormel’s continued transformation to a branded food firm, as it has deprioritized commoditized fresh meat, has enhanced its moat. With no brand differentiation, raw meat producers are often price takers that are more exposed to commodity price fluctuations and general supply/demand dynamics, as consumers tend to make purchase decisions based on price rather than brand. In comparison, food producers with established brands command pricing power with their customers. As evidence, Hormel generates high-teens into low-20% gross margin, compared with high-single-digits gross margin for meat producer Pilgrim’s Pride, low-double-digits for Tyson Foods, and midteens for private-label food companies like Treehouse Foods. This requires investment to stay at the forefront of changing customer tastes, as Hormel’s R&D expense as a percentage of sales of about 30 basis points compared with 20 basis points for Tyson and less than 1 basis point for Pilgrim’s Pride.

Additionally, Hormel’s typical advertising expenses, usually less than 2% of sales, are well below the industry average of more than 4%. But this hasn’t led to a deterioration in its brand intangible assets as market shares for core brands like Hormel, Spam, and Jennie-O have seen market shares rise at this level of spending. Hormel’s core brands carry enough lasting power that they don’t need as much advertising spending to remain strong within their categories.

Hormel’s relationships with both retailers and food-service operators are another key to its intangible assets. Buoyed by leading brands in several categories and an established distribution network, Hormel guarantees its placement in-store despite shelf space limitations and online at the top of searches and pages. This is particularly important because it helps Hormel launch new product innovations (which in turn drives excitement and strengthens retailer relationships) and expand distribution of acquired brands across its national footprint—breadth that a new entrant doesn’t have or would have to pay to access. The importance of distribution can’t be understated—it’s costly, time consuming, and difficult to recreate these relationships in the fragmented retail channel. Arguably, the frequent acquisition of smaller, emerging brands is evidence of how hard it is to replicate that scale.

Similarly, Hormel can leverage its relationships with food-service operators to launch products that fit their changing needs. For example, 2022 food-service sales grew 20% as Hormel was able to offer foods that required less preparation given customers’ labor shortages. Existing relationships put the company in a position to continue to gather insights quickly and sell corresponding products widely. Moreover, these operators are willing to pay for these innovations, as evidenced by the higher margins Hormel earns in this segment.

We think Hormel’s capital allocation strategy has largely supported its moat, both through inorganic and organic growth. For example, acquisitions of Skippy peanut butter, Justin’s nut butters, and Planters expanded it into branded non-meat protein, adding about $11 billion in opportunity in nut spreads and snacking nuts compared with just $2.4 billion for shelf-stable meat. The company’s positioning in the deli space was enhanced by the acquisition of Columbus, a premium deli company that complemented its offerings and expanded into a market where branding is possible. Organically, Hormel has captured the on-the-go trend with several product innovations, including Skippy (P.B. Bites, P.B. & Jelly Minis), which helped the brand increase points of distribution by 30% from 2013 to 2018. We view this as an impressive feat given that Skippy had previously been owned by wide-moat Unilever and likely benefited from its own retail relationships. 

Although Hormel’s dedicated salesforce provides some benefits, we don’t think it is a source of competitive edge. Competitors Tyson and Smithfield Foods forgo their own salesforce in favor of brokers. Hormel argues that its dedicated salesforce allows it to witness firsthand the challenges their clients face, allowing for unique insights to create innovative products to meet these needs. Additionally, the company believes it fosters stronger relationships with clients and distributors. Although there may be some argument that it has helped with Hormel’s success in the food-service industry, we don’t think this is an inimitable competitive advantage. Even though Tyson and Smithfield currently appear to have no plans to launch their own salesforce, we think capital is probably the largest roadblock if they were to switch strategies.

We refrain from assigning Hormel a wide moat due to the uncertainty around both its competitiveness and the food landscape beyond 10 years. Competing in a highly competitive food industry, we cite a few reasons that support our assessment. First, Hormel’s strongest brands still tend to be tied to its historical meat focus. Although its expansion into other categories is reducing its exposure to categories where pricing power remains elusive, there hasn’t been enough progress to establish multicategory leadership that we see in other wide-moat food names like Kellogg. Second, its strongest brands don’t carry far-away dominance like wide-moat Hershey does in chocolate, for example. Third, unlike wide-moat Mondelez, Hormel’s strength is exclusively tied to its home U.S. market. Demonstrable brand power across many markets would give us more comfort of the staying power of its competitive advantages. Lastly, we don’t see any additional moat sources to strengthen Hormel’s overall moat, as we don’t see benefits from scale in either purchasing or production processes.

Narrow

Economic Moat

Hormel Foods

Skippy is a brand of peanut butter manufactured in the USA. First sold in 1932, Skippy is currently manufactured by Hormel Foods, which bought the brand from Unilever in 2013.

Skippy

Applegate is a producer of high-quality natural and organic hot dogs, bacon, sausages, deli meats, cheese and frozen products. Products are made without GMO ingredients and sourc meat from farms.

Applegate

Spam is a brand of canned cooked meat made by Hormel Foods Corporation. It was first introduced in 1937 and gained popularity worldwide after its use during World War II. By 2003, Spam is sold in 41 countries on six continents and trademarked in over 100 countries (except in the Middle East and North Africa). In 2012, the eight billionth can of Spam was sold.

Spam

Hormel Foods Corp. engages in the manufacturing and marketing of branded food products. It operates through the following segments: Retail, Foodservice, and International. The Retail segment consists of the processing, marketing, and sale of food products sold predominantly in the retail market. The Foodservice segment includes the processing, marketing, and sale of food and nutritional products for foodservice, convenience store, and commercial customers. The International segment focuses on processing, marketing, and selling company products internationally. The company was founded by George A. Hormel in 1891 and is headquartered in Austin, MN.

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