Spam Maker Takes Smart Step Into Organic Meats

By Markets Fool.com

Hormel Foods Corp. has a long and proud history dating to 1891. It built its reputation upon flagship shelf-stable brands such as Spam and Hormel Chili, which have served the company and its shareholders well. Hormel is a renowned dividend stock, making payouts to shareholders for 348 consecutive quarters dating to the company'sincorporation in 1928. Hormel is also Dividend Aristocrat that has increased its payout for 49 consecutive years.

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But times are changing in the food industry. Consumers are demanding fresher foods, particularly organics. In response, Hormel is making a big move to reshape its image via the $775 million acquisition of Applegate Farms, owner of the Applegate brand, which sells "natural and organic value-added prepared meats." Hormel expects the deal to be accretive to EPS by approximately $0.07 to $0.08 in fiscal 2016.

Getting with the times
According to a 2013 study by market research firm TechSci Research, the U.S. organic food industry is set to grow at a 14% compound annual clip through 2018. Large food companies must adapt to this reality.

At the same time, Hormel could use a boost even as Hormel's core brands will remain staples of its portfolio and continue to generate significant profits for the company. Spam, Hormel Chili, and its other core shelf-stable brands helped Hormel increase its earnings per share by 12% from 2009 to 2014. But growth in these categories is slowing.

For example, Hormel's grocery business, which represented 16% of the company's total sales and 20% of its operating profit in 2014, grew sales by just 2% last year. Operating profit in that segment actually declined by 8% year over year.Over the first two quarters of FY 2015, Hormel's net sales were up just 1% from the same period last year.

Hormel's portfolio also includes Jennie-O turkey products (19% of net sales in the most recent quarter); specialty foods including Muscle Milk (13%of net sales in the most recent quarter); and refrigerated foods, includingHormel pepperoni and Hormel bacon, that go to retail and foodservice customers (45% of net sales in the most recent quarter).

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The deal makes sense from multiple perspectives
The Applegate acquisition, the biggest deal in Hormel's history, makes sense both strategically and financially. According to May 26 Hormel press release, Applegate is the No. 1 brand in natural and organic valued-added prepared meats. Operationally, Applegate's products, which include bacon, hot dogs, and deli meats, will fit perfectly into Hormel's existing meat product portfolio.

Source: Applegate website.

Only now, Hormel will have access to a new demographic of consumers who demand fresher, organic foods.

Applegate expects to generate $340 million in sales this year. That means Hormel paid slightly more than two times sales for Applegate, which is a modest multiple for a high-growth business. Furthermore, Hormel could easily afford the price tag, as the company had $624 million in cash on the balance sheet at the end of last quarter. This cash was likely earning little to no interest, so it makes sense to deploy the money in a way that creates value for shareholders.

Plus, as is typical in mergers and acquisitions, the deal will result in significant synergies. Hormel should be able to eliminate duplicative costs when bringing in Applegate. This is why Hormel anticipates the deal will be EPS neutral this year, then add approximately $0.07-$0.08 per share in earnings in the next fiscal year.

Investors should like this deal
Hormel built its reputation on its core brands, which enriched shareholders for many decades. But consumer preferences are changing. The fact that Hormel is responding to the evolution of the food industry is a great sign that management isn't stuck in the past.

Buying Applegate will add leading organic meat brands into Hormel's product portfolio. Plus, the deal price is entirely manageable. This merger makes plenty of sense strategically and financially, which is why Hormel shareholders should feel very good about the deal.

The article Spam Maker Takes Smart Step Into Organic Meats originally appeared on Fool.com.

Bob Ciura owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.