Hormel: Peak Pessimism, Buy For A Trade And Then Hit The Fade (NYSE:HRL)

It has been a tough year for Hormel Foods Corporation (NYSE:HRL) investors. The stock has chronically disappointed and has underperformed the broader market, i.e., S&P 500 (SPY) and the Consumer Staples Select Sector SPDR (XLP), by a huge margin.

In addition, HRL has suffered its largest drawdown from peak price. The current drawdown has dwarfed even the 2008-2009 selloff. You can see that in the little bump right at the end in the line below.

Contrarian investing requires a modest amount of valuation help, lots of patience and a heavy dose of luck. We look at HRL today and tell you why it is suffering its worst drawdown. We go over why a bounce is extremely probable and also tell you why this is not a longer term buy point. But first, the three reasons it is down in the dumps.

1) Loftiest Start Valuation

When the crowd embraces a new paradigm, even if it is wrong, the crowd can be right for a while. HRL was a prime example of that. Pushing past regular valuation boundaries in the name by buying “the best”, slingshot HRL into ultra-bubble territory. Investors saw the entire history of price to sales multiple and for 30 odd years and then decided “hey, you know what would make sense, if we valued it at 3 times the long term average.”

You should look at the hostile responses on our earliest piece on this. Such is the nature of bubbles, that they tend to go on far longer than most expect. You can see below the black circle was when the article was released and HRL peaked more than 14 months later.

2) Chasing Dividend Growth

This is an offshoot of a silly metric that gained popularity with the dividend growth investing crowd. You add the yield and then you add the growth of the dividend and if it meets some magical number (>12%), then you close your eyes and buy, valuation be damned. HRL met this, thanks to one of the most aggressive dividend growth rates between 2010 and 2020. This caused an influx of these investors, buying at any price and a self-reinforcing behavior was born. Notice just how closely the two (price and dividend growth) tracked each other over that decade.

What was missing in all of this, was this was a one trick pony. HRL had started this period with an extremely low payout ratio, so the dividends could grow far faster than earnings. Not any more. With a 75% payout ratio, you can kiss that growth rate and that magical equation goodbye.

3) Ignoring Actual Headwinds

HRL has had multiple issues on the margin front. These have been blamed on multiple one-time issues. Investors were happy to overlook these and just buy “cause its going up”. But there are limits. We are now expecting $1.55 in earnings per share in fiscal 2024 (ending in October 2024).

If you don’t think that is a poor performance then well, here are 2014 and 2015 EPS numbers for you.

Earnings are down an astounding amount over the last decade. That this has happened after the highly vaunted Planters acquisition, is plain nuts.

Why A Bounce Is Highly Probable

So that in a nutshell (pun intended) was why HRL got beaten down. Markets seldom move in a straight line though the last 15 weeks in the SPY seem to suggest otherwise. HRL’s drop has been rather extreme for a consumer staples company and while there are headwinds, the sentiment looks extremely one-sided. Relative to its 200 day moving average, HRL was only lower on a handful of occasions.

Expectations are low and analysts are throwing in the towel.

The setup looks good for a bounce that clears away the excess pessimism.

How To Play

If you are looking for a Buy & Hold entry, this is not it. But a straight buy here and hold through the next 1-2 months likely gives you a profitable exit. But if you do enter, keep your eye on the exit. In other words, buy for a trade and then hit the fade.

Investors can also consider the $29-$30 call spreads for March 15, 2023.

For a longer term entry perspective, you still have to be careful. But you can use the negative sentiment to create a decent entry point. That is the beauty of options. You can always find a strike that you are bullish at. The deep in the money covered calls offer an excellent “yield”, with very little risk of losing your shirt. In this case we would aim for our “fair value” of the stock, which is close to $25.00 per share.

Note that we have only counted three dividends as the fourth ex-dividend is extremely close to option expiration (around January 10, 2025), and since this is an in-the-money call, premature exercise is extremely probable. Of course if HRL goes below $25.00 by then, you will get a quantum of solace in collecting the fourth dividend.