J.M. Smucker (NYSE: SJM) might not get the same coverage afforded to its larger consumer defensive peers but its quality is just high. To add some weight to that assertion just consider these two facts. Firstly, the famed manufacturer of jams and peanut butter has increased its dividend in every year since the early 1960s. It has simply become a fact of US corporate life that J.M. Smucker will pay its shareholders more this year than it did the year before. Secondly, over 90% of American households own a Smucker product at any given time. This is a company that has engrained itself into the American way of life to such an extent that only a small minority of domestic households aren’t regularly handing it money.
If those two points weren’t enough then get this. You can buy J.M. Smucker right now for an earnings yield of over 8%. Too good to be true, right? Well the detractors would probably point out two things. Firstly, food stocks like Smucker are apparently facing secular decline with earnings growth becoming increasingly difficult to come by. Why spend twice as much on branded goods when discount retailers like Aldi will flog virtually identical generic products for lower prices? In 2016 Smucker made just over $7.70 per share in net profit from the sale of brands like Jif, Smucker’s and Folgers Coffee. This year the figure will clock in at around $8.40 per share (tax cuts providing most of the boost).
The second point relates to the state of the company’s balance sheet. Predominantly as a result of the 2015 purchase of Big Heart Pet Brands Smucker is sitting on a total net debt pile of around $6.5 billion. To put that figure into context the company currently earns somewhere in the region of $900 million a year in net profit.
That said I like Smucker for much the same reason as Molson Coors: it represents a pretty cheap deleveraging play. First of all you get to start off with that chunky 8% earnings yield. Secondly, there’s around $175 million in annual interest that could be accretive to earnings alongside debt reduction. As mentioned above cash profits are somewhere in the vicinity of $850-$900 million. Of that figure, around $350 million is currently spent on annual shareholder dividends. In other words total annual “free” cash stands at around $500 million. If you earmark all of that for annual debt reduction then you are probably looking at a couple of percent in terms of annual earnings per share.
Imagine buying the stock now and holding for a decade. Let’s assume earnings only grow in tandem with inflation plus two percentage points – call it 5% per annum on average. Let’s also make the same growth assumption for the current $3.40 per share cash dividend. Given the current payout ratio is under 50% that is almost certainly too conservative but let’s stick with it.
Under these conditions this is what you see when you check back in the late-2020s. Earnings per share will have grown from the current level of $8.40 to around $13.70. Stick a 15x earnings valuation on that and you get a hypothetical share price of around $205. In addition, cumulative cash dividends would total somewhere in the region of $40 per share. Add those numbers together and you are looking at a realistic total return of around $245 per share compared to the current share price of $103 (on ultraconservative growth assumptions). All-in-all it’s a good deal for a defensive company that prints cash off the back of such ubiquitous brands.