Digging through consumer goods company reports is akin to digging through your own backyard. Everything is familiar and largely understandable, but the way things actually work can often be surprising -- like a ficus. J. M. Smucker's (NYSE:SJM) little surprise is that it's not really a jam and jelly company, even though that's the face it displays most prominently to the consumer. In reality, the company derives slightly more revenue from coffee than it does from consumer foods. Here are the three things investors need to watch from Smucker's second-quarter earnings release last Friday.
Coffee is doing well, but could be better
Last quarter, Smucker increased coffee volume sales by 6%, which is a good level of growth for the company. The big driver continues to be the increasing popularity of the company's K-Cup lines for Green Mountain's (NASDAQ:GMCR.DL) home brew machines. A drop in green coffee prices meant that Smucker was able to increase coffee profit at a higher rate, adding 13% to last year's position. The company also got a boost from increased prices for the K-Cups it sold. The product accounted for six percentage points of growth in the coffee segment's revenue but only one percentage point of its volume growth.
The rest of the year will be telling for both Smucker's and Green Mountain, as Starbucks' (NASDAQ:SBUX) Verismo home brewing machine is now on the market. There have been two prophesied outcomes for K-Cups: Analysts see either an increase in sales from the increase in home brewer visibility or a decrease due to the new competition. Either way, Smucker is likely to feel some sort of impact over the holiday quarter.
Commodity prices make the difference
This year, green coffee prices dropped against last year's high position, and Smucker reaped a large reward. But that benefit was offset by high prices in the peanut world -- the world of brittle and butter. Smucker, like all product producers, is subject to the whims of the environment and of producers. Green peanuts were the company's undoing last quarter, and the increase in the material costs was coupled with a fall in average sales prices. Across the whole company, commodity prices fell slightly, as coffee makes up a larger portion of sales than peanut butter. Unfortunately, prices for finished goods fell as well, and the gross margin was largely unaffected, rising less than one percentage point from last year.
For the rest of the fiscal year, Smucker has said that it should at least be able to avoid cost and price increases owing to the Midwestern drought. That means coffee and peanuts will hold sway over the bottom line, and Smucker is predicting that for the full year, it will end up with lower overall commodity costs. The company is also unconcerned about supply issues, which it dealt with earlier in the year. It now looks like smooth commodity sailing, but investors should keep an eye on green coffee costs. If they increase significantly, then Smucker could experience meaningful margin compression.
Earnings guidance increased
The outcome of all the commodity and sales interplay was that Smucker ended the quarter in a good position. Earnings per share increase 21% from last year, coming in at $1.36. That was in line with analyst expectations, and the stock has maintained its preannouncement price. But Smucker also increased full-year guidance, raising its expectation by about 2% to a range of $5.12 to $5.22.
That increase makes an important assumption in K-Cup sales growth, which was pointed out in the earnings call question-and-answer session. KeyBanc analyst Akshay Jagdale said that in order for Smucker to hit the K-Cup sales target, sales near the end of the year would have to increase by close to 50% over already high sales figures from last year. That's a big assumption, though Smucker says it's ready to hit that high.
Investors need to keep an eye on all three points -- increased coffee sales, commodity prices, and K-Cup ramp-up -- if they're going to be comfortable with Smucker. Right now, I'm not convinced that the market has seen the full impact of Starbucks' new product, and I want to see how the Christmas season shakes out before I make up my mind.
Luckily, Motley Fool readers can follow all the Green Mountain action by signing up for our new premium report on the company. It details all the challenges that are coming up and also highlights the steps Green Mountain is taking to overcome those obstacles. Click here to sign up for your copy today.