I liked J.M. Smucker (NYSE:SJM) on a relative basis back in November, and the stock hasn't disappointed since – trading up about 20% and slightly outperforming peers like General Mills (NYSE:GIS), Kellogg (NYSE:K), and Kraft (Nasdaq:KRFT) in the packaged food space. I still like Smucker as a company – management is happy to run a business of relatively small, focused, market-leading brands, and run them pretty profitably. While guidance of a year-on-year decline in free cash flow (FCF) and stagnant sales may have disappointed the Street, this still remains a relatively interesting name in the food space.

SEE: Analyze Cash Flow The Easy Way

Some Good, Some Bad In Fiscal Fourth Quarter Numbers
Although Smucker posted a strong bottom-line beat, the weaker top-line performance and soft guidance seem to be siphoning off the Street's enthusiasm for the results.

Revenue fell a little more than 1% for the quarter, leading to a roughly half-point miss relative to the Street estimate for growth this quarter. Smucker continues to post positive volume (up 2%), but price/mix (down 3%) is cutting the other way. Retail coffee saw a 1% revenue decline on 6% volume growth, while consumer foods (which includes Jif peanut butter, fruit spreads, Crisco, and so on) grew 5% on a 4% volume improvement.

Margins were quite strong this quarter, supplying about half of the reported EPS beat. Adjusted gross margin improved 240bp from the year-ago level, while adjusted operating income grew 3% despite a 17% increase in marketing spending. At nearly 17%, Smucker's operating margin is very competitive within the packaged food sector. By segment, coffee earnings rose 18% while consumer earnings declined 2%.

SEE: How To Decode A Company’s Earnings Reports

Sluggish Sales Going Nowhere Fast
Not only did Smucker miss the consensus guess for the quarter on sales, but this was the first time in a while for the company to come in below where Nielsen data suggested. I wouldn't make all that much of it, but it does suggest that business has softened despite ongoing spending on marketing and promotion. That said, the coffee business has gotten increasingly competitive lately, and Hormel's (NYSE:HRL) acquisition of Skippy could mean more competition in peanut butter.

I suspect that investors were also put off by the update on the company's K-cup business. K-cup revenue rose 18%, making a sharp decline from the 50% growth in the fiscal third quarter. While Smucker has about one-third of the U.S. coffee market (more than twice as much as Kraft, and a lot more than Green Mountain (Nasdaq:GMCR) or Starbucks (Nasdaq:SBUX), the comapny's share in K-cups is a more modest 20%. Given investor fears about stagnant (or negative) growth prospects for traditional roast and ground coffees, decelerating K-cup growth seems to be a cause for concern.

Spending To Support The Business, But What About M&A?
With the company increasing its capital expenditures over the next few years to support growth in the coffee, peanut butter, and spreads businesses (two-thirds of the company's revenue base), free cash flow generation will ease off a bit. Likewise, I'm sure investors worry about margins given the company's higher cost basis in peanuts (due to locking in supply at higher prices) and commitment to support ongoing marketing.

I'm more interested in whether or not the company will pursue more M&A. Smucker management has commented in the past that they believe there's still more “shaking out” to occur in the packaged food space as companies digest large deals (like ConAgra (NYSE:CAG) and Ralcorp) and companies with non-strategic assets in food (like Unilever (NYSE:UL)) look to monetize them.

I would expect management to be on the hunt for businesses with less than $1 billion in sales, but strong market share and store shelf presence. Businesses like Clorox's (NYSE:CLX) Hidden Valley salad dressings or PepsiCo's (NYSE:PEP) Aunt Jemima syrups come immediately to mind, as well as other products like sauces (Sweet Baby Ray's in the BBQ category). With a debt to equity ratio of about 40%, I think Smucker could add some assets without too much financial stress.

SEE: Evaluating A Company’s Management

The Bottom Line
I'm looking for Smucker to grow revenue at a long-term rate of about 4% (excluding M&A), with free cash flow (FCF) growth of about 5%. That works out to a price target in the mid-$90s; not particularly compelling, but not bad in a generally over-heated and over-priced packaged foods sector. While I do like the Smucker business and the stock is relatively attractive, I'm a little concerned about the possibility of a bigger swing away from consumer staples – though this is supposed to be one of the sectors that does better in a higher rate/slower growth environment, the big move over the past year could have institutions looking to cash in profits and could make it hard for any of these stocks to continue the hot run of the past year.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Personal Finance

    Most Affordable Cups of Coffee

    With coffee playing an important role in social norms, this article looks at the most and least affordable cups of coffee available.
  2. Fundamental Analysis

    An Evaluation Of Emerging Markets

    Get the full story on this asset class before you write it off as too risky.
  3. Personal Finance

    An Introduction To Capital Budgeting

    We look at three widely used valuation methods and figure out how companies justify spending.
  4. Markets

    How To Choose The Best Stock Valuation Method

    Don't be overwhelmed by the many valuation techniques out there - knowing a few characteristics about a company will help you pick the best one.
  5. Bonds & Fixed Income

    The Real Cost Of Drinking Coffee

    How much is your morning jolt hurting your wallet? More than half of Americans drink coffee every day, and the costs add up.
  6. Bonds & Fixed Income

    Equity Valuation In Good Times And Bad

    Learn how to filter out the noise of the market place in order to find a solid way of determing a company's value.
  7. Markets

    Investment Valuation Ratios

    Learn about per share data, price/book value ratio, price/cash flow ratio, price/earnings ratio, price/sales ratio, dividend yield and the enterprise multiple.
  8. Stock Analysis

    How Toyota Succeeds at Home and Abroad (TM)

    Japan's biggest car manufacturer is also one of North America's biggest, delighting shareholders with its high profit margins.
  9. Budgeting

    Trunk Club Review: Is It Worth It?

    Take a close look at one of the best-known online clothing services in the country, and determine whether it's a good fit for your style and budget.
  10. Budgeting

    HelloFresh Review: Is It Worth It?

    Discover one of the world's most successful meal subscription services, and learn more about how the service operates and what it costs.
  1. What is the difference between a capital good and a consumer good?

    Capital goods and consumer goods are classified based on how they are used. A capital good is any good deployed to help increase ... Read Full Answer >>
  2. How does a cost-of-living adjustment (COLA) affect my salary?

    Some companies build salary adjustments into their compensation structures to offset the effects of inflation on their employees. ... Read Full Answer >>
  3. Where can you buy NetSpend reload packs?

    You can only purchase NetSpend reload packs at Giant Eagle, Albertsons, Roundy's and Pathmark supermarkets. NetSpend cards ... Read Full Answer >>
  4. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  5. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  6. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
Trading Center