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J. M. Smucker Company (SJM)

Founded by Jerome Monroe Smucker in 1897, Smucker's (SJM) has grown into a leading purveyor of various consumer food products and specialty pet foods that can be found in an estimated 93% of U.S. households. 

The company's main products are coffee, pet food, pet snacks, peanut butter, fruit spreads, shortening and oils, baking mixes and ready-to-spread frostings, frozen sandwiches, flour and baking ingredients, juices and beverages, and portion control products. Some of Smucker's iconic brands include:
Source: Smuckers Annual Report
Smucker’s obtains more than 90% of its sales in the U.S. and has four main business segments that generate over $7 billion in annual revenue:
Source: Smuckers Investor Presentation

Business Analysis

Smucker’s has done an admirable job of achieving some of the packaged food industry’s best overall growth in the past few years, compounding its sales at a mid-single digit annual rate while growing free cash flow per share by more than 10% annually.

The company's profitable growth has come from a combination of factors, including maintaining leading market share in its core brands. For example, Smucker’s owns the #1 or #2 brands in segments that make up 75% of its total revenue.

Smucker’s is especially strong in mainstream coffee, where Folgers (acquired for $3.8 billion in 2008) leads its nearest competitor by 30% in market share.
Source: Smuckers Investor Presentation
The economies of scale that Smucker’s is able to generate (from low-cost supplies and efficient distributions and logistics), combined with a long-term $250 million cost savings program, has helped the company obtain above-average profitability while continuously investing in branding and new product development to keep its portfolio relevant.

Smucker's has been consistent with its efforts to adapt to changing consumer preferences. For example, the U.S. coffee market is becoming increasingly dominated by single serve K-cups, which have impacted the company’s coffee volume growth (one reason the stock performed so poorly last year).
Source: Smuckers Investor Presentation
To adapt, Smucker’s has made strategic acquisitions such as its $360 million purchase of Hispanic coffee brands Cafe Pilon and Cafe Bustelo in 2010. The Bustelo acquisition in particular has been a big success, with sales growing 12% a year since 2012.

In addition, Smucker’s has been successfully introducing new product categories under its strong brands, which give it an edge on center store shelf space (which is notoriously difficult to obtain). This includes the Uncrustables line of snack products, which has seen 17% annual sales growth over the past 15 years and 12% over the past five years.
Source: Smuckers Investor Presentation
Smucker’s believes that it can more than double uncrustable sales in the coming half decade, which is why it’s building a new dedicated factory in Longmont Colorado, scheduled to come online in 2020.

This new factory is just part of a larger and more aggressive investment plan, which is boosting the company’s capital expenditures thanks to new categories such as nut butter offerings, snack bars, and plant-based protein products (currently highly in demand).
Source: Smuckers Investor Presentation
Despite the company’s increased capital spending (about 4.4% of sales), Smucker’s is still generating large amounts of free cash flow which is going to paying its dividend, investing in the business (new products and strategic acquisitions), and paying down debt taken on in previous acquisitions.
Source: Smuckers Investor Presentation
Acquisitions have been the largest source of Smucker’s growth historically, with the company having done around two dozen deals since 1963.

Most of these have been highly successful, including the 2008 Folgers deal, which boosted sales by 50%, and the recent Big Heart Pet Brands purchase for a whopping $5.8 billion in 2015, which allowed Smucker's to enter the large and fast-growing premium pet food and pet snack market.

This strategic shift demonstrates Smucker’s long-term efforts to adapt its business as pets appear to be a booming industry due to two large trends in America. Specifically, aging boomers are looking for increased companionship as their children leave the home. Meanwhile, Millennials, due to a slower career start thanks to the Great Recession (and record amounts of student loan debt), are waiting to start families, and pets are increasingly popular stand-ins for children.

Furthermore, Millennials are increasingly focused on health and natural food products, showing a greater propensity for paying a premium for healthier pet foods. As a result, brand loyalty in the pet food market has shown to be fairly high. For example, private label (store brands) pet food commands 12% of the market, compared to 20% market share in human foods.

By acquiring Big Heart, Smucker’s achieved instant market leadership since Milk Bone is the dominant market leader in pet snacks, which is a very high-margin business (people are willing to pay a lot to keep their pets happy).
Source: Smuckers Investor Presentation
Smucker’s pet food R&D facility in Orrville, Ohio, is constantly working on new product offerings it can launch to further capitalize on the pet food and snacks industry, including launching new premium biscuits and low calorie pet snacks.

The bottom line is that Smucker’s has shown itself to be a thoughtful acquirer and grower of strong consumer brands over the past 120 years, and more importantly for income investors, it’s also been very generous with its dividend growth as well.

That being said, as with all packaged food companies, there are several key risks to keep in mind.

Key Risks

There are three main risks for almost any food company.

The first risk is an increasingly fast pace of change in consumer preferences as spending power gradually shifts from older Gen X and baby boomers to Millennials. Specifically, this means that many food companies are struggling with consumers’ increasing preference for fresh foods over packaged offerings.

This is making the center of the store (where Smucker’s dominates) highly competitive. Constant innovation and new product launches are required to compete for market share in several market segments that are in decline, such as baked goods and certain oils.

In fairness to Smucker’s, evolving consumer tastes and preferences isn’t a new risk to the industry, and the company has proven itself adept at responding to a rapidly evolving consumer market over its 120-year history.

However, this brings up another major risk, which is that the way most mature food companies grow is through acquisitions, a strategy that brings several challenges.

The first is the potential to overpay, especially to gain entrance into faster-growing markets, such as pet food.

In fact, in 2015 Smucker’s got into a bidding war with Church & Dwight (CHD) over Big Heart, the maker of Meow Mix and Milk Bone. Smucker’s ultimately bought Big Heart for $5.8 billion (including debt assumption) in a deal that included 17.9 million shares of Smucker's and $1.3 billion in cash, most of which was borrowed.

While the deal made some strategic sense in that it diversified Smucker’s into a fast-growing and premium market, paying 13 times EBITDA is highly questionable, even assuming management can obtain all $200 million in synergistic cost savings (far from guaranteed), which would lower the multiple to 9.0.

In addition, Smucker’s most recent acquisition, a $285 million deal for Wesson Oil, is potentially questionable as well. Wesson Oil is meant to shore up Smucker’s Crisco oil segment; however, the entire oil market is facing declining sales due to an increased consumer focus on healthier foods.

The deal is expected to boost sales by $230 million a year (about 3%) and increase adjusted EPS by $0.10 after the first year (about 1.3%), meaning that it’s far from a needle-mover and one that might ultimately prove unwise given the shrinking oil market.

In other words, food companies, while defensive, also face real challenges in maintaining and growing market share in their low-growth product categories over time, which is why often the only way to achieve the kind of earnings (and dividend) growth investors expect requires acquisitions that can ultimately hurt shareholders.

A final risk faced by Smucker's is commodity prices, especially in volatile goods such as coffee. A major component of packaged food earnings growth is cost cutting, but rising commodity prices can easily offset several years of hard earned cost savings over the short-term.

Closing Thoughts on Smucker's

While the packaged foods industry is extremely competitive and fraught with numerous needs to adapt to rapidly-changing consumer tastes, Smucker’s has proven itself more than up to the task to stay relevant over the past 120 years.

With an impressive 20-year track record of annual dividend increases and a very safe payout, Smucker's could be an idea for long-term dividend growth investors to consider. However, investors need to be comfortable with the industry's overall risk profile and management’s ability to conservatively allocate capital and improve profitability going forward, especially following the Big Heart Pet Brands acquisition.

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