As I write this, I've just finished eating some Uncrustables. They're packaged peanut-butter-and-jelly sandwiches on crustless white bread: choice of grape jelly or strawberry jam. I had one of each. A new convenience for harried parents and school lunch programs, Uncrustables come frozen. Yet trust me when I say they tasted as good as fresh. At about $5.50 retail for a box of 10, will they make their inventor, J.M. Smucker, as profitable as, say, Microsoft? No. Nevertheless, Uncrustables show that innovation can flourish even in the homeliest things.
They also are just one sign of new vigor at Smucker (SJM). The 105-year-old jelly-and-jam maker aims soon to close its purchase of Procter & Gamble's (PG) Jif peanut butter and Crisco shortening brands. Valued at $731 million in Smucker stock, the deal is small potatoes on Wall Street: Only two analysts bothered to pose questions during a Feb. 14 conference call. But at Smucker's headquarters on Strawberry Lane in Orrville, Ohio, "it's transformative," Co-CEO Richard Smucker told me. "Employees are really energized." Co-CEO (and brother) Timothy Smucker said: "We are doubling our sales and tripling our profits" (table).
Even a merger that seems to make as much sense as this one isn't without risk. "Anytime a company makes a sizable acquisition, that should always be cause for concern," notes John Miller, an analyst at Ariel Capital Management, which owns nearly 10% of Smucker. Yet I think Miller is right to expect further gains for Smucker, which he estimates would command a price 30% above its recent stock-market price of $33.61 were it to be bought by another food company. At a time when investors are squinting to see true value in the likes of Tyco International (TYC), the value of Smucker's simple businesses are easily understood.
Started by the current CEOs' great-grandfather as a cider mill and apple-butter maker, Smucker today sees its sales and earnings rise consistently each year, as it leads the U.S. market in jelly, jam, and preserves. It also sells ice cream toppings and health drinks, as well as peanut butter under an assortment of brand names. But since the mid-1970s, Smucker has had its eye on P&G's Jif, the peanut butter category's leader.
Besides doubling Smucker's revenues, to an estimated $1.3 billion in fiscal 2003, adding Jif and Crisco, which also leads its market with a 24% share, offers some side benefits. Not big enough to field its own sales team, Smucker sells through brokers, who will have to pay more attention to its distribution needs. Also, the company recently finished a three-year, $35 million overhaul of its inventory and customer-service computer systems. Spreading those costs over more volume should widen profit margins. And with the capital project already done, cash flow should surge. Smucker expects free cash flow, after capital spending and dividends, to reach $60 million to $70 million in fiscal 2003, up from $20 million to $25 million this year.
Smucker plans to pay for Jif and Crisco by issuing stock to P&G shareholders, roughly doubling its shares outstanding. That means two things. First, Smucker won't be adding to its $135 million in long-term debt. When the new stock is issued, debt will be only a modest 13% or so of equity. Paying in stock also means the interests of current Smucker shareholders will be diluted. Yet if Smucker's profit and cash flow grow as executives expect, per-share rewards will be sharply higher: net earnings of $2 a share in fiscal 2003, vs. the $1.35 forecast this year; free cash flow of more than $1.30 a share, vs. less than $1; and dividends that I estimate will jump to about 90 cents a share, from 64 cents now.
What could go wrong? Besides the hazards of folding Jif and Crisco, now part of giant P&G, into little Smucker, many P&G shareholders can be expected to dump their new shares in Smucker. P&G is heavily owned by institutional investors, including many index funds. All of them will have to unload Smucker since, unlike P&G, it's not in the Standard & Poor's 500-stock index. Other institutions will sell because Smucker is too small for their tastes. All that selling may pressure the stock in the near term, creating a good opportunity for long-term investors to buy--whether they're PB&J lovers or not. By Robert Barker