J.M. Smucker Is Beginning To Look Appealing Again

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About: The J. M. Smucker Company (SJM)
by: Wolf Report
Summary

Due to a somewhat disappointing quarter, J.M. Smucker share price has begun to drop once again from the comparative lofty heights its been trading in for a number of months.

J.M. Smucker is one of my primary consumer staple holdings in the NA part of my portfolio, and I'm looking to increase my allocation to the company.

We look at whether this price drop warrants investment at this stage or if we should wait for a further drop prior to investing.

In my last article about The J.M. Smucker Company (SJM), I posited that the company's share price had grown to levels where I personally considered the stock too highly valued for investing, given the risk factors and headwinds the company might face in its key segments and markets. While my own YoC/purchase price was far more favorable, I wasn't looking to sell at that point - as I never am - and my long-term ambition for the company remains to hold as much as possible.

Since that time, we've seen the stock price starting to plummet due to a soft quarterly report that came in below expectations, with well-known company headwinds and risk factors once again rearing their head.

With that said, some of you may be wondering if the company can still be considered to be a "good" investment here or if now may finally be the time to leave the sidelines and buy some SJM.

Let's take a look.

Bildresultat för JM Smucker logo

Second thesis update - A poor quarter leads to weakness

1Q20 for SJM has been published - a quarterly I've been waiting for some time. The results weren't as I expected (not exactly), but neither were they as poor as some feared. Let's check out some of the highlights (or downsides).

The quarter saw:

  • A not-inconsiderable drop in net sales of 6% on a quarterly comparison.
  • A 4% drop in profits.
  • An 8% drop in operating income, and a 0.4% drop in margins.
  • An 11% drop in Earnings per share (EPS)

Obviously, this isn't what you want to see from a consumer staples company. So what caused this?

(Source: 1Q20 Quarterly Results slides)

The company has a number of explanations, as we can see above. Two large reasons become apparent - a volume/price mix issue, which certainly is a problem if it persists. Competition is, after all, always a thing. Secondly, there was a large ($48 million) M&A charge weighing things down in the quarter.

Sales are dropping - why?

The company rightly characterized the quarter as unacceptable, and has proceeded with initiatives, including measures to address financial discipline in the company (including a three-step/three-part approach), expecting an overall decrease in SD&A costs (Selling, General & Administrative).

In terms of the sales drop, the company reports that the unfavorable sales and volume mix was caused by the timing of food shipments, drops in coffee and peanut butter sales, as well as increased competition in the pet food/dog food category.

While these results may seem disheartening, nothing has changed in terms of the company's brand leadership. Folger's remains the company's number one brand, with SJM owning several of the top household coffee names across the nation. In addition, people aren't suddenly buying smaller amounts of peanut butter - the decline here during this quarter was related to a combination of:

a) a list price decline taken in 4Q19.

b) reduced inventory due to a 15% shipment increase in 4Q19, indicating that certain retailers overstocked during that quarter, as well as key price promotion moved to 2Q20 instead of this quarter.

As mentioned, SJM is also battling increased competition in pet foods, which lead to sales drops here as well - something the company is trying to address in the coming actions through marketing strategies and loyalty programs.

So, in short, the company is battling increased competition, margin pressure and other factors affecting its profits - and these are, of course, unlikely to simply disappear.

It's not all bad - Positive results remain

Not everything is bad, however - not in the quarter, and not looking forward.

(Source: 1Q20 Quarterly Results slides)

Company FCF is growing, and SJM has managed to navigate a sizeable reduction in debt, as well as an EBITDA increase.

Bildresultat för uncrustable

(Source: Meijer)

In addition, company operations in snacks continue to grow - both products aimed at pets as well as humans. SJM's uncrustable sandwiches brand experienced net sales growth of 11%, contributing to an overall segment increase in snacking of 7%. The company also completed the long-awaited Longmont facility, producing these sandwiches, and thanks to expected capacity increases here, one can expect further sales increases when this occurs.

(Source: Petco)

Insofar as pet snacks go, this grew as well, with Milk-Bone, Nutrish and other brands providing further growth and net sales. SJM projects another $100 million in net sales towards the end of the year.

The company also expects Nutrish to provide further growth in the mid- to high single digits, despite competition, and SJM remains convinced by its pet food business, which has provided growth and progress. It's not just dog food but cat food as well, with sales increases driven by brands such as 9Lives and Meow Mix.

I consider it important to remember that what you're investing in when buying SJM is basically people's love of snacks, coffee, jams and now dogs/cats and other pets. The company's brands remain amongst the top sellers across the nation, and despite a weak quarter, there are plenty of arguments that such headwinds are more temporary than permanent.

Its e-commerce initiatives are bearing fruit as well, with sales to pure e-commerce retailers up 30%, all while enforcing the company's pricing structure. While the share of sales is still small (5%), it nonetheless positions SJM for future growth in the online segment.

The company's marketing initiatives have provided positive results as well, with Jif Power Ups reporting increased household penetration for both Jif as well as Jif snacks. In addition, retailers are increasing SJM coffee distribution due to performance - with K-Cup and others being mentioned (Source: 1Q20 earnings call).

It's also important to remember that all SJM categories mentioned - snack, pet and coffee - are growing faster than center stores (in aggregate). So, while the quarter brings some top line problems and outlook writedowns/adjustments and other negatives, the overall picture in the long term is one of continued positivity - at least as I see it. Naysayers may point to the structural risk and increased competition in the market, particularly in pet foods, but I choose to consider SJM's long tradition of large market share a point in the company's favor, in addition to all the advantages previously discussed.

With positives and negatives/headwinds out of the way, let's look at the key change here.

(Source: F.A.S.T Graphs)

While not as amazingly discounted as earlier, approaching 11 times earnings, today's share price still represents a historically rare discount to the company's usual share price.

To be clear, I don't consider the market's assigned premium to be relevant here - competition and structural changes in the grocery market have, in my view, nullified the justifications for such premiums. However, that does not change the fact that SJM has grown operating earnings at an average of 6.7% annually over the past 10 years.

The company has also outperformed the S&P 500 both in terms of capital appreciation and by more than doubling the dividend development of the S&P 500 over the past 20 years. SJM has brought annualized rates of return of 8.8%, including dividends per year. While the dividend growth rate hasn't been explosive, it has nonetheless grown dividends on average at a rate of 9.2% per year - which, for a consumer staple, is something I consider more than acceptable.

With this in mind, the current valuation becomes one of appeal.

(Source: F.A.S.T Graphs)

The reason I'm writing about the company is that we've recently entered valuations where an investment into SJM can yield returns of above 10% simply by returning to more "normal" valuations, not even its market-assigned premium. A return to premium would at this juncture bring annual returns of almost 18% per year until 2022 - but as I said, I don't consider the premium relevant any longer.

The question, as such, becomes - is a 10.7% potential annual rate of return enough of a reward in return for the risk of investing in The J.M. Smucker Company?

Thesis

My answer to the question posed is "Yes."

We're talking about a consumer staples company with several brands excellently positioned in the market. Thanks to over 120 years of tradition, strong brand recognition and forward strategies and initiatives that I, at the very least, consider likely to bear some positive results, SJM remains a company I consider amongst the strongest in its field and on the relevant markets. It's also a company whose products I've tasted personally (the PB/Coffee, not the dog food), and I like companies where I can honestly say that I personally like the product(s).

While SJM may indeed face further headwinds going forward, I consider the long-term risk level here to be modest. The company will never deliver explosive earnings growth or surprise with large dividend payouts. It's a modest payer and a stalwart, basing its business on things people need on a daily basis - both for themselves as well as for their pets.

If expectations are moderated and you go into the investment with the mindset of a safe growth rate of 8-12% per year, I find it doubtful that you will be disappointed in the long term.

Thanks to a soft 1Q20, we've been offered the opportunity to once again invest in SJM at a valuation that can be said to be discounted in relation to fundamental valuation metrics. It reminds me a lot about the time I initially invested in the company - which was also at a discount valuation.

Due to the long-term expectations here, combined with strong fundamentals, this stock is one I consider a "Buy" at this stage - and that is where my recommendation lands.

I currently own the stock in my private portfolio - I may add shares in my corporate portfolio at this stage.

Thank you for reading.

Recommendation

At current levels of ~$106/share, I consider SJM a "Buy" due to what I consider to be fundamental undervaluation. I consider the company likely to meet or beat forward expectations, which means that fair value of 15 times earnings isn't at all unlikely here - which makes annual returns of above 10% possible.

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.