SJM - J. M. Smucker: Losing My Taste

Summary

• J. M. Smucker has seen shares enjoy a re-rating since the pandemic.
• Valuations appear more than fair, as structural (sales) growth is still hard to find.
• Amidst a market multiple and another cheap divestment, I am leaning a bit cautious here.

Towards the end of 2020, I concluded that J. M. Smucker ( SJM ) was showing more sales following the pandemic, but it was less impressed. The company was selling some assets at low sales multiples. While each individual deal was small and not a game changer, the cumulative impact of selling assets cheaply was significant and added up.

This observation and lack of growth made me a bit cautious, with shares hovering around the $115 mark at the time.

A Review

In the final quarter of 2020, Smucker announced two divestments: a $550 million divestment of Crisco to B&G Foods ( BGS ) and the sale of Natural Balance, a premium pet food business for just $50 million, equivalent to a fraction of its sales. These divestments were the result of the strategic decision to focus on pet food, coffee and snacking, involving the exit of the US baking category, albeit at lower prices with quite some earnings dilution incurred.

While these deals were relatively small in relation to a $17 billion enterprise valuation, the impact on the $7.8 billion revenue base was much higher at nearly half a billion for the two assets combined.

The core business generated $7.8 billion in sales in 2020 on which it posted EBITDA of $1.7 billion and reported operating earnings of $1.2 billion. Given the dilution incurred with the divestments, sales would fall by nearly half a billion. Net debt would fall to $4.1 billion, resulting in leverage ratios of around 2.4 times. With earnings power seen around $8 per share, valuations were very reasonable at 14 times earnings. The issue is that Smucker has been buying assets on the high in order to boost its growth profile, with little growth to show for it, while selling assets on the cheap as well, providing few reasons for me to get involved.

Doing Well

Since the end of 2020, shares have traded range bound between $120 and $160 per share, now trading hands at $149 per share.

Forwarding to the summer of 2022, Smucker posted its fiscal 2022 results with revenues being dead flat compared to 2021 at $8.0 billion, up actually a bit from the pro forma results posted in 2020. The company saw operating profits fall from $1.39 billion in 2021 to $1.02 billion amidst amortization charges and inflationary trends.

The company posted GAAP earnings of $5.84 per share, down nearly two dollars from the year before on the back of the trends discussed above. Adjusted for amortization charges, adjusted earnings per share were down 3 percent to $8.88 per share, as a modest reduction in the share count to 108 million shares limited the fall in earnings per share.

Net debt was reported at $4.3 billion, a substantial amount as adjusted EBITDA for the year fell to $1.6 billion, resulting in a leverage ratio of 2.7 times. So, if we look at the current stock price of around $149 per share, it really has been a re-rating from about 14 to 17 times adjusted earnings which drove the share price gains as the underlying results were quite flattish since 2020.

The company guided for fiscal 2023 sales to rise by 4% at the midpoint of the guidance, with adjusted earnings seen between $7.85 and $8.25 per share, including a $0.90 per share impact from the recall of certain Jif peanut butter products. Despite the softer outlook, the company hiked the quarterly dividend by three pennies to $1.02 per share, needed in order to continue to provide a compelling yield in a rising interest rate environment.

First quarter results brought few reasons to become optimistic with reported sales up just a percent, yet adjusted earnings per share were down 12% to $1.67 per share. Despite a softer start to the year, due to the Jif recall (in part), the company upped the full year guidance, now seeing sales up by 4.5% by the midpoint of the guidance, with the midpoint of the earnings per share guidance hiked to $8.40 per share.

In November, second quarter sales rose 8% as adjusted earnings per share were flattish at $2.40 per share, as the company hiked the guidance further. Full year sales are now seen up 6%, with the midpoint of the adjusted earnings per share guidance being hiked to $8.55 per share. Net debt has risen to $4.6 billion yet adjusted EBITDA has fallen to a run rate of $1.4 billion, for a leverage ratio equal to 3.3 times.

The 107 million shares now represent a $16.0 billion equity valuation at $149 per share, for an enterprise value of $20.6 billion here. This is equal to about 2.5 times sales, 14 times EBITDA, and 17 times adjusted earnings.

2023 - Starting With A Sale

In February of this year, Smucker announced that it has reached a deal with Post Holdings ( POST ) to sell several pet food brands in a deal valued at $1.2 billion. Deal terms call for a $700 million cash payment to Smucker and a reception of nearly 5.4 million shares of Post Holdings.

The $1.2 billion deal looks a bit soft as the range of activities combined generates some $1.5 billion in sales, revealing a 0.8 times sales multiple was fetched, a huge discount to Smucker's own valuation. Smucker expects a $0.45 per share dilutive impact, which is equal to about $50 million, indicating that these are low-margin activities. The dilution is ahead of standard corporate cost allocation, yet ahead of the deployment of the proceeds as well, which at treasury yields should offset this.

So Smucker will likely see no earnings per share dilution from the deal, yet the business will shrink from let's say $8.4 billion to $7.0 billion, as net leverage would come down to $3.4 billion (assuming that the Post shares are counted as cash equivalents). The question is how much EBITDA will fall. Believes it might come down to $1.3 billion, leverage ratios would come down to 2.6 times, after coming in above 3 times now. Investors have no strong feeling about this, as shares have hardly moved in reaction to the news announcement, with investors buying the improved positioning and reduction in the share base over absolute sales growth.

Too High

Truth is that I am quite cautious on this deal as again as a large divestment takes place at a modest valuation multiple, making me a bit cautious as valuations have been re-rated a bit over the past couple of years.

All this makes me very cautious as the re-rating has taken place already while I am not that impressed with the operating performance, making it very easy to stay on the sideline here.

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