HRL

Consumer Sales in China Are Still a Trouble Spot for This Dividend King. Here's What to Watch Out for Before You Buy the Stock

Shares of Hormel Foods (NYSE: HRL) rose dramatically after it reported fiscal first-quarter 2024 earnings. There were very good reasons for this, but investors still need to dig into the details before they get too upbeat about the future of this iconic food maker. China is an important and lingering trouble spot.

Hormel had a strong quarter

When Hormel reported fiscal Q1 earnings, management proudly highlighted that volume grew 4% year over year. Since volume fell 4.2% in 2023, the Q1 results suggest that the food maker is at an important inflection point. Notably, volume rose in all three of the company's divisions, which include retail, food service, and international.

A person pushing a cart in a store.

Image source: Getty Images.

The weakest performance was in the company's retail business, basically all of its U.S. business that isn't food service. Volume in this segment rose 2%. Foodservice, which has been performing relatively well, continued its strong performance, with volume up 8%. Outdistancing even that showing was Hormel's foreign business, with volume rising 11%.

This is where things start to get a bit more interesting. Per the earnings release, foreign "Segment profit increased due to the inclusion of our investment in Indonesia and significantly higher results from our partnership in the Philippines." So, in some ways, that 11% improvement in volume wasn't exactly an apples-to-apples comparison.

And more to the point here: "...in China, foodservice results improved as we lapped COVID-related disruption last year. This benefit was more than offset by continued weakness in the retail channel." This consumer staples maker's best-performing business on the volume front may not be quite as big a positive as it seems.

Reading between the lines

If you had to summarize the foreign business' results, it would probably go something like this: Volumes grew thanks to the addition of a new business, but China is only just beginning to show signs of recovery. That's not terrible, but it certainly isn't good, either.

China is a large and importantglobal market and Hormel has been investing heavily in the country. To put some numbers on that, it is the single-largest foreign market for Hormel, with 842 production facilities, 33 warehouses, and 26 corporate offices.

While Hormel doesn't actually break out China as a percentage of its overall business, its presence in the country accounts for roughly two-thirds of its foreign properties. It is reasonable to assume that China is very important to Hormel's future. If you own Hormel, you need to keep an eye on the still-struggling China operations.

The good news is that the Chinese market has reopened after a long closure related to the coronavirus pandemic. That's clearly resulted in a material improvement in the country's foodservice segment now that people are able to go out and about again. But they still aren't buying Hormel's products for their homes like they used to. Two things should be monitored here.

First, investors need to remember that foodservice demand in China is likely coming off a very low base. So, the improvement is nice to see as an early sign of a turnaround, but the real questions are what happens through the rest of the year and what happens when these results are eventually lapped. Listen carefully to ensure China's food service business continues to grow.

Second, and probably more important, Hormel needs to get people in China to buy its products again. That hasn't happened yet, and it is a worrying sign. It seems highly likely that Hormel will eventually figure out how to get this business back on track, but the longer it takes to do that, the worse it is for the company and investors. Watch what management says about Chinese customers over the next few quarters, too.

Not huge, but important to the future

Foreign sales make up only around 6% of Hormel's top line. China is a big part of that. While 6% isn't a massive figure, foreign expansion is expected to be an important long-term growth driver for the food maker. As such, long-term investors will want to closely monitor China's still-weak performance. If the company can't get back on track in China, it will be much harder to grow the business.

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Reuben Gregg Brewer has positions in Hormel Foods. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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