Peanut Butter Jelly Time: J.M. Smucker As A Comfort Stock

My father is a big believer in taste tests. Growing up, if any of the four kids in my family wanted to stick to a brand of a certain popular food item, Papa put us through the blind taste test to see if we could prove that the brand in question was more valuable to our taste. It was in this way that my older brother won the right to drink Tropicana orange juice. So too did we discover that green peppers are boring, yellow and orange a little sweet, and red just about right.

My big taste test victory came with Jif Peanut Butter. Creamy, sugary, but not stuffed with tons of chemicals or nasty stuff, the magic spread triumphed over all other brands. Considering I was (and still am) a daily eater of peanut butter sandwiches - usually straight up on toast, at times with fluff or jam added on - this was a significant win. By the time I left the house for school, the only other brand that made it into our pantry was Skippy, and that only because Costco (COST) sold only that brand, in obscene sizes.

It is with a great hankering for Jif while marooned in Europe that I look into the current owner of the brand, J.M. Smucker Company (SJM). The 115-year old jam company has expanded into a major food processing company. Beyond the series of Smucker's jams and jellies that anchor the company, the firm is also home to Jif and Crisco (both purchased from Procter & Gamble (PG) in 2002), Pillsbury baked goods and products, a variety of boutique brands such as R.W. Knudsen juices, and several major coffee brands, including Dunkin Donuts (DNKN) coffee and Folger's coffee, the latter another acquisition from Procter & Gamble (and a piece of the Rajat Gupta insider trading trial) in 2008. Most recently, the company acquired a majority of Sara Lee's (SLE) coffee and hot beverage business, including the Douwe Egbert brand.

J.M. Smucker is a largely domestic play - the company's international segment, 20% of its net sales last year, is based in Canada - which is attractive to many in this turbulent period. SJM is also a defensive play, as peanut butter and coffee among other foods are staples with relatively inelastic demand. The company also pays a solid dividend (currently yielding 2.54%), one that it has raised every year since the 2001-2002 recession (and one that SA contributor and dividend dynamo David Fish expects to go up this summer). Despite that, the stock has lagged several of its peers over the past year, raising questions about what lurks below the performance.

(click to enlarge)

SJM data by YCharts

The company recently reported its FY 2012 and 4th quarter results (Fiscal year ends in April for SJM), offering a look into the company's current health. The earnings were a strong beat both on guidance and analyst estimates, a welcome change from the company's rough Q3. But for the year, earnings were roughly flat, increasing from $4.69 to $4.73/share. The struggle came in volume and gross margins, obviously two essential areas for a food company to do well in. For the fourth quarter overall volume was down 7% (Jif, as an example, was down 17% on volume), even though net sales went up 14% thanks to higher prices. The gross profit margin was down 230 basis points to 33.2% for the quarter, and down to 33.4% for the year versus 37.3% a year prior. That the company could maintain earnings is a testament to solid company-wide performance and, more so, the strength of the company's brands.

While FY 2012 found J.M. Smucker in a bit of a jam, 2013 looks like it could be a smoother, sweeter year for the company. The company forecasts earnings and net sales to grow about 7% in 2013, with overall volume dropping slightly. Management has adjusted its outlook on the integration of the Sara Lee business; originally, SJM expected a $.10/share accretion in 2013, but is holding on to some negative-margin aspects of the acquisition, postponing that accretion until 2014, with the acquisition expected to be neutral for 2013.

There are reasons to suspect J.M. Smucker's forecast is overly cautious, and they mostly have to do with margins. FY 2012's margins were compressed by high commodity costs, including high coffee and peanut costs (also leading to higher prices and subsequently lower volumes on the company's products). These costs are dropping or likely to drop in the coming year. Coffee prices had been going down already leading into the most recent conference call, and while management does not expect quite as big an effect on margins as some analysts hoped during the call, the company does foresee positive effects from coffee costs. J.M. Smucker has already cut prices on coffee by 6% and offered different size units and products in efforts to meet customer's cost needs and increase sales volume.

Officially, the company expects, "impact of commodity cost changes within our basket of goods to be relatively neutral year-over-year." That said, they include higher peanut cost as a main offset to the lower cost of coffee. All indications are that there will be a bumper crop of peanuts this year, mostly thanks to the famous peanut growers in Argentina. This is expected to lead to a drop in prices in the second half of 2012, but already according to the USDA's figures, peanut prices have already dropped by $275/ton, or 22%, year-to-date. Considering that last year, the company's U.S. consumer foods segment margin and International foods segment margin were down 200 basis points, this could offer breathing room for margins to kick back up. The company has remained circumspect on the possible impact of these drops, but if the crop holds up, this could lead to good things for both the company and peanut butter lovers.

Not much of that good has been baked into the stock when compared with its peers, however. Pulling a handful of similar-sized food companies - Hershey's (HSY), Heinz (HNZ), McCormick (MKC), Hormel Foods (HRL), and Kraft Foods (KFT) for a bigger comparison - shows that J.M. Smucker is quite cheap on valuation, even given a defensive climate that should boost its multiples.

(Sources: WSJ, TDAmeritrade, respective companies' earnings reports)

As of Q1 2012	SJM	HSY	HNZ	MKC	HRL	KFT
Market Cap	$8.5B	$11.3B	$17.2B	$7.0B	$7.7B	$68.9B
Quarterly Revenue Growth (Y-over-Y)	14.17%	10.74%	5.47%	15.83%	2.76%	4.14%
Gross Margin (Most Recent Quarter)	33.20%	44.20%	32.90%	39.18%	16.67%	35.65%
Yearly Revenue Growth	14.54%	7.23%	8.76%	10.82%	9.33%	10.48%
EPS Growth (Annual)	8.39%	14%	5.03%	9.27%	18.75%	6%
Estimated Earnings Growth (next 3 years)	9.03%	10.48%	6.80%	9.37%	8.15%	10.50%
Earnings 2011	4.73	2.82	3.35	2.79	1.74	2.29
Earnings 2012 (Est.)	5.11	3.21	3.53	3.05	1.85	2.52
Earnings 2013 (Est.)	5.61	3.54	3.79	3.35	1.98	2.79
Free Cash Flow/Share 2011	4.04	1.01	3.33	1.82	1.45	1.55
2011 P/E	15.98	24.65	15.99	20.74	16.82	16.97
2012 P/E	14.79	21.65	15.17	18.97	15.82	15.42
2013 P/E	13.48	19.63	14.13	17.27	14.78	13.92
PEG Ratio	1.77	2.35	2.35	2.21	2.06	1.62
2011 P/FCF	18.71	68.81	16.08	31.80	20.18	25.06
Price	75.6	69.5	53.56	57.87	29.26	38.85
Dividend	1.92	1.52	2.06	1.24	0.6	1.16
Dividend Yield %	2.54%	2.19%	3.85%	2.14%	2.05%	2.99%

(Note: SJM and Heinz's fiscal year ends in April, Hormel's year ends in October, MKC's in November; Hershey's and Kraft use, thankfully, normal calendar years)

J.M. Smucker is the cheapest company in this group (roughly on a par with Kraft and Heinz) while having several strengths among these numbers. The company's revenue numbers are on the high end for the group, and its backwards and forwards earnings growth numbers are among the more steady in the group along with Hershey's.

J.M. Smucker is also becoming a free cash flow machine: for FY 2013, the company expects to generate about $4.75/share in free cash flow at the midpoint. In response to a question about free cash flow, which the company hopes to double over a five-year period (FY 2012 being the first year of that period), CFO Mark Belyga said, "We want to invest basically about half of (free cash flow), over time, in the business, whether that's acquisitions and capital expenditures and the other half returned to shareholders, be it dividend or buybacks." This is a very promising sign for investors, considering the company's dividend history and solid reputation for delivering value to shareholders.

Given its valuation, free cash flow growth, forecast for FY 2013, and the positive changes in commodity costs, J.M. Smucker is becoming a very attractive way to play the domestic food industry as a safer pick. As for how to do it: the company has already forecast a weak first half of its 2013, with Q1 expected to be weaker than a year prior due to a drop off in the coffee segment. Between the uncertain market climate and a possibly disappointing (even if expected) first quarter, SJM's stock could take a hit down towards the low 70s. The expected dividend hike should be at least $.08 for the year and could be $.16 for the year as it was last year (the last time the hike was less than that was in 2008/09); the higher raise would bring the dividend to $2.08/share. A 3% yield could serve as a floor for the defensive play, which would be 69.33/share under this hypothetical. So around 72, if the stock gets there, would be a good area to start a position.

There are some things that are certain in life. When it comes to Jif, I know I will be helping add to the company's volume recovery when I visit the states this summer. When it comes to J.M. Smucker, I might just have to become a shareholder too. The ultimate testament to winning taste, I suppose.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SJM over the next 72 hours.