December will need to be very kind to the J.M. Smucker Company (SJM 1.69%) if it's to pull out of a year-to-date slump. The company released fiscal second-quarter 2019 earnings on Wednesday, and investor reaction pushed shares down 8% -- they've lost roughly 16% of their value year to date. Despite revenue contributions from a significant acquisition earlier this year, J.M. Smucker's organic growth remains challenged, and margin issues have also thwarted shareholders' confidence. Below, we'll delve into the quarter for a closer look at the company's near-term condition. Note that all comparison numbers in this article refer to the prior-year comparable quarter (the second quarter of fiscal 2018).
J.M. Smucker: The raw numbers
| Metric | Q2 2019 | Q2 2018 | Growth (YOY) |
|---|---|---|---|
| Revenue | $2.02 billion | $1.92 billion | 5.2% |
| Net income | $188.5 million | $194.6 million | (3.1%) |
| Diluted earnings per share | $1.66 | $1.71 | (2.9%) |
Data source: The J.M. Smucker Company.
What happened this quarter?
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Smucker's revenue advance was made possible by acquired revenue from the company's $1.7 billion purchase of Ainsworth Pet Nutrition in May 2018. Best known for its Rachael Ray Nutrish pet food brand, Ainsworth contributed $184.2 million to Smucker's top line in the third quarter.
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This new revenue was offset by the loss of $74.2 million in revenue from the divestiture of the company's U.S. baking business, which encompassed stalwart but slow-growth brands including Pillsbury, Martha White, and Hungry Jack. Smucker sold its baking business to private equity group Brynwood Partners on Aug. 31, 2018, for $375 million.
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After taking into account the two major items above, net revenue decreased by $12.1 million, or roughly 1%, as a result of lower net price realization in pet food, coffee, and peanut butter.
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The weaker pricing masked a one-percentage-point improvement in volume and mix, which management attributed to the Smucker's, Meow Mix, Jif, 1850 coffee (a new premium label from Folgers), and Uncrustables brands.
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The U.S. retail coffee segment posted a top-line decrease of 2% to $544.9 million, due to lower price realization. Segment operating income rose 4.4 percentage points to $174.3 million, however, as lower commodity input costs offset marketing spending associated with the new 1850 coffee brand.
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U.S. retail pet foods booked revenue of $728.1 million, a 32% increase that reflected the Ainsworth acquisition. Pulling Ainsworth out of the mix, net sales in this segment declined by $7.2 million (approximately 1%), as certain Gravy Train products were discontinued. Segment profit rose 1% to nearly $124 million. However, excluding Ainsworth, higher freight and raw material costs pushed segment operating income down by $18.1 million.
- The divestiture of the U.S. baking business caused U.S. retail consumer foods revenue to slide 12% to roughly $462 million; adjusting for this divestiture, net sales actually inched up one percentage point due to favorable volume and mix. Unfortunately, pricing again impacted profits: After adjusting for a gain on sale of the baking business, operating profit dipped $11 million due to lower pricing for peanut butter and oils, as well as the impact of increased peanut commodity costs.
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In Smucker's smallest segment, its "international and away from home" business, revenue decreased 2% to $286.6 million, and segment profit crept up 2% to $56.7 million.
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Company gross margin dipped by one percentage point to 38.2%. Aggregating the various gross margin factors discussed above, on an overall basis, the softer pricing environment, higher peanut butter costs, and higher pet food costs were slightly offset by lower coffee commodity costs. Operating margin also decreased by a percentage point to 16.3%.
Image source: The J.M. Smucker Company.
What management had to say
Smucker's pricing woes result partly from the matching of competitors' actions in a sluggish consumer packaged goods (CPG) environment. This is exacerbated by declining coffee costs, which the company is passing on to customers. CEO Mark Smucker addressed the resulting margin pressure in the company's earnings conference call and explained management's current perspective:
Obviously margins are important too, but we really are focused on dollar profit. And as you've seen so far this year, we've been successful in doing that. We do -- we continue to believe philosophically that the right thing to do is to not only be competitive, but to pass through up or down cost to the end consumer and so that will continue to be our focus. But I do think at the end of the day, we are focused again on making sure that we can sustain our -- sustain and ultimately grow our dollar profit.
The favoring of gross dollar profit over the expansion of profit margin can be confusing, but it's a strategy often utilized by CPG management teams, which I've explained in more detail here. In the near term, Smucker's management hopes to offset some price compression with new product innovation.
Looking forward
J.M. Smucker revised its full-year fiscal 2019 outlook to adjust for its baking divestiture and the effects of "lower pricing and competitive activity, primarily in coffee and peanut butter." The company now expects full-year revenue of $7.9 billion, versus previous guidance of $8 billion. Adjusted earnings per share (EPS) have been trimmed from an earlier band of $8.40 to $8.65 to a new range of between $8 and $8.20. At the midpoint of this range, full-year adjusted EPS will represent a 2% bump over last year's $7.96 in adjusted EPS: a modest increase in a year that so far has been characterized by modest performance.
