History Suggests Street Will Get Over “Disappointing” Smucker Results

By Stephen D. Simpson, CFA | August 21, 2013 AAA

I don't want to spend too much time defending Smucker's (NYSE:SJM) fiscal first quarter results, as I thought they were fine. Still, the Street is likely to be concerned about the pace of growth in K-Cups and the question of whether the company can maintain its significant share in the retail coffee business against the likes of Kraft (Nasdaq:KRFT), Green Mountain (Nasdaq:GMCR), and Starbucks (Nasdaq:SBUX). To the extent that history is any indication, I expect Smucker shares will be fine, though the valuation has gotten a bit steep in a still-expensive packaged food sector.

Fiscal First Quarter Sales Come In A Bit Light
It's hard to get worked up about Smucker's revenue performance when revenue declined 1% and missed the average estimate by all of $7 million (or 0.5%). Overall volume was up 1%, with price/mix taking away 2%. Consumer foods revenue rose 1% on a 4% increase in volume, while retail coffee declined 1% on a similar increase in volume (the “International, Foodservice and Natural Foods” segment was down 6%, largely on weak volume).

On the margin side, Smucker posted an adjusted gross margin that was not only two points higher than the year-ago level, but roughly a quarter-point better than analysts expected. Likewise, operating income was up 1% and slightly better than expected, with margin up about 40bp and a similar quarter-point ahead of the Street.

K-Cups Kooling?
Wall Street seems to be quite fixated on the health/strength of Smucker's K-Cup coffee operations, and I can understand this to a point. Coffee is a very large percentage of Smucker's business and the company's roughly one-third market share is one of the few “fortress” businesses in packaged foods.

To that end, K-Cup sales growth of 14% was weaker than both the published estimates and the performance suggested by Nielsen data. It also represents further deceleration in growth (up 18% in the last quarter) and perhaps puts the company's full-year target of 15% growth into some doubt. Maybe I'm holding too much faith in Smucker management, but I'm just not feeling that worried yet. Yes, K-Cups are an important category in the coffee market, but I have a feeling that growth across the category is going to be slowing more than many analysts currently expect.

It Was About Time For Some M&A
When I last wrote on Smucker (in early June), I commented that it seemed like it was about time for the company to do another M&A deal. Not only has Smucker established something of a pattern of doing a deal every two years or so (and the two-year anniversary of the Sara Lee deal is approaching), but there are plenty of interesting targets out there, as seen with the recent deal between Performance Foods (NYSE:PF) and Unilever (NYSE:UL).

Smucker announced that it is acquiring Enray, a private company that manufactures various organic grain-based products (pasta, cookies, and so on) under the truRoots brand. This is a small deal (Enray did about $45 million in revenue last year), and it's also a little unusual in that truRoots isn't really a market leader. That's not to say that Smucker won't be able to do good things with the brand and/or acquire other natural/organic food businesses to complement it, but it's not a needle-mover at present.

The Bottom Line
Smucker is a conservatively-run food company that not only invests the resources to support and develops its brands, but gives an uncommon amount of disclosure and clarity about its activities. I like that. I also like the company's intention to introduce potentially 50% more new products this year (around 100) than last year.

What I don't like as much is Smucker's valuation. I still like the business, but the market's love for the stock has outpaced the company's own improvements such that it now looks like one of the pricier names in the space. I'd prefer to own Nestle (Nasdaq:NSRGY) today given the relative valuations, but there's nothing actually wrong with Smucker from an operating perspective.

Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.

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