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J. M. Smucker: Uninterrupted Dividends Since 1972

J.M. Smucker's (SJM) roots date back to 1897 when founder Jerome Monroe Smucker began selling apple butter from his horse-drawn wagon. Since then, Smucker has grown into a leading purveyor of numerous consumer packaged goods that can be found in an estimated 90% of U.S. households.

Smucker's main product lines are coffee (32% of sales), dog food (17%), pet snacks (10%), cat food (10%), peanut butter (10%), and fruit spreads (4%). The company also sells shortening and oils, frozen foods, canned milk, flour, frosting, and baking mixes, but it has been realigning its portfolio to focus less on struggling packaged foods.

The company's well-known brands include Smucker's, Jif, Folgers, Milk-Bone, Crisco, Meow Mix, and Dunkin' Donuts, and the business generates more than 90% of its sales in the U.S.
Source: Smucker Annual Report
Smucker has paid dividends each year since 1972 and increased its payout annually since 2002.

Business Analysis
Smucker's portfolio of over 40 brands, including iconic names like Folgers and Jif, compete in an industry that's characterized by several barriers to entry, including brand recognition, immense advertising budgets, retailer relationships, economies of scale, and significant financial capacity to adapt as consumer preferences change.

People are often choosy about what they eat. Given the choice between two competing food products, people will usually opt for the brand they trust most, even if the brand is slightly more expensive.

Smucker and other consumer staple producers know this and spend billions each year to influence customers' perceptions of their brands. Smucker alone spends around $200 million annually in advertising, a sum that upstart food companies seeking to compete with Smucker's well-known brands are incapable of matching.

Combined with continuous cost-cutting measures, the economies of scale that Smucker generates from low-cost supplies and an efficient distribution network has helped the company obtain solid profit margins. The significant investments required to scale profitably keep new food producers from easily encroaching on Smucker's territory.

As a result, across Smucker's U.S. retail businesses, approximately 70% of the firm's sales are derived from categories where the company holds either the No. 1 or No. 2 branded position, according to management.

Nevertheless, even large food producers like Smucker must evolve their portfolios as consumer preferences change, lest their products become irrelevant over time.

Fortunately, Smucker has been consistent with its efforts to adapt to changing consumer tastes. Most recently, management has realigned its portfolio away from struggling packaged foods (baked goods, frozen food, etc) and towards coffee and pet food, both stronger long-term growth opportunities.

For instance, in 2010 Smucker purchased Hispanic coffee brands Cafe Pilon and Cafe Bustelo for $360 million to bolster the company's stronghold in coffee. The Bustelo acquisition in particular has been a success, with double-digit sales growth since 2012.

Thanks to investments in its coffee portfolio, Smucker remains a leader in the U.S. at-home coffee market with 25% market share. By expanding into premium coffee and continuing to invest in its mainstream coffee offerings, management hopes the company's coffee segment will achieve long-term annual sales growth of 2%.

Outside of coffee, the company made a major push into the fast-growing pet food market when it acquired Big Heart Pet Brands in 2015 for $5.8 billion. The acquisition gave Smucker’s instant market leadership since Milk Bone, a Big Heart brand, is the dominant market leader in pet snacks, which is a very high-margin business (people are willing to pay a lot to keep their pets happy).

Then in 2018, Smucker acquired Ainsworth, another leading producer of premium pet food and snacks, in an all-cash, debt-funded deal for $1.9 billion.

The fact that these two deals cost $7.7 billion, or more than half of Smucker entire market capitalization (about $12 billion today), underscores the significance of the changes taking place to Smucker's portfolio of food products.

The reason behind this strategic shift is that pet food appears to be a booming and attractive industry, due mostly to two large trends in America.

First, aging baby boomers are looking for increased companionship as their children leave the home. Meanwhile, millennials are waiting longer to start families, and pets are increasingly popular stand-ins for children.

Furthermore, many pet owners are increasingly focused on health and natural food products, showing a greater propensity to pay a premium for healthier pet foods. As a result, brand loyalty in the pet food market has shown to be fairly high, increasing the appeal of a big-brand company like Smucker entering the market.

With a renewed emphasis on coffee and pet food, Smucker claims that over 80% of its U.S. retail portfolio includes brands that compete in growing categories. As a result, management believes the company can generate 2% to 3% annual sales growth and average annual earnings per share growth of 8% going forward.

The bottom line is that Smucker appears to be a potentially solid choice for conservative dividend growth investors. However, as with all packaged food companies, there are several risks that could challenge the company's long-term growth profile.

Key Risks
Like almost all packaged food companies, Smucker must contend with the brisk pace of change in consumer preferences the industry is experiencing as spending power gradually shifts from older Gen X and baby boomers to Millennials and Gen Z.

Specifically, many food companies are struggling with consumers’ increasing preference for fresh foods over packaged offerings. Private label is also taking market share in important categories such as single-serve coffee pods, and upstart competitors are taking advantage of e-commerce to bypass the traditional retailer relationships that helped many of Smucker's brands become household names.

Simply put, constant innovation and new product launches are now required to maintain market share in what were once highly stable categories like peanut butter and coffee.

In fairness to Smucker, evolving consumer tastes and preferences aren’t a new risk to the industry, and the company has proven itself adept at responding to an evolving consumer market over its 120-plus year history.

However, the U.S. packaged food market is highly competitive and difficult to grow in (food consumption generally tracks population growth, which has slowed to a crawl in the U.S). Faster-growing segments like pet food attract a lot of competition, which could force Smucker to keep prices low and hamper the company's long-term growth efforts.

Speaking of pet food, the way most mature food companies like Smucker grow is through acquisitions, a strategy that brings several challenges.

The first is the potential to overpay, especially to gain entrance into faster-growing markets like pet food. For example, to win a bidding war with Church & Dwight (CHD), Smucker paid a 13 times EBITDA multiple to purchase Big Heart. Less than four years later, Smucker recorded an impairment charge related to its pet food segment, recognizing it likely overpaid for this deal.

Smucker's acquisition spree has also necessitated the company to take on more debt and raise the firm's leverage ratio (debt / EBITDA), which gives the company less financial flexibility moving forward. Management is now focused on using excess cash to reduce the firm's debt load and avoid a credit downgrade, so investors should not expect much dividend growth over the next few years.
Source: Smucker Investor Presentation
Food companies, while defensive, face real challenges in maintaining and growing market share in their low-growth product categories. Often, the only way to attempt the kind of earnings (and dividend) growth investors expect is to make acquisitions that can ultimately hurt shareholders.

A final risk faced by Smucker is commodity prices, especially in volatile goods such as coffee. A major component of packaged food earnings growth is cost cutting, but rising commodity prices can easily offset several years of hard earned cost savings over the short-term.

Closing Thoughts on Smucker
While the packaged food industry is extremely competitive and fraught with numerous needs to adapt to changing consumer tastes, Smucker has proven itself more than up to the task to stay relevant over the past 122 years.

However, investors need to be comfortable with the industry's risk profile and management’s ability to reduce debt and improve profitability going forward, especially following the recent string of pricy pet food brand acquisitions. Dividend growth will likely remain slow during this deleveraging phase, but Smucker's long-term outlook appears to remain intact.

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