J.M. Smucker: Dunkin' K-Cups And Pet Food To Fuel Strong Dividend Growth

| About: J. M. (SJM)

Summary

The company’s announced better-than-expected earnings were due primarily to its recent acquisitions, lower coffee costs and the launch of Dunkin’ Donuts K-cup pods.

The company’s reinvigorated coffee division results aided earnings through its previously announced 5-point plan to improve results for such division.

The company’s entry into the pet food market also boosted earnings as it is now the largest provider of premium quality, branded pet food and pet snacks in the U.S.

The company’s improving coffee division results, entry into the growing pet food market and its innovation in its remaining product categories will ensure long term revenue and profit.

The company will reward investors with yearly dividend increases, share repurchases as the company transforms to serve the human and pet food markets.

J.M. Smucker (NYSE:SJM), until 2015, had been a producer of products such as coffee, peanut butter, fruit spreads, shortening, and ice cream toppings. The company's divisions included: 1) the U.S. retail coffee division, 2) the U.S. retail consumer foods division which includes peanut butter, fruit spreads, baking products, shortenings and oils, and canned milk, and 3) the international, foodservice and natural foods division. In 2015, however, the company became the largest pet food provider in the U.S through a transformative acquisition. In the company's latest earnings report, it announced better-than-expected earnings due primarily to its recent acquisitions, Dunkin lower coffee costs and the launch of Dunkin' Donuts (NASDAQ:DNKN) K-cup pods. SJM had, for many years, manufactured and distributed Dunkin' Donuts brand premium bagged coffee where groceries are sold under license from DNKN. In 2015, however, SJM and DNKN entered a new, multi-year agreement, whereby SJM would distribute and market Dunkin' K-Cup packs exclusively to grocery chains, mass merchandisers, club stores, drug stores, dollar stores and home improvement stores. SJM's extended agreement with DNKN to distribute K-Cups is just one part of the company's better than expected earnings results. The other part is the company's entry into the pet food through the above-noted 2015 acquisition.

In 2015, SJM entered the growing pet food market with its acquisition of Big Heart Pet Brands ("BHPB"). As we noted in an article on the companion pet market, such market has become increasingly desirable as a business given that companion pet spending continues to remain strong as owners spend more of their disposable income on pets. SJM, therefore, has chosen to enter a market of a substantial size that it expects to experience consistent growth in the intermediate and long-term. SJM's announced acquisition of BHPB made it the largest producer, distributor, and marketer of premium quality, branded pet food and pet snacks in the U.S. BHPB brands include Meow Mix, Milk-Bone, Kibbles 'n Bits, 9Lives, Natural Balance, Pup-Peroni and Gravy Train. The company believes the acquisition will provide it with greater scale and strategic balance and position it for continued growth. The company also believes the BHPB acquisition will provide it with an immediate and significant presence in the $21 billion pet food and snacks category, one of the largest and fastest growing center of the store categories in the U.S. With such acquisition, the company hopes to market and sell to the about two-thirds of U.S. households that have at least one family pet and enable the company to be able to serve the mealtime and snacking needs of the whole family (including pets).

SJM's better than expected revenue and earnings results were due to not only its introduction of DNKN K-Cups and the BHPB acquisition, but also its 2015 announced effort to reinvigorate the performance of its coffee division. The company's most recent earnings report indicates that SJM's effort to boost the performance of its coffee division has been successful so far. SJM's 5-point plan includes: 1) ensuring consistent taste profiles; 2) transitioning the Folgers roast to a more competitively priced smaller canister; 3) restructuring costs to adjust for lower prices; 4) promoting premium coffee partnerships; and 5) capitalizing on the K-Cup trend. With the company's efforts to improve its results in mind, we believe that potential investors should consider investing in SJM at an advantageous entry point to capitalize on the company's plan to grow revenue and earnings over the intermediate and long term through the human and pet food markets. An SJM investor will then be rewarded with dividend growth, share buybacks and share price appreciation over the long term.

Fiscal second quarter 2016 earnings

In November 2015, SJM announced adjusted earnings of $1.62 per share, a 6 percent increase from the year-ago quarter. Adjusted earnings, excluding amortization, were $1.91 per share, a 13 percent increase from the year-ago quarter due to strong revenue growth and improved operating profits. Net sales increased 40 percent from the year-ago quarter to $2.08 billion due to the acquisition impact of BHPD and growth within the U.S. Retail Coffee division. The acquisition of BHPB contributed $576.7 million to the quarter's revenue. Excluding the BHPB acquisition, the small impact of the Sahale Snacks acquisition, and adverse currency effects, net sales increased 2 percent due to favorable volume/mix led by the U.S. Retail Coffee division.

The company's U.S. retail coffee division, its largest division, recorded 10 percent revenue growth from the year-ago quarter to $586.1 million due to the launch of Dunkin' Donuts K-Cup pods which led to favorable volume/mix. Profit for the division increased 7 percent from the year-ago quarter to $161.7 million due to the contribution from Dunkin' Donuts K-Cup pods, other favorable volume/mix, and the benefit of lower costs, which were offset by lower prices. The company's U.S. retail consumer foods division recorded 3 percent revenue growth from the year-ago quarter to $644.0 million due to lower net price realization in the Jif and Pillsbury brands, which more than offset the favorable volume/mix led by Uncrustables frozen sandwiches and Eagle brand. Profit for the division was flat at $125.4 million as lower net price realization and higher manufacturing overhead costs offset overall lower commodity costs, primarily for milk, peanuts, and oils, and the impact of favorable volume/mix. The company's U.S. retail pet foods division recorded revenue of $576.7 million, a low-single digit percent increase from BHPB's results in the year-ago quarter due to distribution gains in the Natural Balance brand and growth in Milk-Bone dog snacks, which more than offset declines in Kibbles 'n Bits dry dog food. Profit for the division was $88.2 million, a low double-digit percent decrease from the year-ago quarter due to a planned increase in marketing expense in support of new item launches. The company's international and foodservice division revenue decreased 1 percent from year-ago quarter to $280.9 million, as adverse currency effects more than offset the contribution from BHPB and minor impact from the Sahale acquisition, favorable volume/mix and higher net price realization. Profit from the division increased 33 percent to $50 million.

SJM revised its sales and earnings guidance for fiscal 2016, reflecting the projected impact of its announced canned milk divestiture on the company's operating results (but excluding a one-time gain related to the transaction). The company expects net sales of about $7.9 billion, an increase of 38 percent from 2015, reflecting a full-year contribution from BHPB. The company has also narrowed its adjusted earnings estimates to the range of $6.85 to $6.95 in 2016, from earlier estimates of $6.80 to $6.95 per share.

Our View

We believe that potential investors should consider purchasing SJM's shares in the price range noted below. As noted, the company has been successfully reinvigorating its coffee division through its 5-point plan. In addition, the company is embarking on a journey to serve the growing pet food market subsequent to its game-changing BHPB acquisition. With the BHPB acquisition, the company recognizes that many pet owners see their pets as family members and are becoming premium shoppers that are willing to purchase premium pet food even in difficult economic times. We believe that SJM's acquisition of BHPB is likely to capitalize on U.S. companion pet spending trends and will reward SJM shareholders over the intermediate and long term. While concerns remain with regard to the market trends that the company's U.S. coffee division faces, the company is responding successfully to such concerns with its above-noted plan to counter such trends. Further, where the company's coffee results may sag from time to time, its pet food offerings will likely to experience above average growth and strong profitability. The company's near-term sales growth will likely continue to be pressured, however, by adverse currency effects in the near term. The company's gross margins are likely to increase in fiscal year 2016 as input costs are expected to decrease. Finally, the company is likely to experience some cost savings benefits from productivity improvements to offset higher marketing costs and other capacity expansion related initiatives.

The company's earnings estimates for fiscal year 2016 is $5.79, and for fiscal year 2017 is $6.43. SJM's forward price to earnings ratio based on 2016 fiscal year earnings is about 20.40 and about 18.25 based on 2017 fiscal year estimates. We should note that SJM's earnings estimates have remained steady for the fiscal years 2016 and 2017 in recent months. We believe a potential investor in SJM should wait for the company's share price to pull back to a range of $98.50 to $104.25 to establish a full position (a forward price to earnings ratio in the range of 17.00 to 18.00 based on the 2016 earnings estimate). Over the long term, SJM will reward shareholders with yearly dividend increases, share repurchases and share price appreciation. The company is likely to work through its near-term adversities in the U.S. coffee market and excel in the companion pet market.

Disclosure: I am/we are long SJM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.