Business Strategy and Outlook
Despite having leading positions in many categories (fruit spreads, peanut butter, dog treats, coffee, and cat food) it is seen Smucker lacks an economic moat, either via its brand intangible assets or entrenched retail relationships. It is anticipated that for most of its sales base, Smucker does not possess pricing power and its market shares are slipping. This dilemma cannot be attributed to a lack of support, as Smucker’s brand investments exceed that of its peers (with marketing and R&D averaging 7.4% of sales the last three years compared with 5.4% for peers). Rather, it is perceived these expenditures are not as productive as its competitors, a problem not easily resolved in long interpretation.
It is assumed Smucker’s organic sales growth will average 2% annually over the long term, slightly less than the growth that was seeming for the total at-home food and beverage industry. It was foreseen market share losses in coffee and dog food to persist (Smucker’s two largest categories, at 47% of sales), as Smucker struggles to compete with strong brands such as Starbucks (licensed by wide-moat Nestle) and BLUE (owned by narrow-moat General Mills). Further, the fruit and nut spread categories, another 15% of sales, exhibit minimal growth. Even so, 2% growth represents an improvement from the modest declines in organic sales the firm realized before the pandemic. It is contemplated Smucker will be one of the few packaged food companies to realize lasting benefits from the pandemic, given the high-single-digit increase in pets adopted during the crisis and the likelihood that more flexible work arrangements should result in higher consumption of at-home coffee. This impact will not be immaterial, as collectively, pet food and coffee compose nearly 70% of Smucker’s sales. Further, Smucker’s sales trajectory should improve as Uncrustables (5% of fiscal 2021 sales) becomes a greater portion of the mix, as the brand has grown double-digits in each of the past several years. In addition, recent and pending divestitures of slower-growing brands (Crisco, Natural Balance, private label dry pet food, juices, and grains) should further improve Smucker’s ability to accelerate its top-line growth
Financial Strength
After years of a conservatively leveraged balance sheet, with net debt/adjusted EBITDA consistently below 2 times, the Big Heart Pet Brands acquisition in 2015 increased the ratio to above 6. Smucker paid $5.9 billion for the business, 13 times EBITDA, it is believed to be rich, particularly considering the acquired brands’ poor positioning in the category. It is interpreted management was prudent in its decision to sell the nonstrategic canned milk business shortly thereafter for $194 million to free up capital in order to accelerate debt reduction. Share repurchases were also significantly curtailed in 2015, which could be seen as sensible. Net debt to adjusted EBITDA declined to a manageable 2.8 times by 2018, though it is anticipated, before the firm announced it was acquiring pet food producer Ainsworth for $1.9 billion, which increased leverage to 3.5 times in 2019 before falling to 2.4 times in fiscal 2021. Smucker’s free cash flow (CFO less capital expenditures) as a percentage of revenue has averaged high single digits to low double digits historically, and it is supposed similar results going forward. Smucker seeks to invest half of its capital in growth initiatives (capital expenditures and acquisitions) and return half to stakeholders via dividends, share repurchase, and debt reduction. While it is foreseen Smucker will invest 3.5% of annual sales in capital expenditures over the long term, we model an elevated level of investments in the next two years as the firm adds Uncrustables capacity. We think Smucker will continue to reshape its portfolio through acquisitions and divestitures, although we have not modeled unannounced transactions. We think Smucker’s dividend payout ratio will range between 40% and 50%, in line with management’s long-term targets, it is anticipated 2%-6% annual dividend increasing. It is estimated Smucker to repurchase 0%-5% of shares annually, which is seen as a prudent use of capital if the share price remains below fair value estimates.
Bulls Say’s
- Smucker’s sales trajectory should improve over time due to the divestiture of slow-growing brands and the increasing mix of Uncrustables, which grows at a double-digit pace.
- During the pandemic, consumers adopted 11 million pets and purchased 3 million coffee machines, which should provide a lasting benefit for categories representing nearly 70% of Smucker’s fiscal 2021 sales.
- Executive leadership changes (newly created chief operating officer role, leadership changes for the U.S. sales organization and the pet food segment) should improve execution and enhance accountability.
Company Profile
J.M. Smucker is a packaged food company that primarily operates in the U.S. retail channel (88% of fiscal 2021 revenue), but also in U.S. food-service (5%), and international (7%). Its largest segment is pet food and treats (36% of 2021 revenue), with popular brands such as Milk-Bone, Meow Mix, 9Lives, Kibbles ‘n Bits, Nature’s Recipe, and Rachael Ray Nutrish. Its second-largest category is coffee (33% across channels) with the number-two brand Folgers and number-six Dunkin’. Other large categories are peanut butter (10%), with number-one Jif, fruit spreads (5%) with number-one Smucker’s, and frozen hand-held foods (5%) with number-one Uncrustables.
(Source: MorningStar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.