Adding some big barbecue flavor from the wide open spaces of Texas to its product lineup, Hormel Foods (HRL 0.53%) announced its acquisition of Sadler's Smokehouse on the same day it released its Q1 2020 results. The distinctive taste of barbecue is taking off right now, not only in the USA but worldwide, and Hormel appears determined to lasso some profits from the trend. At the same time, its Q1 earnings dipped because of a major divestiture, raising the question of whether Sadler's can counterbalance the sale's effects.

Hormel acquires a longtime ally

Feb. 20 was a busy day for Hormel, with the release of its fiscal Q1 2020 report and a same-day earnings call. Intertwined with its earnings report was the announcement of its deal to acquire privately held Sadler's Smokehouse for $270 million in cash. The acquisition, slated to close in March 2020, adds a brand specializing in genuine, traditionally made pit-smoked meats used in barbecue cuisine by restaurants to Hormel's refrigerated foods sector.

Outside of meat purchases by Hormel, one of its major customers for around 20 years, Sadler's Smokehouse generates approximately $140 million in net sales annually. During the Hormel Q1 earnings call, Chairman, President, and CEO James Snee expanded on how the Sadler's acquisition would help the company push aggressively into supplying foodservice customers with specialty barbecue meats. He noted that the rapid growth of the barbecue-related Austin Blues brand, already owned by the company, suggests that Sadler's will probably add value to Hormel, too.

Meat being barbecued at night on an outdoor grill.

Image source: Getty Images

Thanks to its large amount of cash on hand, Hormel doesn't need to borrow money to complete the transaction. In fact, the effective final price for the deal is only $230 million, reduced by a cash tax benefit of $40 million. The multiple paid was approximately 9x EBITDA. Hormel intends to invest heavily in expanding Sadler's Smokehouse's facilities once the deal closes, making the acquisition either neutral or mildly negative to earnings per share during 2020.

CytoSport's exit makes Q1 results dip

Hormel's acquisition of Sadler's Smokehouse comes hard on the heels of its divestiture of another brand, CytoSport, maker of protein shakes and powders under the Muscle Milk name. As revealed on Feb. 19, PepsiCo (PEP -0.37%) bought the brand for $465 million. The divestiture contributed to an 11% drop in sales and a 14% decline in volume in Hormel's Grocery Products segment, along with a 1% drop in the company's overall volume.  

Despite this temporary impact, it's easy to understand why Hormel chose to rid itself of CytoSport. The brand was a poor fit for the company's overall focus from the start, with plant-based proteins as its major focus. These products meshed awkwardly with Hormel's meat-focused business connections and strategies. The brand has been steadily losing sales and racked up a $17 million non-cash impairment in Q4 2018, according to a Hormel earnings call. This followed a voluntary 2016 Muscle Milk recall over spoilage concerns.

Hormel's Q1 news wasn't all bad. Diluted EPS (earnings per share) rose by 2%; the Refrigerated, Jennie-O Turkey, and International segments saw net sales growth of 3% to 8%; and cash flow rose 1% to $188 million. Cash on hand has grown from $673 million to $724 million during the fiscal year so far.

Hormel looks to be trimming the fat, keeping things lean and healthy

The combined divestiture of CytoSport and acquisition of Sadler's Smokehouse appear to show that Hormel is attuned to the performance of its brands and to market trends alike. CytoSport's performance has been jinxed for at least three to four years, generating losses with its recalls, impairments, and difficulty in moving its products. Hormel seems well-advised to clear out the deadwood by selling off the problematic brand to PepsiCo, a company with a portfolio better suited to its plant-based protein shakes.

Sadler's, by contrast, is right in Hormel's wheelhouse. Buying a supplier Hormel has dealt with successfully for two decades has obvious advantages. Sadler's position as a barbecue supplier is perhaps even more important for profitability. According to a 2018 study by Technomic, sales of barbecue cuisine at restaurants rose by 8% from 2015 to 2017.  Without providing specific figures, Hormel indicated that its research shows this trend is continuing. American barbecue is also growing rapidly in popularity overseas. Sadler's Smokehouse opens the door to Hormel benefiting even more strongly from this food and cuisine sector.

While neither the divestiture nor the acquisition are necessarily large enough to make a landmark difference on their own, they're still worth noting if you're investing in food stocks and interested in Hormel. These actions demonstrate that the company is pursuing a strategy of keeping up with food consumption trends, eliminating underperforming portions of its business, and using its large volume of available cash to make carefully chosen brand purchases to build future sales growth. These traits are positive signs that Hormel is staying lean and competitive for the long term as it enters the 2020s.