Stock in The J.M. Smucker Company (NYSE:SJM) has shed 9% of its value in the two trading sessions following the company's release of fiscal first-quarter 2019 earnings on Tuesday. Smucker shares are in a jam despite what, on the face of things, would seem to be a positive report:
J.M. Smucker: The raw numbers
|Metric||Q1 2019||Q1 2018||Year-Over-Year Growth|
|Revenue||$1.903 billion||$1.749 billion||8.8%|
|Net income||$133.0 million||$126.8 million||4.9%|
|Diluted earnings per share||$1.17||$1.12||4.5%|
What happened this quarter?
The company's vigorous top-line increase was driven entirely by acquired revenue from its purchase of Ainsworth Pet Nutrition for $1.7 billion in May. Ainsworth notably owns Rachel Ray Nutrish, one of the fastest-growing premium pet food brands in the United States.
Excluding Ainsworth's contribution, net sales dipped by 1%. Smucker attributed the company's lack of organic growth to lower price realization in coffee, pet foods, and oils.
While overall organic revenue remained sluggish, the company's retail coffee segment was able to post positive, if marginal, revenue growth of 2%, to $489.5 million.
Higher volumes and improved product mix offset weaker pricing in coffee. Smucker cited strength in Dunkin' Brands licensed coffee, Cafe Bustelo, and its newly launched "1850" premium coffee brand. However, the company's Folgers label proved a drag on the segment. Growth in Folgers K-cups was nullified by declines in roast and ground canister sales. Smucker signaled that it will invest in pricing and merchandising activities over the next three quarters in an attempt to revitalize Folgers' revenue. On a brighter note, coffee segment profit increased 20% to $147.8 million thanks to the favorable condition of falling coffee commodity costs.
Consumer foods revenue dropped 1% year over year to $483.3 million. Smucker had announced an agreement on July 9 to sell its U.S. baking business to private equity firm Brynwood Partners for $375 million. Excluding the results of the baking business within this segment, revenue was essentially flat against the fiscal first quarter of 2018.
The company reported little pricing power in consumer foods during the period. Volume and product mix gains thanks to Smucker's Uncrustables(frozen sandwiches) were offset by weakness in Jif peanut butter and Crisco oil. Management stated that Jif's issues were "primarily related to the timing of merchandising at a key club customer." The organization anticipates achieving full-year comparable growth in the Jif brand by the end of the current fiscal year.
In the company's retail pet foods segment, sales jumped 29% on the inclusion of Ainsworth revenue, resulting in a total top line of $671.2 million. After extracting the Ainsworth contribution, though, organic pet food sales dipped by 2%.
Sales decreased by 1% in Smucker's smallest segment, International and Away From Home, to $258.5 million, due to lower net price realization.
Although overall company gross profit increased by 2% to $678.2 million (due to the higher sales resulting from the Ainsworth acquisition), gross margin slipped by 230 basis points to 35.6%. Management cited an "unfavorable change in unallocated derivative gains and losses" of $34.6 million as the primary culprit behind the lower profitability. After removing this item, adjusted gross margin landed at 37.4%, 50 basis points below the prior-year comparable quarter.
- Interest expense rose 28% to $53.6 million, reflecting higher debt incurred to finance the Ainsworth transaction. During the company's earnings conference call, CFO Mark Belgya observed that Smucker's debt-to-EBITDA ratio now stands at 4.1 (i.e., a bit higher than what's typically considered to be moderate leverage), and affirmed that the company will focus on reducing its debt load over the next few years.
What management had to say
Smucker's difficulty in realizing underlying organic growth has pressured its stock this year, and it certainly informed the market's dubious reaction following fiscal first-quarter results. However, management's willingness to jettison venerable revenue staples, like the baking division's Pillsbury and Hungry Jack brands, in favor of contemporary categories such as premium pet food, should provide (at the least) a pathway to more vigorous earnings growth. During the quarterly conference call, CEO Mark Smucker explained that fast change is a strategic imperative:
[L]et me reiterate that we are taking and will continue to evaluate appropriate actions that support our consumer-led strategy to be a food and beverage leader focused on high-growth on-trend categories. Whether through innovation, acquisitions, divestitures or improving capabilities and execution in key areas, these actions are indicative of the fast pace of change within our company.
J.M. Smucker tweaked its financial outlook alongside first-quarter earnings. The company reduced its top-line fiscal 2019 guidance from $8.3 million to $8 million, in light of forgone revenue from last month's baking divestiture. For the same reason, the full-year outlook for free cash flow has been trimmed from a previous range of $800 million to $850 million, to a new band of between $770 million and $820 million. Smucker will separately receive approximately $315 million in net proceeds from the baking business sale.
Full-year adjusted earnings per share, however, are still expected to fall between $8.40 and $8.65. To hit the high end of this range, Smucker will need to spur activity in its old guard revenue streams like Jif and Folgers over the next few quarters -- new investments notwithstanding.