EUR 850.00 For Business Accounts Only

Morningstar | Higher Brand Spend Pays Off With Organic Revenue Growth for No-Moat Smucker; Shares Fairly Valued

We do not anticipate making a material change to our $101 fair value estimate for no-moat Smucker after the firm’s third-quarter earnings release. The year is tracking largely in line with our expectations for 7.6% revenue growth (+0.6% organic) and $8.01 earnings per share for fiscal 2019. Longer term we continue to expect organic revenue growth of just under 3% and operating margins falling from 19% to 15% due to pricing pressure and higher marketing spend, leading to long-term earnings per share growth of around 3%.

We are pleased to see organic revenue growth turn positive (+1.0% in the quarter); an encouraging indicator that higher investments in innovation and marketing seem to be resonating with consumers. The firm’s on-trend brands continued to report attractive growth rates (Dunkin’ Donuts and 1850 in coffee, Uncrustables, and Jif Power-Ups in food, Rachael Ray Nutrish and Nature’s Recipe in pet). But we are most encouraged to see a 10% revenue bump in Meow Mix, one of the firm’s larger pet food brands that has been under competitive pressure. New products, like the Tender Centers line, have seen a 4% increase in Meow Mix consumption since Smucker began a marketing and innovation campaign earlier this fiscal year. We are curious to see if this momentum can be sustained beyond the initial launch.

However, we were disappointed to hear that management has no intention of expanding its super premium pet food brand Natural Balance into the food, drug, and mass channels, as the specialty pet channel has come under severe pressure with steady traffic declines. In our view, the company is ceding share to wide-moat General Mills’ Blue Buffalo brand, a super-premium brand that is solidifying its position by expanding into these broader channels. Smucker stated that it believes it can return the brand to growth with new products, marketing support, and e-commerce expansion, although we believe that its absence in food, drug, and mass is a missed opportunity.

Although coffee continues to see pricing pressure (from lower green coffee prices and lack of a brand intangible asset), +5% volumes more than offset the 2.7% price decline, driven by 9% growth in Dunkin’ Donuts and continued strong sell-in of 1850. Although the initial trial of 1850 has slightly lagged management’s expectation, repeat purchase has surpassed its expectation. As such, current marketing efforts are centered on driving higher trial. Operating margins for the coffee segment are on track to meet our 30.5% target for the year.

The food segment also reported organic revenue growth, with 3% volume growth and flat prices. Uncrustables grew 12%, with Jif Power-Ups leading the Jif brand to 5% revenue growth. Further, expanded Sahale distribution resulted in a 63% increase in revenue for the brand, more than offsetting declines in fruit spreads. The firm plans to increase prices on Jif peanut butter in March and anticipates that volumes will likely respond negatively. This segment is tracking slightly ahead of our 22.5% operating target for the year, but startup expenses for the new Uncrustables plant in the fourth quarter and the Jif price cut keep us comfortable with our full-year estimate.

Organic pet food revenue fell slightly as a 3.0% volume decline more than offset a 2.8% price increase to offset higher input costs. However, the volume decline can be fully attributed to the discontinuation of Gravy Train wet dog food and some legacy contract manufacturing business. Expense control efforts drove a 150-basis-point sequential improvement in adjusted operating margins, although margins are 80 basis points lower year over year due to the Ainsworth acquisition, on track for our 17% fiscal year estimate.