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Is SJM undervalued enough to be a smart defensive investment?

Is SJM undervalued enough to be a smart defensive investment?

Over the last week, uncertainty appears to have become the primary theme of the market, as concerns over interest rates and global growth are starting to take hold and lead investors to question the market’s ability to sustain its long, bullish trend. As of this writing, in fact, the S&P 500 is sitting right on top of its 50-day moving average line, an indicator that a lot of technical investors like to use as a visual queue for the market’s intermediate-term trend. A break below this line could signal at least a short-term reversal, with more downside ahead that could see the market drop as much as another 4% before finding its next support level. That’s not exactly correction territory, but it is enough short-term downside to keep uncertainty high and prompt investors to start looking for “safe haven” investments that offer some measure of protection should things get even worse.

If the market keeps dropping, I think there could be some very interesting opportunities in defensive industries, and as I wrote yesterday, I think some of the best valuations in the market right now are coming in the consumer sSJMles sector in general, and the food industry in particular. If you’re looking to be conservative about the positions you take, it’s smart to be selective about how many stocks you buy in a single industry, and so even though I’ve been highlighting different stocks in the industry that I think offer interesting value propositions, you should take some time to compare each one carefully and decide for yourself which ones you think would offer you the right mix of opportunity, fundamental strength, and risk management.

One food company that I do think is really interesting right now is The J.M. Smucker Company (SJM). The name probably makes you think about the same products I do – fruit spreads. That’s because the company’s namesake Smucker’s brand is the #1 fruit spread brand; but this is a company that also owns the leading peanut butter (JIF), coffee (Folger’s), and dog snack (Milk-Bone) brands. When you consider they own other well-known brands like Crisco, Dunkin’ Donuts, Kibbles ’n Bits, and Carnation, to name just a few, you have a company with a pretty well-diversified product line that covers a pretty broad spectrum of the packages food industry. There are some risks about the food industry that have started to impact some important measurable components of SJM’s profile; however for the most part, this is a company with strong fundamentals, including good cash flow, decent (albeit declining) margins, and manageable debt. They also carry a very attractive dividend yield right now, with a very compelling long-term value proposition. Let’s take a look.



Fundamental and Value Profile

The J. M. Smucker Company is a manufacturer and marketer of branded food and beverage products and pet food and pet snacks in North America. The Company’s segments include U.S. Retail Coffee, U.S. Retail Consumer Foods, U.S. Retail Pet Foods, and International and Foodservice. The Company’s U.S. retail market segments consist of the sale of branded food products to consumers through retail outlets in North America. In the U.S. retail market segments, the Company’s products are sold to food retailers, food wholesalers, drug stores, club stores, mass merchandisers, discount and dollar stores, military commissaries, natural foods stores and distributors, and pet specialty stores. In International and Foodservice, the Company’s products are distributed domestically and in foreign countries through retail channels and foodservice distributors and operators, such as restaurants, lodging, schools and universities, healthcare operators.SJM’s current market cap is $11.6 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings increased almost 18%, while sales growth increasing not quite 9%. Growing earnings faster than sales is difficult to do, and in the long-term generally isn’t sustainable, but it is also a positive mark of management’s ability to maximize business operations. In the last quarter, earnings decreased almost 7%, despite an increase in sales of almost 7%. That points to increasing costs, which right now are coming from from foodstuffs as well as transportation costs. This reality is also reflected in SJM’s margin profile; over the last twelve months, Net Income was nearly 18% of Revenues, but declined in the last quarter to about 7%. That is a red flag, but the company’s balance sheet indicates that their margins remain adequate.
  • Free Cash Flow: SJM’s free cash flow is good, at a little over $800 million for the trailing twelve month period; that translates to a Free Cash Flow yield of about 7%.
  • Debt to Equity: SJM has a debt/equity ratio of .78, a relatively low number that indicates the company operates with a generally conservative philosophy about leverage. This number did increase significantly in the last quarter from .59, which I believe is a reflection of their acquisition of pet food company Ainsworth in May of this year for $1.7 billion. In the last quarter, their long-term debt increased from about about $4.7 billion to almost $6.2 billion, suggesting the larger portion of the purchase was financed by debt.
  • Dividend: SJM pays an annual dividend of $3.40 per share, which translates to a yield of 3.33% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for SJM is $69.72 per share and translates to a Price/Book ratio of 1.46 at the stock’s current price. Their historical Price/Book average is 2.04, which suggests that the stock is trading at a discount right now of about 39.5%. Their Price/Cash Flow ratio offers an even more optimistic perspective, since it is currently running 62% below its historical averages. Between the two measurements, the long-term target price, based strictly off of value analysis could lie anywhere in a range between $142 and $165 per share. The low end of that range was last seen in the early spring of 2017.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: The chart above traces the stock’s downward trend from late April of 2017, where it peaked at around $144 per share, to its trend low point at close to $100. It also informs the Fibonacci retracement lines shown on the right-hand side of the chart. The stock is currently sitting near that trend low, with strong support at that point from previous pivot lows in November 2017 and June of this year. The stock is about 15% below the resistance marked by the 38.2% Fibonacci retracement line, so a bounce higher off of support could see the stock revisit that level fairly quickly. A break below current support at around $100 could give the stock additional room to drop to multi-year lows that may not find support until around $90 per share – a level last seen in early 2013.
  • Near-term Keys: A strong bullish pivot from the stock’s current support level could be taken as a good signal for a short-term bullish trade using call options or even buying the stock, with a near-term target between $110 and $115 per share. The strength of the stock’s downward trend, however could push the stock below its current support at $100, which would be a strong indication to consider shorting the stock or working with put options. Given the stock’s valuation measurements and general fundamental strength, including a very healthy dividend, the current price represents a very impressive bargain if you’re working with a long-term time horizon and don’t mind accepting some nearer-term price volatility.


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