When executed properly, the dividend growth investing strategy can help take investors to the promised land of personal finance: financial freedom. Given that the best businesses up their sales and profits over time, it shouldn't be surprising to learn that they often reward shareholders with higher dividends as well.
Having boosted its quarterly dividend for 57 years straight, the consumer staple Hormel Foods (HRL -2.63%) meets the 50-year requirement to be a Dividend King. For context, this puts the company among just 47 other official Dividend Kings and two "unofficial" Dividend Kings.
But is the stock worth buying for dividend growth investors? Let's dig into Hormel's fundamentals and valuation to resolve this question.
Image source: Getty Images.
A challenging quarter doesn't break the investment thesis
At the surface level, Hormel's fiscal second quarter ended May 1 wasn't the most encouraging for the consumer staple. The company's net sales fell by 3.8% year over year to $3 billion during the quarter. However, investors should take comfort in knowing that this was in line with Hormel's expectations.
| Metric | Q2 2022 | Q2 2023 |
|---|---|---|
| Volume growth rate (YOY) | (7.9%) | (5.6%) |
| Net margin | 8.4% | 7.3% |
Data source: Hormel. YOY = year over year.
One key takeaway from the company's most recent quarter is that its products remain in high demand: More than 40 of Hormel's brands are ranked No. 1 or No. 2 in their categories, including Skippy peanut butter, Planters nuts, and Jennie-O turkey. In fact, the big reason why the company's volume and net sales didn't grow was due to a highly pathogenic avian influenza (HPAI) in its supply chain. This pressured the sales volume of Hormel's Jennie-O turkey brand.
But the company's CFO, Jacinth Smiley, delivered some good news for investors. Smiley anticipates that with the HPAI headwind expected to be behind it, a strong rebound in its turkey business is on the way in the second half of this fiscal year.
Hormel's diluted earnings per share (EPS) dropped by 16.7% over the year-ago period to $0.40 in the fiscal second quarter. The company's supply chain headwinds resulted in a sharp rise in its cost of products sold and selling, general and administrative expenses. This is what pushed net margin meaningfully lower for the quarter.
That explains how Hormel's diluted EPS contracted at a faster rate than net sales during the quarter. As the company bounces back from headwinds, analysts believe that its diluted EPS will grow at a mid-single-digit rate each year over the next five years.
The payout is competitive and sustainable for shareholders
Income investors will be delighted to learn that Hormel's 2.7% dividend yield is significantly more than the S&P 500 index's 1.6% yield. And with the quarterly dividend per share more than tripling over the last 10 years to $0.275, the company is serving up more than just appetizing starting income.
HRL Dividend data by YCharts
Best of all, the payout appears poised for further growth. This is because the company's dividend payout ratio is projected to be just under 63% for the current fiscal year ending in November. That allows Hormel to retain the funds needed to expand its business and reduce its debt.
Hormel's valuation may be too rich
Due to the obstacles that its business faced in recent quarters, shares of Hormel have shed 11% of their value so far in 2023. But even with this recent share price weakness, the stock seems to be overvalued at the current $41 share price.
Hormel's track record of dividend growth undoubtedly makes it deserving of a premium valuation. But its forward price-to-earnings (P/E) ratio of 21.3 clocks in well above the packaged foods industry average forward P/E ratio of 16.6. That's why I would advise investors concerned with balancing income and total return potential to wait on the sidelines for the time being.
