SJM - J. M. Smucker: Stable Prospects

2023-07-26 00:44:18 ET

Summary

• Smucker's is focusing on higher-margin pet snacks and coffee products to support stable financial performance long term.
• Revenue growth and margin expansion prospects are centered around three pillars: Uncrustables, Milk-Bone, and Dunkin' Coffee.
• Risks include changing trends as well as competitive risks in the coffee market from Nestle.

J. M. Smucker ( SJM ) portfolio transformation towards products with higher-margins, and better growth prospects could support stable financial performance long term. Valuation appears fair.

U.S. Pet Foods segment to benefit from growing pet snacks

Smucker’s U.S. Retail Pet Foods segment generated $3 billion for the company in FY2023, its biggest segment by revenue, but after accounting for the divestment of several pet food brands which were sold in February 2023 (which collectively generated $1.5 billion of net sales in FY2023), the segment’s revenues are likely to shrink to roughly around $2 billion next year.

The company has been optimizing its pet food portfolio to focus on higher-margin pet snacks; several pet food brands were sold to Post Holdings in February year, following a slew of pet-related divestitures since 2021 (Smucker’s Natural Balance premium pet food brand as well as private label dry dog food business were disposed). Following the divestment, Smucker’s will focus on pet treats (through brands Milk-Bone and Pup-Peroni which combined give Smucker’s a market leading 23% share in dog treats) as well as cat food (through Meow Mix which is the number 1 brand in dry cat food according to the company).

Prospects are cautiously optimistic for Smucker’s dog treats brands. America's $3 billion dog treats industry has a steady usage rate of more than 70% and current humanization and premiumization trends in the pet food industry could drive market growth in pet snacks. Management is aiming to turn Milk-Bone into a $1 billion business and towards this end is ramping up investments in marketing , packaging and premium product innovation.

Meanwhile Meow Mix prospects are also cautiously optimistic. Wet cat food (which currently has a usage rate of around 59% versus over 90% for dry cat food) is increasingly gaining favor over dry cat food, a potentially negative trend for Meow Mix however management is aiming to leverage Meow Mix’s leading position in dry cat food to expand into wet cat food. Although there may be some revenue cannibalization, given that wet food tends to be more costly than dry food, potential for revenue growth is still possible.

Dunkin’ to support growth of U.S. Retail Coffee segment

Smucker’s U.S. retail coffee business comprises Smucker’s coffee brands Folgers, Dunkin’ and Cafe Bustelo which are among America’s top 8 coffee brands giving Smucker’s its market leading 26% market share of America’s coffee market. The segment currently generates around $2.7 billion for the company and has a segment margin of 27%, making it Smucker’s highest margin business.

Looking ahead, prospects look generally stable. Folgers, the segment’s biggest revenue generator as a billion dollar business, could grow marginally, likely lagging overall growth projections for America’s coffee market (forecast at low single digits over the coming years) as the brand has been losing market share to specialty coffee brands which have been growing in popularity among younger coffee drinkers, a demographic Folgers has so far struggled to gain meaningful traction despite sustained efforts from cracking into the higher end coffee segment with products like Folgers 1805 and Folgers Black Silk to new advertising campaigns to reshape their brand image.

Prospects for Dunkin’ are more positive. The brand isn’t plagued with the reputational struggles Folgers has (Folgers is often perceived as a “grandma’s coffee” brand), and although Dunkin’ doesn't have as strong a grip as Starbucks on millennial and Gen Z coffee drinkers, they nevertheless have a steady market position among younger coffee drinkers as a low-cost alternative to Starbucks.

Management is aiming to turn Dunkin’ into a billion dollar business within the next four years . Towards this end, the company is investing in specialty coffee innovations (for instance with the launch of a cold brew line). Dunkin’ is a $300+ million business currently and would need double digit YoY growth rates (exceeding 20%) to achieve management's $1 billion target over four years. This looks ambitious considering North America’s specialty coffee market is projected to see growth rates of around 20% annually over the coming years and suggests Dunkin’ would have to outgrow rivals and take share. Nevertheless, Dunkin’ could enjoy good growth which could support decent segment performance over the coming years assuming minimal market share erosion for Folgers and stable market share for Cafe Bustelo (the number one Latin coffee brand in the U.S.).

U.S. Retail Consumer Foods leaning on Uncrustables for growth

Smucker’s U.S. Retail Consumer Foods business is the smallest U.S.-based business with revenues of $1.6 billion. The segment largely comprises products such as Smucker’s and Jif branded jam and peanut butter, as well as Uncrustables-branded frozen sandwiches.

With Jif being the number one peanut butter brand in the U.S. and Smucker’s jams being the number one jam brand of Jam in the U.S., these two products are the segment’s biggest revenue generators, estimated at around $1 billion in revenues annually (largely from Smucker’s market share of more than 40% of America’s $2 billion peanut butter market).

These two products, however, are unlikely to see meaningful growth in the foreseeable future. North America’s peanut butter and market is expected to grow in the low single digits, similar to jams and jellies . Management is leaning on Uncrustables to drive growth, building on its recent growth momentum driven by a current trend of consumers returning to childhood snacks. Smucker has ambitions to turn it into a $1 billion brand partly helped by innovations (Uncrustables Meat and Cheese Bites was launched recently and low sugar versions will return to distribution soon), increased marketing investments, and expansion into new territories like Canada. New entrants are entering the fray to capitalize on the trend, from Chubby Snacks to Gallant Tiger to name a few however Uncrustables has a few advantages to remain in the lead including scale and reach (Uncrustables has an 85% household penetration), as well as certain patents and technological hurdles (such as around bread technology).

Uncrustables currently generates $500 million currently, and a conservative low single digit growth rate would take at least a decade to reach management’s $1 billion target. Along with low single digit growth for the segment’s biggest business i.e., peanut butter and jams, overall segment growth could be decent, albeit unexciting, over the coming years.

Risks

Wet cat food expansion efforts may fail to gain traction, potentially resulting in falling performance if wet cat food eats into dry cat food sales

Apart from execution risks associated with Smucker’s efforts to expand into the fast-growing wet cat food market, competitive risks are significant as well notably from Nestle (who together with its collection of various cat food brands commands a market leading position across both wet and dry cat foods in the U.S.) as well as rivals like Mars who is also aggressively expanding into wet cat food in the U.S. and worldwide. Scale and branding advantages may give Nestle an edge over Smucker.

Uncrustables trend could be short-lived

Uncrustables isn’t a novel product, and they are ultra processed, and expensive . The trend could be short-lived.

Swiss coffee giant Nestle is making inroads into the U.S.

Nestle ( OTCPK:NSRGY ) is a formidable player in the global coffee space commanding market shares of 25% in Europe, 25% in Latin America, more than 50% in Greater China, and 18% in the rest of the world. Its share of just 15% in North America is the smallest among all major geographic regions but the company is looking to change that and could be a potential threat to J.M. Smucker.

Like SJM, Nestle’s coffee portfolio spans premium brands as well as affordable ones, starting with Nescafe at the affordable end all the way to Blue Bottle at the super premium end with Starbucks, Nescafe Gold and Seattle’s Best Coffee (the latter of which was acquired from Starbucks late last year as part of a strategy to increase its North American presence) falling in between. Unlike Folgers which has a branding problem among younger consumers, Nestle’s affordable coffee brand Nescafe arguably doesn’t suffer the same problem and could stand a better chance at becoming the value brand of choice for Gen Z, whose coffee consumption as of now is largely centered around social-media-worthy, status symbol coffee beverages rather than daily pick-me-ups. Older generations such as Baby Boomers and the Silent Generation, Folgers’ core market, remain as more significant coffee drinkers overall but this may change as Gen Zs enter the workforce and develop a daily coffee habit, an opportunity Nestle may be better positioned to capture. Moreover, scale advantages driven by Nestle’s global presence (in contrast to Smucker who is largely U.S. based), could give coffee sourcing and cost advantages to Nestle, potentially enabling the company to offer a better value proposition in the value coffee segment.

Conclusion

Analysts are mostly neutral on the stock.

From a P/E standpoint, SJM’s forward P/E of 16 , is lower than peers like Nestle (forward P/E 20 ) and on a price-to-FCF basis (market value divided by TTM free cash flow), SJM’s multiple of 22x is considerably lower than Nestle’s 43x. However, Nestle’s premium may be justified considering better profitability metrics as well as arguably better growth prospects due to its wider geographic presence and exposure to fast growing emerging markets.

Assuming good execution, SJM management’s efforts to build Uncrustables, Dunkin’, and Milk-Bone into $1 billion businesses could support meaningful albeit unexciting revenue growth and margin expansion could support cash flow generation as well. Taking their free cash flow of $717 million as at FY2023 and conservatively assuming a low single digit growth rate over the coming years (2%) and a discount rate in the mid-single digits ( 7% ), brings a value of around $14 billion, roughly on par with the company’s current market value of $15.6 billion. The stock could be viewed as a hold.

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