J.M. Smucker Stock: Still Looks Appetizing (NYSE:SJM)

These are interesting times for consumer staples companies, as high prices have been hitting consumers hard and leading to trading-down (or reducing consumption), but the alternative of just absorbing the hit to margins is hardly better. J.M. Smucker (NYSE:SJM) (“Smucker”) has navigated this better than many, leading to above-average performance over the last year relative to other packaged foods companies, but sticking the landing and ratcheting back pricing when (hopefully “when” and not “if”) cost inflation subsides will be an important test for management, as will capital allocation in the coming years.

Valuation is often tricky with stocks with Smucker, especially in periods of weak market sentiment, as investors will often bid them up on the expectation of their acyclicality and more durable earnings. Up close to 20% over the past year, I can still see upside into the high-$150s for Smucker, but I’d rather wait for a sale before making a large commitment to the shares.

Inelasticity Is Preserving Volumes

There’s been a lot of chatter (at least among analysts) as to whether Smucker’s volumes could withstand ongoing pricing actions in the low-to-mid-teens (management guided to 15% pricing in this current quarter). Looking at Nielsen data, the answer seems to be “yes”, as much of the business is proving to be less elastic than feared.

From the most recent Nielsen scanner data I could find (early October), Smucker sales were up over 16% on a 3% decline in volume, ahead of the 14% sector-wide average, and with acceleration in coffee, peanut butter, and dog food. Looking at the price and volume action over the past year, Smucker screens as more inelastic (meaning that higher prices lead to proportionately smaller declines in volume) than Kraft Heinz (KHC), Kellogg (K), or Campbell (CPB), and significantly more inelastic than ConAgra (CAG) or McCormick (MKC).

There are a lot of factors that play into this. Strong brands/brand value help, and Smucker has strong share in coffee (with brands like Folgers, Dunkin’ and Café Bustelo), peanut butter (the Jif brand has almost 45% share of peanut butter), fruit spreads (the Smuckers brand), and niche categories like frozen sandwiches (Uncrustables), as well as respectable share in areas like pet food (Meow Mix and Milk-Bone). Still, only about half of Smucker’s revenue comes from products where they have #1 or #2 market share (a lot less than Mondelez (MDLZ), Tyson (TSN), Kellogg, ConAgra, or McCormick).

Still, the nature of the products probably helps more than the statistics might otherwise explain. Coffee-drinkers tend to be loyal to their brands, likewise with pet food and peanut butter. It also helps that Smucker faces relatively less private label competition in many of its businesses than its rivals – while private label is about 22% of the industry overall, it’s less than 20% in coffee, peanut butter, pet food, and niches like Uncrustables.

Navigating Price And Cost

Smucker hasn’t been shy about taking pricing actions, but the company has still taken a hit to margins from input cost inflation – EBITDA margins are still a few points off the 22% pre-pandemic level, and this last quarter saw gross margin still down a few tenths of a point year over year (adjusted for the Jif recall).

Management has said recently that pricing inflation has stabilized, and based on what a host of companies are reporting in this current earnings cycle, that seems to be the consensus view. How quickly gross margin rebounds remains to be seen, though, as I think it will be tempting for companies to compete on price. With that, I think it could be some time before high-30%s gross margins come back into play, although this would be an invaluable source of upside if margin rebounds faster than I expect.

Is M&A On The Way?

Smucker is in good shape with respect to balance sheet liquidity, and with the company liking to start generating around $1B/year in free cash flow, what to do with that capital will become a more pressing question for management.

A decade ago, Smucker was an acquisitive company with a significant deal about every two years. More recently (since around 2018), the company has gone the other way and sold off several businesses, largely businesses where there was less brand value and/or more competition from private label.

I think Smucker wants to do deals, but smaller than what the company used to do (at least on a relative basis) and more tuck-in/add-on than moves into new spaces. Acquiring additional coffee brands would be an option, as would additional brands in the pet food space. Freshpet (FRPT) is rumored to have hired bankers to feel out a potential sale, and Smucker could be a logical acquirer. There would be some meaningful upfront dilution, but if Smucker could lend more operational scale to Freshpet and boost margins, expansion into the premium pet food space could make sense (where General Mills (GIS) has done well with Blue Buffalo).

The Outlook

My modeling assumptions work out to around 3.5% revenue growth over the next five years and around 3% to 3.5% over the next decade. I expect EBITDA margins to get back to the 21%-22% range over the next two or three years, and I model a slow climb toward a mid-teens FCF margin (versus a trailing average around 12%), driving high-single-digit FCF growth.

My discounted cash flow valuation suggests a prospective annualized return in the mid-to-high single-digits (whatever you would call “7%”), which is lower than I’m usually willing to accept, but isn’t so bad for a company like Smucker. Margin/return-based EV/EBITDA leads me to conclude that a 12x forward EBTIDA multiple is fair, supporting a fair value in the high-$150s. I’d note that my margin, return (ROIC, et al), and EBITDA assumptions are a little above the sell-side average now, and I’m more bullish on Smucker’s ability to generate good price/volume trade-offs.

The Bottom Line

Smucker’s valuation looks to me like a “good but not great” scenario, but sometimes that’s the best you can hope for in some sectors. There are cheaper stocks out there, but I like Smucker’s business and operating strategy now. A sale would make this a much easier recommendation, but with the Street still not especially positive on this name (in terms of Buy recommendations), it’s one to consider, as further rerating and beat-and-raise quarters could be on the way.