Food manufacturer J. M. Smucker (NYSE: SJM) just turned in a frothy quarter to round out fiscal year 2009. Brands such as Pillsbury and Hungry Jack performed well, but the biggest jolt to profits and margins came courtesy of the Folgers coffee brand, which Smucker acquired from Procter & Gamble (NYSE: PG) in late 2008. Future quarters will likely have less caffeine kick, but performance should nonetheless be steady, with moderate downside risk.
Representing 27% percent of net sales, by my estimates, in the recently completed quarter, it'd be hard to argue that Smucker's greatest strength isn't the Folgers brand. With cost-conscious consumers brewing at home in favor of paying up at Starbucks (Nasdaq: SBUX), Folgers should continue to be a boon. What's more, according to the International Coffee Organization, there's no evidence that the recession has watered down coffee demand. Smucker has historically succeeded in acquiring and building leading food brands, and I expect the Folgers story should play out similarly.
However, it's noteworthy that quarterly sales gains excluding Folgers came largely on the back of price rather than volume increases. Cooking oils in particular lost share to private label. Also, margins will compress a bit in fiscal 2010 as the company ramps up ad spending on the Folgers brand.
Potential offsets include opportunities to further leverage the fast-growing Dunkin' Donuts retail coffee brand -- responsible for more than $200 million in annual sales -- and to profit from more consumers eating at home. Premium brands such as Knott's Berry Farm spreads should appeal to those who are trading in a meal at Darden Restaurants' (NYSE: DRI) LongHorn Steakhouse for a gourmet PB 'n' J at the kitchen table. OK, maybe not that. However, you should note that on a relative basis, Smucker has superior margins to packaged foods peer Con-Agra (NYSE: CAG), and I expect this to be an ongoing strength.
Smucker's long-term debt to capital stands at 14.1% -- low in absolute terms and also significantly less than that of peers. Unless the capital markets once again grind to a halt, the company should be able to raise funds for potential acquisitions. If such opportunities materialize, I would like to see management utilize fixed-rate debt via bond issuance rather than rely on variable-rate bank debt, of which the company already has $350 million.
Although I view Folgers as a company strength, it's also potentially the greatest threat. I see the recession's end as far off, and I also believe that consumers will carry a strong sense of value and caution into any recovery. But there will come a time when the prosperous once again grab their joe on the go, and that will be a challenge to Folgers sales. In addition, coffee is a historically volatile commodity. Price spikes would likely contract Smucker's margins, while sustained high prices in the commodity might mean price hikes at the shelf, and that brings on the possibility of a price war with Kraft's (NYSE: KFT) Maxwell House. All told, the single big brand raises Smucker's risk profile -- possibly above what investors expect from a consumer staples investment.
Shares have had a big run in the past few months, gaining close to 8% last week alone. Trading at a current fiscal year P/E of 14 with a still-palatable 2.9% dividend yield, the stock isn't yet riding a caffeine high. For investors who can stomach the risk of Folgers turning in a decaf performance at some future date, there's still time to buy.
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