The J.M. Smucker Company Could Grow in the Coffee Market in 2015

Everyone loves a good cup of freshly brewed coffee, and investors love the fast growing coffee industry, particularly companies fighting for market share in the rapidly growing single-serve segment.  While Starbucks (NASDAQ: SBUX) is the king of coffee, the market is large enough for names like J.M. Smucker (NYSE: SJM) to grow its market share over the coming years due to several initiatives in the pipeline.

On February 14, J.M. Smucker reported disappointing fiscal third-quarter 2014 results. The company reported earnings per share of $1.66 which missed the consensus estimate of $1.68. Its revenue of $1.47 billion fell short of the consensus estimate by $60 million. Many investors showed concern over the company's U.S. retail coffee segment which saw its sales decline 8% to $578.9 million from the year-ago quarter.

J.M. Smucker has some catching up to do
Coffee is a large component of J.M. Smucker's revenue base, representing more than 40% of the company's sales in the third quarter.

The K-Cup coffee segment remains an important category for not only J.M. Smucker but for every coffee producer that is banking on continued growth in the single-serve category.  

J.M. Smucker's K-Cup segment involves them selling single use pods named K-Cups for use in Keurig machines, owned by Keurig Green Mountain. (NASDAQ: GMCR)  Both Keurig and the K-Cup brand and logo are fully owned by Keurig Green Mountain.  

For the past 12 months, Keurig Green Mountain saw roughly $4.5 billion of revenue and more than $1 billion EBITDA.  The company has been growing revenue at around 12% a year with operating margins of 18%.  J.M. Smucker's K-Cup segment involves them selling the small single-use K-Cups with Folgers brand coffee for use in Keurig machines. Both Keurig, and the K-Cup brand/logo are owned by Green Mountain Coffee Roasters and I would recommend mentioning and possibly tickering this fact.  

J.M. Smucker initially entered the K-Cup market in early 2010 and it has since grown its sales in the category to $300 million in 2013.  

During J.M. Smucker's third-quarter conference call, management guided for K-Cup sales to rise only "slightly" for 2014. Looking forward, however, the company remains "optimistic" about the segment's growth in 2015 and beyond due to a number of initiatives it has in the pipeline.

Giving a new image to an old brand
J.M. Smucker plans to give its Millstone brand a face-lift to increase its visibility to consumers. The company intends to "restage and repackage" the brand and provide additional support so it can compete in the premium ends of the K-Cup and bagged-coffee segments.

Millstone and J.M. Smucker's other brands, such as Folgers and Gourmet Selects, have mid-tier prices of around $0.55 to $0.60 per K-Cup, while Starbucks K-Cups retail for close to $0.80 per serving. This implies that J.M. Smucker has some pricing power if it wants to shift its prices higher to better reflect a more exclusive premium offering.

Many coffee consumers will debate whether Millstone is a true "premium" brand as it stands today. Starbucks clearly operates in the premium segment and the company continues to significantly outpace the category in terms of growth and new product innovation.

Starbucks' K-Cup business saw its sales rise 7% year-over-year to $401 million in the first quarter and the company anticipates "higher channel development growth from the second half of fiscal '14," which implies that the K-Cup market is still experiencing growth, especially at the premium level.

J.M. Smucker's relationship with Dunkin' Donuts

Another attractive way for J.M. Smucker to penetrate the premium segment would be to obtain the K-Cup rights for the Dunkin' Brands Group (NASDAQ: DNKN  ) Dunkin' Donuts brand. Dunkin K-Cups are only sold in Dunkin' Donut stores but J.M. Smucker holds the license rights to sell Dunkin's bagged coffee in the AOC, or All Outlet Coverage, space.

Dunkin' Donuts could see tremendous growth in K-Cup sales if the product became available in the AOC space as it remains one of the very few major recognizable brands without exposure in the grocery aisles, despite the company selling ground coffee since 2007.  

In fact, Dunkin' Donuts coffee sells the most coffee poundage in California, where there are zero stores, according to the comments made by the company's Chief Financial Officer Paul Carbone during a 2013 Wells Fargo retail and restaurant conference..  

While management has shied away from acknowledging it is considering adding a K-Cup line to grocery stores, investors could get excited over the eventual possibility and it seems to be a natural evolution given industry shifts and consumer preferences toward single serve offerings. 

J.M. Smucker would jump at the opportunity to obtain the rights to sell Dunkin' Donuts K-Cups. If J.M. Smucker cannot obtain the license, the company could licence another brand or pursue M&A activity. J.M. Smucker has a roughly $6 billion annual revenue base and recent reports (such as that from Bloomberg) showed that it was interested in purchasing the Ragu brand from Unilever for $1.5 billion to $2 billion, so the company has the means to finance large acquisitions to fuel growth. 

Foolish take
Shares of J.M. Smucker could be seen as well-positioned for gains over the longer-term as the tides are turning and the company will be operating with new and revamped products. Although market sentiment among investors remains low, the company could exceed expectations and show strong results as its new initiatives began to pay off.

Arabica futures have risen roughly 20% since the beginning of 2014. J.M. Smucker does not comment on its specific hedging strategy but management did note during its third-quarter conference call that "we feel consummate in our ability to adjust pricing when warranted" which could give investors a better degree of confidence that management is well prepared and positioned for any market situation that may arise in 2015 and beyond.

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