J.M Smucker: We're Intrigued
J. M. Smucker (SJM), the powerhouse name behind Folgers coffee, specialty jams, oils and other related foods, as well as pet snacks, has just reported its Q3 earnings. It is our opinion that the results we are seeing from the company, in conjunction with the benefits of tax reform, the stock is becoming very compelling at present levels, although we would like to acquire it cheaper if possible.
Price action
Ultimately, the question is, can we buy the recent rally in shares here? The stock is in the middle of a 52-week range:
Source: Yahoo Finance
J.M. Smucker shares are currently trading at $124.55. The stock has rallied off its lows but is still 20 points off its highs last year. So, what is going on here?
Sales are on the rise again
Well, as you can imagine, the recent rally has been driven by the company surpassing estimates on both the top and bottom lines. Let us first discuss what we are seeing on the sales front, and the trends we are seeing in the last few Q3s:
Source: SEC filings
Well, there has been significant pressure here. Net sales decreased $24.5 million, or 1% from last year. They came in at $1.903 billion, versus $1.878 billion last year. Further, beat estimates, albeit only slightly, by $10 million.
What drove sales increases?
The change in net sales was driven by favorable volume and mix issues in several categories. Overall, there was a 1 percentage point impact from the more favorable volume/mix. The largest positives were seen in pet food and coffee, partially offset by declines in the oils. Pricing slightly offset the impact of the favorable mix. These sales trends reflect a turnaround from earlier in the year where J. M. Smucker was seeing weakness in coffee and oil. Within coffee, the K-cups brands have performed well ahead of expectations, growing 3% in the quarter, well above our expectations.
Expenses could be better managed
With the increase in sales, we were hopeful that expense management would lead to better than expected profits. Sales were up 1% but the costs of products rose 2% to $1.174 billion. That rise is a bit higher that we would like, but gross profit still expanded. Gross profit grew to $728.5 million, up from $722.9 million. That said, gross profit margins fell down to 38.3%, from 38.5% last year. Factoring in changes in project costs, selling and administrative expenses and amortization, we see operating income dropped 20% to $162.7 million. That is not a recipe for a winning stock run, as reported. However, making needed adjustments for special items, operating income actually rose 4%, reversing a trend of weakness.
Tax reform a huge benefit
But what about earnings per share? They saw a benefit. Net income per share as reported was up huge thanks to tax reform. When we factor in necessary adjustments for comparability, adjusted net income rose 25% to $2.50:
Source: SEC filings
That is a strong result. In fact, it surpassed our estimates by $0.35. That is pretty strong. We were also encouraged by some of the commentary from management. Commenting on the quarter, Mark Smucker, chief executive officer, stated:
“We had a strong third quarter, with sales growth for key brands in every business and strong earnings per share growth fueled by the benefits of U.S. income tax reform and ongoing cost discipline…In addition, the benefits of income tax reform provide incremental fuel to invest in our growth initiatives and support our employees and communities as well as opportunities to increase cash returned to shareholders."
This stands out as bullish, because this global giant now has additional funding to pump directly into its brands, and this is a major development for the company which had been struggling earlier in the year.
Our take
Make no mistake coffee sales are significant for the company and tax reform will help the company invest much more into innovation and research. But it is not just this segment that saw issues in 2017. The quarter revealed that there is fundamental pressure still in other areas, however, the company has turned the corner in our opinion. With the impact of tax reform we have grown bullish. There is a lot of pressure on volumes, and the mix has been unfavorable for much of 2017, but things improved this quarter. The impact of cost management programs has kept margins in line, but there is more work to be done.
We would like to see more work done to control expenses, but as long as sales are growing and the bottom line is expanding, small hikes in expenses are tolerable. As far as buying here is concerned, we are intrigued by the value at present levels given that tax reform is a reality. Fiscal 2018 looks like it will be worse off than expected. We would like to see the stock fall under $120 before entering the name, at which point the dividend yield and multiple on the stock would be attractive for a long-term entry into the name.
Quad 7 Capital has been a leading contributor with various financial outlets since early 2012. If you like the material and want to see more, scroll to the top of the article and hit ...
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