There aren't many bargains in packaged foods these days, and it seems like all too many quarterly reports require a little explanation. That said, J.M. Smucker (NYSE:SJM) still looks like a worthwhile name that could offer investors some upside. Management still needs to improve how it utilizes its assets, but volume trends are looking OK and the stock's valuation looks like a relative bargain in the space.
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Fiscal Second Quarter Numbers Come in as Expected ... Sort Of
From just the reported numbers, it would seem that Smucker performed as expected in the second quarter. A closer look, however, shows some moving parts that may add uncertainty to the stock through the next quarter.
Revenue rose 8% as reported, with organic revenue growth of just 2%. Volumes declined about 2%, while price/mix improved 4% - largely on the introduction of K-cups. The U.S. retail coffee business saw 1% revenue growth on 6% volume growth, while the situation was reversed on the consumer foods segment. Revenue there rose 1% also, but volume dropped 6% on weakness in fruit spreads and tough comps in the Jif peanut butter business.
Margins were once again murky because of a host of charges and "special" items. Adjusted gross margin declined about 40 basis points. Operating income was up a reported 17%, while management's own adjustments pointed to operating income growth of 8%. It is possible, however, to adjust that down even further to about 3% growth, though segment profit was up in the mid/high single digits. All in all, Smucker basically met most analysts' profit expectations, as a lower gross margin was compensated for with lower operating expenses.
Send in the Clones
With the expiration of certain valuable patents, Green Mountain Coffee Roasters (Nasdaq:GMCR) has seen the expected land rush into its lucrative K-cup business. Wal-Mart (NYSE:WMT) and Smucker have both reported strong interest in these new entrants, with companies such as Starbucks (Nasdaq:SBUX) and TreeHouse (NYSE:THS) also looking to exploit the trend.
Keep in mind that Smucker is the largest retail coffee company in North America, with roughly one-third share of the market (close to triple the share of Kraft Foods (Nasdaq:KRFT), and more than double the combined share of Green Mountain and Starbucks (in the retail channel). What's more, with brands such as Folgers, Dunkin' Donuts and Bustelo, customer acceptance of K-cups should be a volume extension opportunity.
Are the Consumer Food Issues Fixable?
Smucker will definitely need to do something about that weak volume print in the U.S. consumer food business, as explanations about tough comps will only go so far. The company is intend to spend more on marketing in the fourth quarter, and it's a safe bet that analysts will closely track the trade-offs between marketing spend and volume performance.
Hopefully Smucker can smooth out whatever retailer-specific issue troubled the Crisco business. Likewise, the company will need to figure out how to balance volumes with price competition in the spreads business from other branded companies and store brands from companies such as Kroger (NYSE:KR), Costco (Nasdaq:COST) and Wal-Mart. On the positive side, there's not much in the Nielsen data to suggest that rivals like Unilever (NYSE:UL), Kraft or General Mills (NYSE:GIS) are really gaining significant share, though private label offerings remain a threat across the sector.
The Bottom Line
Smucker isn't a screaming bargain today, but it is a relative bargain in the food space. The company's inferior record with respect to returns on capital shouldn't be ignored, but Smucker is at least as compelling as General Mills, Kraft Foods, or Kellogg today, and perhaps has more volume growth potential if the company's K-cups really take off.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.