Consumer packaged goods (CPG) giant J.M. Smucker (SJM 0.88%), which released its fiscal second-quarter earnings report on Friday, is both a beneficiary and a victim of broad product diversification.
The business model used by the very biggest consumer staples conglomerates can seem self-limiting. Including product variants with unique SKUs (stock-keeping units), the typical CPG multinational sells thousands upon thousands of products spread across consumer categories, brands, and geographical regions.
Smucker, which derives most of its sales from within the U.S., seems as fond as its peers of breaking into promising categories and continually innovating within product lines. Ongoing diversification helps stabilize revenue, and in theory, new revenue streams should benefit the top line. But exposure to an enormous array of markets means that leading CPGs rarely seem to issue quarterly results without highlighting at least one problem child.
For J.M. Smucker, in the second quarter, difficulties arose in one of the company's newer markets: its higher-end pet food business. Escalating competition in the premium dog food category was a primary factor behind a year-over-year sales decline of 3%, to $1.96 billion.
This is somewhat surprising, as Smucker acquired Ainsworth Pet Nutrition in May 2018 for the express purpose of capitalizing on the fast-growing pet foods sector to supplement more-plodding growth in its core packaged-foods lineup.
Smucker gained the Rachael Ray Nutrish brand in this $1.7 billion transaction, and while Nutrish sales increased by 3% in this most recent quarter against fiscal Q2 2019, the result fell below management's expectations. Another of Smucker's premium pet food lines, Natural Balance (one of the company's legacy labels that predates the Ainsworth acquisition), saw its sales decrease by 25% during the quarter.
Weakness in the premium pet food category has forced management to reassess the company's overall growth potential for fiscal 2020. The organization had already reduced its full-year outlook in the first fiscal quarter of 2020, from projected revenue growth of 1% to 2%, to a range of a 1% decline to flat growth. In Friday's release, management readjusted the top-line expectation further, and now projects a 3% decrease against fiscal 2019.
Similarly, in the first quarter of 2020, Smucker crimped expected full-year adjusted earnings per share (EPS) from a range of $8.45 to $8.65 to an envelope of $8.35 to $8.55. This time around, it knocked its adjusted EPS expectation down to $8.10 to $8.30.
Competition for market share in premium pet food is intensifying as rivals like General Mills (via its own $8 billion acquisition of Blue Buffalo Pet Foods in April 2018) are also seeking a boost from this briskly growing category. Ironically, rather than seeing growth, J.M. Smucker's U.S. pet retail volume actually contracted by 4% last quarter.
Nonetheless, Smucker's stock gained more than 4% on Friday, as investors were persuaded that promising momentum in core competencies like coffee and snacks would mitigate impacts from the pet foods segment for the remainder of the year. Management said that vigorous sales of Dunkin' branded coffee, and a new marketing campaign for the company's Cuban-inspired Cafe Bustelo coffee brand, pushed volume in the retail coffee segment higher by 4 percentage points during the quarter.
I suspect that institutional and retail investors have come to tolerate the straitjacket of diversification that most CPG multinationals seem to be constrained by. As a group, these organizations combine plodding organic revenue expansion with slight EPS improvement achieved via cost-cutting and share buybacks. Yet observe that low growth translates into smooth stock price movement -- Smucker's three-year average beta of 0.41 means that it exhibits roughly 60% less volatility than the overall market.
The biggest CPG players also tend to write handsome dividend checks (Smucker's current quarterly payout yields 3.2% annually). Thus, income-oriented investors who aren't after explosive stock appreciation may actually embrace the offsetting impacts of the typical CPG's overly diversified portfolio, since such a structure insulates against a dramatic revenue plunge even as it caps growth potential.
And over long periods of time, the math seems to work out: Smucker has averaged an annual total return of roughly 13% over the last 10 years without troubling its shareholders with overly burdensome downside risk.