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When J.M. Smucker (NYSE:SJM) announced its intention to acquire Hostess in a $5.6 billion deal in September, I raised some real questions about leverage, strategy and growth potential.
Even as current earnings multiples looked not too demanding at the time, I was very cautious given the myriad of issues which concerned me, as mentioned above. As shares have come down a bit advance, interest rates have fallen and the organic growth performance looks good over the most recent quarter, this makes shares of Smucker look a lot healthier now than they did a few months ago.
On Smucker
With the pandemic influencing many businesses, including Smucker which benefited from a hoarding effect and greater demand from in-home consumption, it is wise to look at 2019 as a base year.
That base year was pretty much the fiscal year 2020 which ended in April 2020, as the results were only influenced by the pandemic at the very end of that fiscal year. At the time, Smucker was a $7.8 billion diversified good empire (including coffee, spreads and pets, among others) which posted adjusted EBITDA of $1.7 billion and operating profits of $1.2 billion.
Following two tiny divestments, net debt was set to fall to the $4 billion mark as a mid-2s leverage ratio looked fair. With earnings power trending at $8 per share, a $110 stock valued the shares at a fairly non-demanding multiple of 14 times earnings.
Since the pandemic the company has seen a rather sluggish performance, nonetheless shares commanded a higher valuation, actually trading around the $160 mark early in 2023. Amidst flattish earnings power, although that adjusted earnings rose by a dollar, it mostly meant that earnings multiples had expanded, to about 17 times earnings.
With inflationary trends seen in 223, the outlook was a bit underwhelming. The company guided for 4% sales growth for the fiscal year, with adjusted earnings seen down to $8.05 per share, although that included an $0.90 per share charge from a JIF peanut butter recall.
In February, the company announced a $1.2 billion deal to sell some pet food brands to Post Holdings (POST) as the deal made that $1.5 billion in sales would leave the door and pro forma earnings would come down by forty-five cents.
This would result in pro forma sales falling from $8.4 billion to $7.0 billion, with net debt seen down to $3.4 billion. The deal with Post closed over the summer when the company posted its fiscal 2023 results with revenues up from $8.0 billion to $8.5 billion (ahead of the deal with Post) as earnings came in at $7.92 per share (adjusted earnings those are). EBITDA was reported at $1.6 billion.
The 2024 outlook was impressive with comparable sales seen up 9% and adjusted earnings seen up to $9.20-$9.60 per share, as net debt came in at $3.7 billion, excluding shares held by the business in Post in connection to the deal with the business. Net debt ticked up to $4.1 billion following the first quarter earnings outlook for the fiscal year 2024, although that the earnings guidance was hiked by a quarter per share as well.
Trading at $142 per share, the 103 million shares granted the business a $14.6 billion equity valuation, or $18.7 billion enterprise valuation. This valuation was seen in the light of a $7.5 billion business which posted $1.5 billion in EBITDA and earnings close to $10 per share, all looking quite fair.
Going After Hostess
The investment case changed overnight in September as the company announced a $5.6 billion deal for Hostess Brands, in a deal set to add sweet and baked good brands appreciate Hostess, Twinkies and CupCakes to the line-up of the business. Taking place at 17.2 times EBITDA multiple, the deal was expensive, as a $100 million synergies number could push down the EBITDA multiple to 13 times, a multiple at which the business itself traded.
This however meant that synergies to the tune of 7% were needed to be achieved, which looked quite ambitious. Of course, it could be questioned if the growth and health profile of these business was as good as those of Smucker itself. Adding a similar (compared to the deal with Post) of $1.5 billion in sales, the price tag was quite a bit different, after all. The company guided for accretion in year one, which looked ambitious given the prevailing interest rates (and costs), likely as testament that real synergies were seen in year one.
With pro forma net debt seen up to $8.6 billion, leverage was seen at 4.4 times, with EBITDA seen around $2.0 billion (including synergies). Given this dynamic, I was not surprised to see shares down $10 per share in response to the announcement, shedding a billion in value in response to a $5.6 billion deal.
Even if the company would deliver on its promises, earnings were stuck around $9-$10 per share, for a 13–14 times multiple, while leverage shoot up to nearly 4.5 times, making me very cautious as the deal added leverage, no immediate earnings accretion and did not boost the positioning in my view.
Coming Down advance
Since September, shares of Smucker have fallen from levels around the $130 mark to a low of $107, before rebounding to $118 at this moment in time.
Later in September, Smucker announced the divestment of Sahale Snacks in a deal valued at $34 million, that is for a segment which generated about $48 million in revenues. The sales multiples were non-demanding, but this is a bolt-on divestment after all, not moving the needle in any way.
In November, the company closed on the purchase of Hostess, relatively soon after announcing the deal in September.
The second quarter results for the fiscal year 2024 were released early in December. Reported sales fell 12% to $1.94 billion, with revenues hurt by divestments, with organic sales growth reported at 7%. More important was an 8% enhance in adjusted earnings to $2.59 per share.
Following the purchase of Hostess, the company cut the higher end of the comparable sales growth guidance by half a point to 9%, with the adjusted earnings guidance range cut by twenty cents to $9.25-$9.65 per share. Due to the earlier close of the Post brand divestment, in relation to the Hostess purchase, full year sales are now seen down about 3%. Net debt was reported at $4.1 billion, but this was ahead of the closing of the Hostess purchase, of course, which closed days after the quarter ended.
And Now?
Having lost another 10% since September, despite a small rally in recent weeks, a $118 stock commands a 12-13 times earnings multiple, which quite frankly is modest. This comes as the press release talks about 4% organic growth but talks about 3% volume grist and 1% pricing gains, while many peers are still seeing volume declines, being a very strong sign.
This observation, the lower earnings multiple and lower interest rates make the situation look a bit more compelling, although that Smucker will continue to work with a lot of debt and certainly some product lines (certainly those acquired with the purchase of Hostess) might be susceptible to a negative impact from the success of weight loss drugs.
Weighing it all together, current levels look a lot more appealing, as I might be using any pullback to the $100 mark to begin a position here.
