J.M. Smucker (NYSE:SJM) is a producer and marketer of products such as coffee, peanut butter, fruit spreads, shortening, and ice cream toppings, and, more recently, pet food products due to its acquisition of the largest U.S. pet food company. The company's shares have sold off sharply from its 52-week and all-time highs earlier this year largely due to such shares trading at a historically high price to earnings ratio. In other words, investors used the company's latest earnings report as an excuse to sell off SJM's overpriced shares. Although SJM's shares have sold off, there is a strong likelihood that such shares may trade lower during a significant overall market sell off in late 2016 or early 2017 (or if interest rates rise further). As such, potential investors in this dividend growth star's shares, should put the company's shares on their watch list to buy within our price range set forth at the bottom of this article. We should note that while the sell off in SJM's shares was primarily because such shares were overpriced, the company does face adverse market circumstances such as lower pricing in its coffee and foods divisions, in addition to weakness in some of its mainstream pet-food product categories.
Longer term, however, the outlook for SJM and its shares are more positive given that the company's near-term efforts are likely to result in cost control savings, potential improvement in gross and operating margins, debt reduction, share repurchases, and annual dividend increases. As noted above, the company's most recent earnings were adversely effected by weakness in two of its most significant businesses, coffee and pet-food products. With respect to its SJM's coffee business facing weaker pricing issues, the company has been engaged in its 5-point plan to boost the results of such business. The company'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. Although the company's U.S. coffee division continues to face market headwinds, the company is responding successfully to such concerns with its above-noted plan to counter such coffee pricing trends.
While SJM has a plan to overcome market factors adversely effecting its U.S. coffee division, the company is in the early stages of serving the expanding over $21 billion U.S. pet food market after its acquisition of Big Heart Pet Brands ("BHPB"), one of the largest and fastest growing center-of-the-store categories in the U.S. (We have noted previously in an article on the companion pet market that such market has become more desirable as a business as companion pet spending continues to remain strong as owners spend more of their disposable income on pets.) SJM's entry into the pet food market, a market completely distinct from its core "human food" businesses, is the company's recognition that such market is a substantial one that it expects to experience above-average growth in the intermediate and long-term. The company also recognizes that the pet food market is less subject to the price competitiveness of the "human food" market as a substantial number of pet owners view their pets as family members and are becoming premium shoppers that are willing to purchase premium pet food even in difficult economic times. SJM's acquisition of BHPB to enter the pet food market will benefit from U.S. companion premium pet food spending trends over the intermediate and long term even if such business experiences short term weakness as the company works to benefit from the premium pet food trend.
Fiscal first quarter 2017 earnings
In August 2016, SJM announced adjusted earnings of $1.86 per share, 16 percent increase from the year-ago quarter due to cost-related acquisition synergies, higher operating income, a lower tax rate and reduced amount of shares outstanding. Net sales decreased to $1.816 billion due to the company's divestiture of its U.S. canned milk business and adverse currency effects. Excluding the divested business and adverse currency effects, net sales decreased 5 percent due to lower net price realization from lower net pricing on coffee and an unfavorable volume/mix in the company's U.S. Retail Pet Foods division. SJM also reduced its sales outlook for its fiscal 2017. SJM's adjusted gross profit decreased 3 percent due to lower net pricing and the loss of U.S. canned milk profits, much of which was offset by a decrease in commodity costs. Adjusted operating profits increased 2 percent to $364 million due to decreased selling, general and administrative expenses.
SJM's U.S. Retail Coffee division recorded a 9.0 percent decrease in sales to $513.3 million due to lower net price realization resulting from decreased packaged coffee prices for most of its products sold in the U.S. Profit for the division was flat at $173.8 million. The company's U.S. Retail Consumer Foods division sales decreased 8 percent to $537.0 million due to the company's U.S. canned milk divestiture. Profits for the division decreased 7 percent to $111.4 million due to the loss of U.S. canned milk profits. The company's U.S. Retail Pet Foods division net sales were $519.5 million, a 6 percent decrease due to unfavorable volume/mix. Profit for the division increased 5 percent to $122.2 million due to acquisition-related cost synergies, lower commodity costs, and a decrease in marketing expenses. The company's International and Foodservice division net sales decreased 3 percent to $246.0 million due to decreased net price realization, adverse currency effects and the divested U.S. canned milk business. Profit for the division increased 9 percent to $39.5 million due to favorable volume/mix, lower commodity costs and pricing.
SJM reiterated its fiscal 2017 earnings estimates to be $7.60 to $7.75 per share. The company, however, expects net sales to decrease 2 percent to 3 percent from fiscal 2016 due to its U.S. canned milk divestiture. The sales decrease is due to reduced net sales forecast for the company's U.S. Retail Pet Foods.
Our View
SJM's U.S. Retail Pet Foods division, accounting for about one-third of its 2016 sales, experienced a sales decline while the remainder of its businesses mostly achieved expectations. Such division's sales decrease was due primarily to a short fall in its mainstream pet food brands, but the company's premium pet food brands sales also recorded a double-digit sales drop due to a fiscal 2016 distribution gain and weakness in the pet superstore channel. Although the company's pet food division faces near-term adversities, the company is likely to benefit long-term from its strategy to capitalize on premium pet food trends by offering premium "functional" pet food snacks that favor trends towards natural and high-protein products. Such strategy focusing on premium pet food products, however, will take time and money to develop and market such products to establish product brand equity and decrease the company's reliance on lower-margin mainstream pet food products. In other words, SJM bought BHPB to enter the pet food market, but aims to shift the focus of its pet food products towards premium products over the intermediate and long term. Until the company establishes a more significant and recognized presence in the premium pet food market, it will remain substantially dependent on specialty pet food retailers for growth, as such retailers are more open to its innovative yet less known premium pet food products.
As for SJM's weak U.S. coffee division, the company has continued its effort to boost its coffee division results through the above-noted 5-point plan. In addition, the company's near-term sales growth will also likely continue to be pressured by adverse currency effects. The company's gross margins, however, are likely to continue to increase as input costs are expected to decrease. Finally, the company will also continue to harvest 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 2017 is $7.68, and for fiscal year 2018 is $8.16. SJM's forward price to earnings ratio based on 2017 fiscal year earnings is about 17.35 and about 16.35 based on 2018 fiscal year estimates. We should note that SJM's earnings estimates have remained relatively steady for the fiscal years 2017 and 2018 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 $119.00 to $126.70 to establish a full position (a forward price to earnings ratio in the range of 15.50 to 16.50 based on the 2017 earnings estimate). Over the long term, SJM will reward shareholders with annual dividend increases, share repurchases and share price appreciation.
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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.
