J. M. Smucker: Show Me Growth Or Give Me Buybacks
Summary
- J. M. Smucker Company is a Dividend Contender with 23 consecutive years of dividend growth. Shares currently yield 3.10%.
- J. M. Smucker is a defensive consumer staple.
- Analyzing J. M. Smucker through its cash flow and balance sheet and valuing the business through multiple angles.
J. M. Smucker (NYSE:SJM) is a well-known consumer staples business with several well-known brands outside of its namesake including JIF, Folgers, Meow Mix and many others. While the business has been steady, the share price has severely underperformed the S&P 500. Over the last five years, Smucker's share price is down 8.9% compared to the S&P 500's 88.0% rise. The stagnant share price while the business has continued to post modest results has led to an arguably cheap share price.
Dividend History
The dividend growth strategy is the one that appealed most to me when I began investing into individual companies. The concept is simple which is to focus on businesses that have a history of paying and growing their dividend payout as a means to harvest the fruit while keeping the tree.
Image by author; data source J. M. Smucker Investor Relations
Smucker is a Dividend Contender with 23 consecutive years of dividend growth. Its consecutive year streak dates back to 1997 which is quite impressive considering the numerous economic environments that have occurred over that time.
During its streak, there have s been 23 year-over-year periods with annual dividend growth ranging from 1.6% to 41.0% with an average of 10.4% and a median of 8.2%.
There have been 19 rolling 5-year periods during Smucker's streak with annualized dividend growth ranging from 6.3% to 13.1% with an average of 9.8% and a median of 10.4%.
Over that same period, there have been 14 rolling 10-year periods with annualized dividend growth ranging from 8.6% to 11.7% with an average of 9.8% and a median of 9.6%.
The rolling 1-, 3-, 5- and 10-year annualized dividend growth rates since 1997 can be found in the following table.
| Year | Annual Dividend | 1 Year DGR | 3 Year DGR | 5 Year DGR | 10 Year DGR |
| 1997 | $0.39 | ||||
| 1998 | $0.55 | 41.03% | |||
| 1999 | $0.59 | 7.27% | |||
| 2000 | $0.63 | 6.78% | 17.33% | ||
| 2001 | $0.64 | 1.59% | 5.18% | ||
| 2002 | $0.72 | 12.50% | 6.86% | 13.05% | |
| 2003 | $0.89 | 23.61% | 12.21% | 10.10% | |
| 2004 | $0.98 | 10.11% | 15.26% | 10.68% | |
| 2005 | $1.06 | 8.16% | 13.76% | 10.97% | |
| 2006 | $1.11 | 4.72% | 7.64% | 11.64% | |
| 2007 | $1.18 | 6.31% | 6.39% | 10.38% | 11.71% |
| 2008 | $1.26 | 6.78% | 5.93% | 7.20% | 8.64% |
| 2009 | $1.37 | 8.73% | 7.27% | 6.93% | 8.79% |
| 2010 | $1.55 | 13.14% | 9.52% | 7.90% | 9.42% |
| 2011 | $1.84 | 18.71% | 13.45% | 10.64% | 11.14% |
| 2012 | $2.00 | 8.70% | 13.44% | 11.13% | 10.76% |
| 2013 | $2.20 | 10.00% | 12.38% | 11.79% | 9.47% |
| 2014 | $2.44 | 10.91% | 9.86% | 12.24% | 9.55% |
| 2015 | $2.62 | 7.38% | 9.42% | 11.07% | 9.47% |
| 2016 | $2.84 | 8.40% | 8.88% | 9.07% | 9.85% |
| 2017 | $3.06 | 7.75% | 7.84% | 8.88% | 10.00% |
| 2018 | $3.26 | 6.54% | 7.56% | 8.18% | 9.97% |
| 2019 | $3.46 | 6.13% | 6.80% | 7.24% | 9.71% |
| 2020 | $3.56 | 2.89% | 5.17% | 6.32% | 8.67% |
Table by author; data source J. M. Smucker Investor Relations
The payout ratio can be used to gauge the relative safety of the dividend in relation to either net income or free cash flow. The more stable the business's operations, the higher proportion of profits or cash flow the business can afford to send back to shareholders.
Image by author; data source J. M. Smucker SEC filings
Over the last decade, Smucker's payout ratio has been more volatile than I would have expected for a consumer staple on a year-to-year basis, but the long-term trend has been relatively consistent. The 10-year average net income payout ratio is 49.7% with the 5-year average at 50.8%. The 10-year average free cash flow payout ratio works out to 45.8% with the 5-year average at 38.4%.
Quantitative Quality
When implementing a dividend focused investment strategy, business quality and stability ranks high on the checklist before purchasing shares. The idea is to shift your focus to that of the business owner and to allow the business fundamentals to generate you returns. Over the short term, sentiment plays a much larger role than fundamentals, but as the time horizon expands, fundamentals are the overwhelming driver of returns.
Image by author; data source J. M. Smucker SEC filings
Smucker's revenue growth has been adequate over the last decade due to a combination of organic growth as well as acquisitions. Revenues grew 62% in total or ~5.5% annualized across the last decade. Gross profits have slightly outpaced sales growth climbing 67% in total or ~5.9% annualized.
Operating income grew 50% or ~4.6% annualized with operating cash flow rising an impressive 220% or ~13.8% annualized. Free cash flow has shown outstanding growth rising 366% or ~18.6% annualized across the last decade.
Image by author; data source J. M. Smucker SEC filings
I want to see stable gross profit margins over time, but don't have an absolute threshold that must be met since they will be highly dependent on the underlying industry. Smucker's gross profit margin has been fairly stable after declining early in the decade. The 10-year average gross margin is 36.7% with the 5-year average at 38.1%.
I would expect to see high-quality businesses to have at a minimum stable free cash flow margins and, ideally, rising margins over time. Smucker's 10-year average free cash flow margin is 10.5% with the 5-year average at 12.5%.
Image by author; data source J. M. Smucker SEC filings
My preferred profitability metric is the free cash flow return on invested capital, FCF ROIC. The FCF ROIC represents the theoretical return the business is generating in distributable cash flow through its operations based on the capital currently invested in the business. The higher the FCF ROIC the better, and I want to see a rising FCF ROIC over time. Smucker's 10-year average FCF ROIC is 6.7% with the 5-year average at 7.4%.
I want my investment dollars to be invested in businesses that use their cash flow in ways that make sense to me. That means that first off I want to see cash flow reinvested in the business to maintain and grow its competitive position. Some portion of sustainable cash flow above those needs should then be returned to shareholders if there aren't enough reinvestment opportunities via a rising dividend. Excess cash flow above that should be spent on some combination of share repurchases, debt reduction or acquisitions.
To understand how Smucker uses its free cash flow, I calculate three variations of the metric, defined below:
- Free Cash Flow, FCF: Operating cash flow less capital expenditures
- Free Cash Flow after Dividend, FCFaD: FCF less total cash dividend payments
- Free Cash Flow after Dividend and Buybacks, FCFaDB: FCFaD less cash spent on share repurchases
Ideally the business would show strongly positive FCFaD year after year. Negative FCFaDB levels in any given year aren't a concern to me as opportunities can be fleeting; however, consistently negative FCFaDB would suggest that the business doesn't generate enough cash flow through its operations to fully fund the capital allocation process. It's more of a caution flag rather than an outright red flag.
Image by author; data source J. M. Smucker SEC filings
As we saw earlier, Smucker has done a remarkable job growing its free cash flow over the last decade. In total Smucker has generated $7.17 B in FCF over the last decade. Management has spent $2.90 B on dividends in total over that time putting the cumulative FCFaD at a healthy $4.27 B. With that $4.27 B in FCFaD management has spent a total of $2.50 B on repurchases putting the 10-year cumulative FCFaDB at a solid $1.77 B.
Overall the cash spent on share repurchases hasn't moved the needle much with the share count declining just 2.6% in total or ~0.3% annualized. That's primarily due to the acquisition of Big Heart Pet Food in FY 2016. From FY 2011 through FY 2015 share buybacks were meaningful with shares outstanding falling 11.5% over that time. Since then share repurchases haven't been much in play.
Image by author; data source J. M. Smucker SEC filings
As an investor in the equity of a business the balance sheet is important to protect the downside. A heavily leveraged business introduces a new set of risks on top of the business risk and unfortunately the leverage issue typically rears its head at the same time as the business risk. I generally want to see a stable debt-to-capitalization ratio over time.
Image by author; data source J. M. Smucker SEC filings
Smucker's debt-to-capitalization ratio has risen over the last decade, most significantly in FY 2015, but has generally been stable to improving. The 10-year average debt-to-capitalization ratio comes to 36% with the 5-year average at 42%.
The capital structure is one way I use to judge the strength of a balance sheet, but I place more emphasis on the debt ratios. I look at net debt versus a variety of income ratios to see how quickly the balance sheet could be de-levered should the debt markets re-rate.
Image by author; data source J. M. Smucker SEC filings
The metrics I use are the net debt-to-EBITDA, net debt-to-operating income and net debt-to-FCF. For Smucker the 10-year average for each metric is 2.9x, 3.6x and 5.5x, respectively. The 5-year averages are 3.5x, 4.2x and 5.6x, respectively. The debt ratios are higher than I'd like, but they aren't overly concerning at this time.
Valuation
For valuing investment candidates I like to examine valuation and returns through a variety of lenses. The valuation methods that I use are the minimum acceptable rate of return, "MARR", analysis, dividend yield theory and a reverse discounted cash flow analysis.
A MARR analysis entails estimating the future earnings and dividends that a business will generate, apply a reasonable expected terminal multiple on those future earnings and then determine what the expected return is. If the expected return is greater than your hurdle rate, then you can feel free to invest provided you're comfortable with the potential risks.
On average analysts expect Smucker to report FY 2021 EPS of $8.88 and to show FY 2022 EPS of $8.61. Across the next 5 years, analysts expect Smucker to show 0.9% annual earnings growth. I then assumed that Smucker would be able to generate 2.5% annual earnings growth over the following 5 years. Dividends are assumed to target a 42% payout ratio.
For the reasonable future multiple I like to see how market participants have historically valued Smucker in the past. Over the last decade Smucker's TTM P/E ratio has ranged from ~8x to ~30x and currently sits at 13.75x. For the MARR analysis I'll examine terminal multiples ranging from 10x to 25x.
Data by YCharts
The following table shows the potential internal rates of return that an investment in Smucker could produce provided the assumptions laid out above are relatively close to how the future plays out. Returns assume that dividends are taken in cash and that shares are purchased at $116.22, Thursday's closing price.
| IRR | ||
| P/E Level | 5 Year | 10 Year |
| 25 | 17.1% | 10.7% |
| 20 | 12.1% | 8.5% |
| 17.5 | 9.2% | 7.2% |
| 15 | 6.0% | 5.8% |
| 12.5 | 2.4% | 4.1% |
| 10 | -1.9% | 2.1% |
Additionally I reverse engineer the process to determine what price I could pay today in order to generate the returns that I desire from my investments. My base hurdle rate is 10%, and for Smucker, I'll also examine 8% and 9% returns.
| Purchase Price Targets | ||||||
| 10% Return Target | 9% Return Target | 8% Return Target | ||||
| P/E Level | 5 Year | 10 Year | 5 Year | 10 Year | 5 Year | 10 Year |
| 25 | $158 | $125 | $164 | $136 | $171 | $147 |
| 20 | $129 | $105 | $134 | $114 | $140 | $123 |
| 17.5 | $115 | $95 | $119 | $103 | $124 | $111 |
| 15 | $100 | $85 | $104 | $92 | $109 | $99 |
| 12.5 | $86 | $75 | $89 | $81 | $93 | $87 |
| 10 | $72 | $65 | $74 | $70 | $77 | $75 |
Dividend yield theory is a valuation method built on the idea of reversion to the mean. The idea is simple and straightforward and assumes that a business will trade around a "normal" dividend yield. For Smucker I'll use the 5-year average forward dividend yield as a proxy for the fair value of the business.
Image by author; data source JM Smucker Investor Relations and Yahoo Finance
Smucker shares currently offer a forward dividend yield of 3.10% compared to the 5-year average yield of 2.81%.
A reverse discounted cash flow analysis is a way to decipher what the current valuation in the market implies about the future cash flows of Smucker. I use a simplified DCF model built on a static EBIT margin of 16.4%, a tax rate of 25% and use a WACC of 7.1% to discount the cash flows. The WACC is derived with a cost of equity using the dividend capitalization method with an estimated 6% dividend growth rate yielding a cost of equity of 9.1%.
Using those assumptions, revenue growth needs to come to just 1.4% across the forecast period to justify the current valuation in the market.
Conclusion
Smucker is a solid business that's shown solid growth over the last decade that's been aided by acquisitions. Free cash flow margins have been solid with a 10-year average of 10.5% and a 5-year average of 12.5% and trending in the right direction. While margins have been showing solid improvement, FCF ROICs are a bit lackluster with a 10-year average of 6.7% and a 5-year average of 7.4%.
Dividend yield theory suggests a fair value range between $116 and $143. While the MARR analysis suggests a fair value range between $85 and $105 based on a 10% hurdle rate and a range of $99 to $123 based on an 8% hurdle rate.
Smucker is a solid business with plenty of recognizable brands and the current valuation appears to be pricing in a pretty bleak future in terms of growth.
The MARR analysis assumption shows small positive returns even with further multiple deterioration over the next 10 years and excellent returns should the multiple re-rate to higher levels. I'm hesitant to bank on that multiple expansion, but the upside potential is pretty big considering that the MARR returns assume just a 1.8% 10-year EPS CAGR and you're looking at potential IRRs inclusive of dividends in the 2%-6% range over the next decade.
While multiple expansion isn't likely to be material if the forecasts are reasonably accurate and will likely require an improvement in business fundamentals. It's that combination of a cheap entry point with muted expectations that turns into better-than-expected future growth that has me pretty excited. If the 10-year CAGR works out to say 4.0% in conjunction with multiple expansion to 15x-20x the expected returns rise to 7.6% to 14.8%.
At the current valuation, Smucker is attractive for those willing to bet that management can find a way to return to at least modest growth moving forward. The average of FY 2019, FY 2020 and the TTM period free cash flows with the current shares outstanding puts Smucker generating a "normalized" $9.03 in free cash flow per share. At the current price of $116.22, that's a hefty 7.8% free cash flow yield.
Smucker is an intriguing investment candidate at current levels and one that I'll continue to follow to determine whether to add to my position. The valuation is incredibly cheap, but in line with comparable peers such as Campbell Soup Company (CPB) and Conagra Brands (CAG) that have both struggled to show meaningful growth.
If growth continues to be a struggle, I'd much rather see management return to the strategy it implemented in the first half of the last decade which was to essentially return 100% of cash to shareholders via dividends and buybacks. Using the average FCFaD from FY 2019, FY 2020 and the TTM period gives management somewhere on the order of $500-$600 M per year in FCFaD that could be funneled towards share repurchases. With a current market cap of $12.5 B, it could repurchase between 4% and 4.8% of shares outstanding on an annual basis.
This article was written by
Analyst’s 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.
I am not a financial professional. Please consult an investment advisor and do your own due diligence prior to investing. Investing involves risks. All thoughts/ideas presented in this article are the opinions of the author and should not be taken as investment advice.
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Comments (12)
You may as well invest in a tax exempt municipal bond...
The returns are about the same...