Hormel Foods (HRL) develops, processes, and distributes various meat, nuts, and other food products to retail, foodservice, deli, and commercial customers in the United States and internationally. It operates through three segments: Retail, Foodservice, and International segments.
The company raised dividends by a paltry 2.70% to $0.29/share last week. This was the 59th consecutive annual dividend increase for this dividend king. This was also the smallest dividend increase for Hormel since 2008.
Annualized dividend growth has been decelerating from a ten year average of 12.50% annualized to a 5 year annualized growth of 8%.
Earnings per share grew from $1.14 in 2014 to $1.91 in 2018, before falling back to $1.45/share in 2023. The company is expected to earn $1.58/share in 2024.
Earnings per share stopped growing around 2016 – 2018. The company has been unable to grow earnings per share for about 6 – 7 years now. This explains the slowdown in dividends per share growth over the past five years.
The dividend payout ratio has increased from 35% in 2014 to 75% in 2023.
The number of shares outstanding has actually increased slightly over the past decade. The number of shares outstanding increased from almost 528 million in 2014 to 546 million in 2023.
The stock sells for 20.50 times forward earnings and yields 3.60%. The lack of earnings per share growth means that future dividend growth will be limited at best. The high payout ratio also increases risk to the dividend payment as well.
As we have discussed before, long-term returns are a function of:
1. Dividends
2. Earnings Per Share Growth
3. Change in valuation multiples
The first two items are the fundamental returns, which drive over 99% of long-term wealth creation in the stock market. That’s long-term wealth creation.
The last item is the speculative source of return, which practically drives none of the historical long-term returns of stocks.
However, in the short-run, (5 – 10 years), your returns are very much influenced by changes in valuation multiples. In some extreme circumstances, if you overpay dearly for an asset, you may spend 15 – 20 years getting the multiple to a normal range, which would impact your conviction, margin of safety and returns. For example, if you pay 80 times earnings for a non-dividend company that doubles EPS over the course of each decade, but the ending P/E ratio is 20 after 2 decades, your total return is zero.
Of course, if you end up paying 10 times earnings for a non-dividend company that doubles EPS over the couse of each decade, and eanding P/E ratio is 20 after 2 decade, your total return is 700%.
In the case of Hormel, it looks like earnings per share have stopped growing over the past 6 – 7 years. Without growth in earnings per share, the company would be unable to grow the dividend and grow intrinsic value.
If EPS doesn’t grow, then the sources of fundamental returns would be entirely dependent upon the dividend, which may likely not grow by much either. Hence, today’s investors may expect 3.50% – 4% annualized total returns over the next decade at best. This of course assumes that the dividend is at least maintained of course.
Note, if investors decide that a low/no growth business does not deserve to sell for 20 times forward earnings, that decline in the P/E could pull down returns by more than the amount of the dividend received. That would increase however the dividend yield, assuming the dividend is at least maintained, pulling forward returns upwards.
Without growth in fundamentals, the company is like a ship without sails – it is exposed to the vagaries of the weather, with limited ability to maneuver and get to where it needs to go.
It is fun to think about the inter-relation between the sources of investor returns, and make some reasonable assumptions, which can be stresstested for various possible scenarios.
