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Continued: Appetite for innovation

  • Article by: MIKE HUGHLETT , Star Tribune
  • Last update: October 25, 2010 - 10:29 AM

AUSTIN, MINN.

Hormel Foods has been turning hog meat into pepperoni here since the early 1900s, back when the company was run by its namesake, George A. Hormel. Today, Hormel is by far the country's largest retail pepperoni producer.

Big deal, you say. King of an obscure meat category -- what do you do with pepperoni anyway but put it on pizza?

Well, this is where Hormel Foods has earned its keep as an innovator. Within the past 18 months, the company has launched several new pepperoni products -- snack-size pepperoni minis, turkey pepperoni minis, pepperoni snack stix. The result: Hormel's pepperoni sales grew 22 percent over the past year.

Take the same creative mentality behind the pepperoni renaissance, and regular-old ground turkey becomes hot-selling Jennie-O preformed turkey burgers, while pork cuts are transformed into preseasoned, fully cooked refrigerated entrees bearing such titles as Balsamic Rosemary Pork Roast.

This value-added process goes a long way in explaining why Hormel's sales and profits have grown handily in recent years, and why its stock has been a winner.

"Innovation and adding value [to commodity meats] -- I think really that's the whole key to success," said Eric Larson, a stock analyst at Soleil Securities. "That's the Hormel story."

Hormel shares have posted a 49 percent return for the five years ending Sept. 30, topping the 32 percent return of the Standard & Poor's Packaged Food Index, a peer group. Over the last year, Hormel has even outperformed Golden Valley-based General Mills, a perennial food industry darling on Wall Street.

Hormel has long had a foothold in consumer markets -- its classic Spam and Dinty Moore brands date to the 1930s. But the company in the 1980s began to consciously shift from being more of meat packer to a consumer products company. The idea: branded retail products entail less price volatility than commodity meats, and can offer superior profit margins.

Branded products make up 75 percent to 85 percent of Hormel's sales nowadays, up 10 to 15 percentage points from a decade ago, said Jeffrey Ettinger, a 21-year Hormel veteran who took the reins as chief executive in 2005.

Hormel's pork and turkey processing operations -- it actually owns its birds -- remain integral to its business model, producing the raw material for its branded portfolio. But Hormel "acts and looks like a consumer products company," said Matt Arnold, a stock analyst at Edward Jones.

That's a good thing from a stock perspective, Arnold said, pointing to Tyson Foods and Smithfield Foods in comparison. Both Tyson and Smithfield sell branded retail products, but they're seen more as commodity meat producers. Over the past five years, Tyson's stock has posted returns to shareholders of minus 6 percent; Smithfield, minus 43 percent.

Diversification pays

Analysts say part of Hormel's success stems from a balancing act among its three main segments: Jennie-O turkey, refrigerated meats, and shelf-stable grocery products. When one's down, as was grocery last quarter, at least one of the others is usually up (turkey posted a blowout performance that quarter).

Hormel's knack for smart acquisitions has also been crucial to its success. The company is known for buying businesses that fit nicely with its existing operations, creating new platforms for growth, analysts say.

For instance, it bought the Country Crock line of refrigerated pasta and potato side dishes from Unilever early this year to complement its burgeoning refrigerated entrees business. The Country Crock line was an orphan at Unilever -- it didn't fit with that company's refrigerated portfolio -- and sales were falling at a double-digit rate. Hormel stabilized the business, and sales have grown over the past eight weeks, Ettinger said.

As the CEO explains it, the food industry offers its own particular blessing and curse when it comes to a product's success or failure. "The blessing part is that you can still sell Spam after 75 years and people still love it," Ettinger said. "The curse part is that people are slow to change their habits [when it comes to food] and new product innovation is a very gradual thing."

Hormel gauges success by measuring current sales from products that have been introduced within the last 10 years -- and are still on supermarket shelves. Of its $6.5 billion in sales in its last fiscal year, $1.3 billion came from new products with staying power.

"What I focus on is a culture of innovation and new products, and that clearly exists in the [Hormel] organization," said Mark Henneman, comanager of St. Paul-based Mairs and Power Growth Fund, an investor in Hormel.

Take pepperoni. Hormel's consumer researchers found that customers liked its pepperoni in salads and casseroles, but were cutting it up because Hormel didn't offer a right-sized version. So the company created pepperoni minis, easy to sprinkle on a salad.

"Then we found out from consumers that these are also great snacks," Ettinger said. That led to a new offering, the pepperoni snack stick. Hormel essentially owns the pepperoni snack market.

The same can be said for Hormel's party tray, an array of precut meats and cheeses and crackers. Food retailers have long made their own snack trays, but they've been vexed by shelf-life problems. Hormel applied a special method of pasteurization to its party tray, giving it a 60-day shelf life.

"It's been a huge innovation around convenience," said Edward Jones' Arnold. "The party trays have been a huge hit and the [profit] margins are great there."

A couple of key areas where Hormel scored with big innovations, particularly its Compleats shelf-stable microwaveable meals, were hit over the past two years by the weak economy and increasing competition.

Recession setback

Compleats come in about 30 varieties, from roast beef with mashed potatoes to sesame chicken with vegetables. They went from a being a $30 million to $40 million business in the mid-2000s to well over $100 million in sales nowadays. For the year ended Sept. 5, Compleats helped give Hormel a healthy 43 percent share of the U.S. shelf-stable microwaveable dinner market, according to SymphonyIRI Group, a researcher that tracks sales in conventional supermarket channels.

Growth was so strong that Hormel decided to build a new plant dedicated to making Compleats. But as the $89 million plant opened in Dubuque, Iowa, last winter, Compleats sales had already slowed. The sour economy hurt relatively higher-priced prepared foods like Compleats. Meanwhile, ConAgra Foods and Del Monte Foods were gaining traction with their own microwaveable dinner offerings.

Hormel ended up using only half of the Dubuque plant's production capacity for Compleats. The other half is for chunked meat production, moved from a factory in California that Hormel then shuttered.

Henneman, of Mairs and Powers, said he thinks Compleats' sales will pick up again as the economy improves, and as Hormel keeps the Compleats product line fresh. The company is about to launch five new Compleats dinners geared for kids. Each meets federal guidelines for being dubbed "healthy meals," Ettinger said.

The way Henneman sees it, Hormel could use more healthy meals, since that's the long-term trend in packaged food. Hormel still has a product line that is relatively high in salt and fat, Henneman said. "We're watching their progress there."

Hormel has taken steps to better its health profile. Since 2008, its reduced sodium by 13 percent and 24 respectively in Compleats meals and Hormel chili. Hormel's Natural Choice lunch meats, introduced in 2006, contain no artificial preservatives. And much of its turkey line-up is inherently low in fat.

Hormel has a lot less control on another big challenge: rising commodity prices. Corn, a key ingredient in turkey and hog feed, hit a two-year high earlier this month.

"It's a very significant input change, putting pressure on the cost side of our business," Ettinger said. "We'll have to see where this market levels out and what that might mean in terms of pricing our products."

Mike Hughlett • 612-673-7003

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  • About Jeffrey Ettinger

    Saturday October 23, 2010

    Age: 52 • Hometown: Pasadena, Calif.

  • Hormel CEO Jeffrey Ettinger with some of the company's newer products.

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