Markets & Finance

Smucker: An Appetizing Value


S&P thinks the stock is trading at an attractive discount to other packaged food outfits, and rates the shares a strong buy

From Standard & Poor's Equity ResearchWe believe the stock of packaged foods company J.M. Smucker (SJM: $51) is attractive for favorable 12-month total return. Although we see Smucker facing commodity cost pressures, we expect this can at least be partially offset by raising prices, reducing costs, and producing operating efficiencies. In our view, the stock is trading at an attractive discount to a group of packaged food stocks.

Based on our 12-month target price of $60, Smucker has prospective upside of 17% from recent levels. Factoring in the stock's recent dividend yield of 2.3% and the company's stock repurchase activity, we have a 5 STARS (strong buy) recommendation on the shares.

Company Profile

The company's food business dates back to 1897, when Jerome M. Smucker started pressing cider at a mill in Orville, Ohio. During the past 111 years, there have been five generations of family management, including brothers Richard and Timothy Smucker, who are currently co-CEOs of the company.

Principal product categories include peanut butter (21% of sales in fiscal 2007); shortening and oils (15%), fruit spreads (14%), flour and baking ingredients (11%), baking mixes and frostings (11%), portion control (5%), juices and beverages (5%), toppings and syrups (5%), Uncrustables frozen sandwiches (4%), pickles and condiments (3%), and other (6%).

The company has said its strategy is "to own and market leading North American icon brands sold in the center of the store." Its brands include Smucker's, Jif, Crisco, Pillsbury, Eagle Brand, R.W. Knudsen Family, Hungry Jack, White Lily, and Martha White in the U.S., and Robin Hood, Five Roses, Carnation, and Bick's in Canada.

In fiscal 2007, Smucker's international business accounted for 15% of net sales. Also, sales to Wal-Mart Stores (WMT) and its subsidiaries accounted for about 20% of fiscal 2007 net sales.

The company's U.S. retail market segment, which includes the consumer foods and oils businesses, accounted for 72% of sales and 81% of segment operating profits in fiscal 2007. The special markets segment, comprised of Smucker's food service, international, industrial, and beverage businesses, accounted for 28% of sales and 19% of segment operating profits.

Corporate Strategy: We see Smucker's growth strategy including acquisitions.

In fiscal 2008, the company acquired both the Canadian Carnation brand canned-milk products business, with annual sales of about $50 million, from Nestle Canada, and the privately owned Eagle Family Foods business, which was the largest producer of canned milk in North America. In the fiscal year ended July 1, 2006, Eagle had net sales of about $206 million. In May, 2007, Smucker completed the Eagle acquisition for $133 million in cash and the assumption of $115 million in debt. Terms of the Canadian Carnation acquisition were not disclosed.

In fiscal 2007, Smucker spent $60.5 million to purchase the Five Roses and White Lily brands, and received $84.1 million from the sale of its Canadian nonbranded, grain-based food service and industrial business.

In 2004, Smucker acquired International Multifoods in a transaction valued at about $840 million, including about $340 million of debt assumption. This brought the company such products as Pillsbury, Martha White, and Robin Hood baking mixes and Hungry Jack pancake mix. In 2002, Smucker acquired the Jif and Crisco businesses from Procter & Gamble (PG).

Divestitures since 2003 have included its Canadian grain-based food service and industrial businesses and its U.S. industrial ingredient business.

Meanwhile, in recent years, Smucker has been taking or planning various restructuring actions that we believe to be aimed at refining its portfolio of businesses, optimizing its production capacity, improving productivity and operating efficiencies, and improving the company's overall cost base and service levels.

Company Finances: As of Jan. 31, Smucker had total assets of $3.2 billion, including $328 million of cash equivalents; $348 million of inventories; $489 million of property, plant, equipment; and $1.1 billion of goodwill. It had $790 million of debt and $1.85 billion of shareholders' equity.

In January, 2008, the company's board of directors authorized a 5 million common share increase to its share repurchase plan. Between January, 2005, and February, 2008, Smucker repurchased nearly 5 million of its common shares.

Financial Outlook

In the fiscal year ending April, 2008, we look for Smucker's sales to be up about 19%, with much of this coming from the acquisition of privately owned Eagle Family Foods in May, 2007. In our view, sales contributions from the Eagle business and the more recently acquired Canadian Carnation brand canned-milk business have more than offset the absence of sales from Canadian nonbranded, grain-based food service and industrial businesses sold in September, 2006.

Although we see Smucker facing commodity cost pressure, including oils and grain, we look for profit margins to be bolstered by cost reduction efforts and economies of scale. As the company's sales base increases, including from the impact of acquisitions, we expect various types of overhead expenses to decline as a percentage of overall revenues, which should help offset at least some of the gross margin pressure from higher agriculture-related costs.

In fiscal 2009, we look for net sales to increase about 8%, to $2.76 billion, from the $2.56 billion we project for fiscal 2008, with some of this due to acquisition activity. In fiscal 2008's first nine months, net sales were up 17% ($280 million), with roughly two-thirds of the increase coming from the Eagle acquisition. During the past year, we believe Smucker's peanut butter sales have benefited from a peanut butter recall announced by a competitor.

Looking ahead, we expect Smucker will have opportunities to benefit from product line extensions (e.g., Jif-branded nuts, Crisco olive oil) and from offering products that appeal to increasingly health-conscious or busy consumers—products such as sugar-free preserves and jam.

At least near term, we expect SJM to face further gross margin pressure from commodity costs. However, we look for at least some of this to be offset by price increases, cost management, and efficiencies.

Valuation

We view the stock as at an attractive discount to shares of other packaged food shares. Based on estimated calendar 2008 earnings per share, Smucker's shares were recently trading at about a 10% discount to a group of other food stocks.

Our 12-month target price of $60 reflects a target price-earnings ratio that is about 18 times our calendar 2008 EPS estimate of $3.36, a moderate discount to the average valuation that we expect from a group of packaged food stocks. We use a discount given Smucker's size relative to other major packaged food players. We note that SJM shares recently had a dividend yield of 2.3%.

Corporate Governance

As of June, 2007, the company's directors and executive officers beneficially owned about 8.2% of Smucker's common shares, including options that could be exercised within the next 60 days. Chairman and co-CEO Timothy Smucker had beneficial ownership of 2.1 million shares (3.6%), and his brother Richard Smucker, who is co-CEO and president, beneficially owned 2.6 million (4.5%).

We would prefer to see the company's chairman and CEO positions more fully separated, but we do not anticipate the current management structure being a major problem. Also, seven members of Smucker's board of directors are nonemployees of the company. Other than the two co-CEOs, the only other Smucker employee on the board is senior vice-president Vincent Byrd.

The company's voting rules seem to encourage longer-term ownership of shares. From the time of purchase until a share has been owned for four years, each share of Smucker stock is entitled to one vote. After four years, if there has been no change in beneficial ownership, that same share becomes entitled to 10 votes on specific matters.

We believe Smucker's long history of family involvement in company management is helpful to creating a favorable corporate culture. However, we think the family's role might also make company management less receptive if an acquisition offer for the business were to surface.

Investment Risks

Risks to our recommendation and target price include competitive pressures in Smucker's businesses, commodity cost inflation, consumer acceptance of new product introductions, and the company's ability to fully integrate and realize expected cost savings from acquisitions.


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