Consumers' views of the Smucker revolve around its bucolic image as a rural Ohio jam maker. Investors, however, likely know the company's recent history of big growth by buying first-class brands in gigantic deals.
The company's top-line growth story, however, is shifting: Revenue expectations are more modest, and earnings gains now will come through cost controls and efficiencies.
While the company remains a favourite pick in the consumer products sector, the current strategy provides the company with a host of challenges, from volatile commodity costs for its inputs to cutthroat price competition on store shelves. Smucker has to be more than good - it has to be excellent.
For its first 100 or so years, the company was satisfied with its jams, jellies and fruit-products business. But the last decade saw a significant retooling: Smucker's management decided it wanted to own top food brands across multiple categories.
It found a willing partner in Procter & Gamble Co., which had decided some of its best known names weren't growing fast enough to satisfy investors. Crisco and Jif peanut butter went first, for $1-billion (U.S.), in 2001; Folgers coffee went to Smucker in 2008 for $3.7-billion. It was a deal so large that P&G shareholders, in a tax-saving move, ended up owning more than half of Smucker when it was done. (In between, the $500-million purchase of International Multifoods Corp. brought Robin Hood flour and Bick's pickles into the Smucker's fold.)
The deals took Smucker's revenue from $687-million in 2002 to $4.6-billion in fiscal 2010, which wrapped in April. (Data courtesy of Standard & Poor's Capital IQ)
While management says it still considers opportunities, its current forecast is less ambitious: The company says it hopes to achieve annual revenue gains of 6 per cent, half from acquisitions and half from organic growth.
There are, however, significant issues with the plan, as indicated by the company's flat sales in its first quarter, which ended July 31.
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Chief among the concerns right now is coffee, one of the fastest-rising commodities this year and the biggest contributor to Smucker's results: With Folgers and a licence to make Dunkin' Donuts brand coffee for retail sales, java makes up more than a third of Smucker's revenue and nearly half of its pretax profit.
In the first quarter, its coffee revenue was up 7 per cent, but rising prices for Smucker's supplies make the second half look cloudy. The analyst team at Jefferies & Co. noted that by the time of Smucker's earnings announcement Aug. 20, Arabica coffee futures prices were up roughly 29 per cent since June 1 and about 41 per cent higher year-over-year.
Smucker announced a 9-per-cent price increase at the retail level in early August, which the analyst team at Bernstein Research says is one of the largest since 2007. The previous big boost - a 6-per-cent hike in early 2008 - drove Folgers volumes down 9 per cent in the following year. "Given the current weakness of the consumer, this scenario seems likely to play out again. … Although demand for coffee in general is relatively price inelastic, we think that price increases of this magnitude generate a risk to coffee category sales volumes," the Bernstein team says.
The good news is that coffee competitor Kraft announced similar hikes three days later. Unfortunately for Smucker, it's been pricing itself above competitors in other categories, chiefly Crisco and its cooking oils: The company's oils and baking market revenue dropped 11 per cent in the first quarter ended July 31, with Smucker blaming a "continuing competitive and promotional environment."
Through it all, Smucker has been able to drive its gross and operating margins higher than many analysts' expectations. Part of it is luck, as prices for peanuts and some fruits declined in the quarter, offsetting the coffee price increases. Another part is believed to be skillful hedging, as the company has some undisclosed amount of its coffee supply locked up in five-month hedges, which may spill over into the second quarter and provide healthier-than-expected margins in the segment.
The margin story helps explain how Smucker disappointed on top-line expectations in the first quarter but still beat the earnings-per-share consensus solidly.
"We now see [Smucker]as an earnings momentum story," the JPMorgan analyst team writes. "The stock has beaten consensus in nine straight quarters by a median 15.0 per cent and the median stock lift on those dates has been 4.3 per cent."
A number of the analysts remarked that Smucker's refusal to increase guidance Aug. 20 is setting the company up for yet another earnings surprise for the second quarter. While many of the analysts argue that Smucker is trading at a discount to food company peers, it's also just a few dollars shy of its all-time high, meaning the next earnings surprise needs to be yet another positive one.
Special to The Globe and Mail