J.M. Smucker Looks Like A Compelling Value Play

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About: The J. M. Smucker Company (SJM)
by: D.M. Martins Research
Summary

J.M. Smucker delivered results and guidance that I believe were solid, although the market seems to disagree.

Revenue is leaning towards higher-growth products, while I expect margin contraction to ease in the longer term.

I now see SJM as a potential winner in the packaged foods sector, alongside General Mills and Mondelez.

Subdued market reaction did not properly reflect what I considered to be J.M. Smucker's (SJM) solid earnings report.

On June 6th, the packaged food company delivered a wide EPS beat of 14 cents. Revenues of $1.9 billion lagged consensus by a small margin, while climbing 7% YOY. Best of all, Smucker provided guidance for fiscal 2020 that fell well above consensus: 1.5% top-line growth (vs. flat) and $8.55 in per-share earnings (vs. $8.33), both at the midpoint of the range.

Credit: Dividend Investor

I do not believe the revenue miss to be too concerning, given the many moving parts that may not have been properly anticipated. For example, currency had a negative top-line impact, while acquisitions and dispositions accounted for the bulk of the YOY change. A drop in price realization (consistent with lower coffee prices) may have been a bit disappointing, but at least, the headwinds were fully offset by favorable volume and mix.

I also appreciate Smucker's move towards product categories that I believe have a better chance of providing top-line support, namely pet food and coffee. These two segments now account for two-thirds of Smucker's revenues (vs. 58% last year), with Ainsworth Pet Nutrition having grown 20% in the most recent quarter. On the other side of the equation, the U.S. foods business (e.g. fruit spreads, syrups and Crisco oil), fighting a shift in consumer preference, now accounts for only 21% of the business.

As a result, Smucker is looking less like the peanut butter-jelly company that it has become traditionally known for, and I believe this is good news for investors.

Source: DM Martins Research, using data from earnings report

Adjusted for the impact of derivatives, gross margin remained flat YOY, at 37.9%. Providing the most support to profitability was the coffee segment, aided by (1) the solid performance of higher-growth brands like Cafe Bustelo and Dunkin' Donuts, and (2) lower commodity prices that more than offset lower retail pricing.

While gross margin could fluctuate depending on coffee price behavior, I am a bit more optimistic about the direction of op margin. In the most recent quarter, SG&A as a percentage of revenues looked rich, at 19.4% vs. 18.2% last year. But I believe this ratio will decline progressively, as the Ainsworth integration runs its course and cost saving initiatives take hold.

On the stock

In early December of last year, I drew a line separating the largest packaged food stocks into most and least enticing investments at that moment, based on my sector study. Kellogg (K) and Kraft Heinz (KHC) underperformed over the ensuing six months as I had projected, with the latter falling off a cliff in February 2019. Meanwhile, General Mills (GIS) and Mondelez (MDLZ) confirmed my optimism, outperforming even the broad equities market.

SJM is the one stock that defied my expectations (see graph below), climbing 21% when I anticipated some stock price pressure from deteriorating margins.

Source: Yahoo Finance

Today, I turn a bit more bullish on Smucker for a few reasons. First, the company seems to be making the right moves to grow the portion of its product portfolio that has the highest likelihood of succeeding, given consumer trends. Second, op margin headwinds are likely to be short-term in nature, considering the shock (e.g. integration costs) caused by recent M&A activity.

Chart Data by YCharts

Company/Ticker Fwd P/E Fwd PEG FCF Yield
J.M. Smucker - SJM 14.5x 2.8x 5.6%
Kraft Heinz - KHC 10.8x 2.1x 4.7%
Mondelez - MDLZ 21.7x 3.0x 3.7%
General Mills - GIS 15.5x 2.6x 7.0%
Kellogg - K 14.3x 5.0x 4.1%

Lastly, I believe that the market has not bid up shares beyond reasonable levels, which makes the stock look like an interesting value play. As the graph and table above depict, SJM still trades at a current-year P/E of 14.5x, well below the earnings multiples of the two names in the sector that I perceive to be of higher quality.

For these reasons, I now see SJM as a potential winner in the packaged foods sector alongside GIS and MDLZ, with K and KHC still looking a bit too fragile for my taste.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.