J.M. Smucker Stock Analysis – Covered Call Profit Skim

(Last Updated On: November 21, 2017)

Summary

  • SJM recently reported Q2 results reflecting a marginal deterioration in adjusted gross profit margin and adjusted operating income margin relative to Q2 2017.
  • Adjusted EPS revised downward for the second time subsequent to the release of FY adjusted EPS in June 2017 but FCF forecast remains consistent at $0.775B.
  • SJM has a 4 pronged strategy in which it intends to generate sustainable, long-term sales and earnings growth.
  • Competitive pressures persist but SJM has strong brand recognition. Underperformance is largely due to temporary factors.
  • SJM will likely trade in a tight range over the next several months thus providing an opportunity to skim some profit through the use of covered calls.

Introduction

On June 10, 2017 I reviewed The J.M. Smucker Company (NYSE: SJM) and indicated that with a pull back in price I viewed SJM as reasonably priced. I, therefore, acquired 200 shares for the FFJ Portfolio. SJM’s stock price experienced a further pullback and I subsequently acquired another 200 shares.

SJM is certainly experiencing some challenges but as a long-term investor I do not bail if I think management has a sound game plan. Having said this, I suspect SJM’s stock price is likely to trade in a tight range over the next several months. I, therefore, think SJM is a suitable candidate in which to employ a covered call strategy thus allowing me to skim some option premiums while I wait for business to improve.

Q2 2018 and Forecast

On November 16, 2017, SJM released its Q2 2018 results and provided guidance for the remainder of the current fiscal year.

SJM experienced a negligible increase in total sales and suffered from margin compression thus negatively impacting cash provided from operating activities and adjusted EPS.

Source: SJM Q2 2018 Results November 16, 2017

On June 8, 2017, SJM projected $7.85 – $8.05 adjusted EPS for FY2018.

On August 24, 2017 when it released its Q1 results, this range was revised downward to $7.75 – $7.95.

With the release of Q2 results we now have a further downward revision in adjusted EPS to $7.75 – $7.90 for FY2018.

On a positive note, Free Cash Flow remains as originally communicated when Q4 2017 results were presented in June.

Source: SJM Q2 2018 Results November 16, 2017

Prior to investing in SJM I reviewed the company’s strategic roadmap in which management explained that four foundational pillars (innovation, investment, cost savings, and acquisitions) were to provide a path to sustainable, long-term sales and earnings growth.

Innovation

On the innovation front, SJM has introduced products in the past 3 years which have contributed 6% of Q2’s net sales. New product offerings include Dunkin’ Donuts Cold Brew Coffee and Natural Balance high protein dog food. In addition, several other product launches are scheduled for later this fiscal year.

Investment

SJM is investing heavily to improve the competitive positioning of its dry dog food portfolio. Results to date are positive.

An area in which SJM is investing is in e-commerce across all brands and businesses. SJM has experienced growth through this channel but much upside potential still remains in that only ~2% of its U.S. retail sales came from e-commerce in Q2; the objective is to increase this to at least 5% of net sales by FY2020.

Investments are being made to improve margins by focusing on supply chain flexibility and customized products and packaging.

SJM is constructing a new “Uncrustables” sandwich facility. Once completed in FY2020, this facility will have the capacity to double annual net sales to $0.5B.

Cost Savings

On the cost savings front, SJM completed its $0.2B pet food synergy program in Q2. A $0.25B cost management program is also a work in progress and most of the cost reductions will come about in the second half of the current fiscal year.

Acquisitions

On the acquisition front, SJM will likely be closing the acquisition of the Wesson® oil brand from Conagra Brands, Inc. (NYSE: CAG) in the current fiscal year.

Dividend and Dividend Yield

SJM’s dividend distribution history can be found here. At $0.78/quarter and a share price of $114.19 (November 17, 2017 close), the dividend yield is ~2.73%.

SJM generates adequate cash flow to meet its dividend obligations.

Source: Morningstar

Valuation

The current mean FY2018 adjusted EPS estimate from various brokers is $7.77. This is a reduction from the $7.93 estimate at the time I wrote my June 10, 2017 article.

Source: TD WebBroker

Given the 2 downward revisions subsequent to June 2017, I am reluctant to use the high end of the new adjusted EPS forecast to determine SJM’s forward adjusted PE. Using $7.75 which is the low end of the new range and the current stock price, I get a forward adjusted PE of ~14.73. I view this as an acceptable level.

Covered Call Strategy

I do not know when SJM’s acquisition of the Wesson oil brand is going to close but even if the transaction closes within the next few months I don’t envision this new business having an immediate impact on SJM’s stock price. In my opinion, SJM’s stock price will trade in a tight range for the next several months and is unlikely to rise beyond $125. I have, therefore, written four $125 July 2018 contracts at $2.90/share thus generating $1160 in option premium before commission.

I am cautiously optimistic these contracts will expire worthless come July 2018. If, however, SJM’s stock price surges above $125 before expiry I will likely close my position and roll forward at a higher strike price as it is not my intent to part with my SJM shares.

The J.M. Smucker Company – Final Thoughts

SJM is certainly experiencing some challenges in various business lines but this is not the first time it has done so in its 120 year history; its products have always competed for shelf space with other well known brands.

Management has a game plan to restore growth and margins. I suspect the current challenges are temporary. Investors, however, will likely keep the company’s stock price in a tight trading range for the next several months as they await the results of management’s efforts to improve performance.

Since my intent is to retain our SJM shares in the FFJ Portfolio and to reinvest all dividends I view this as an opportunity to skim some profit through the use of covered calls.

I wish you much success on your journey to financial freedom.

Thanks for reading!

Note: I sincerely appreciate the time you took to read this post. As always, please leave any feedback and questions you may have in the “Contact Me Here” section to the right.

Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

Disclosure: I am long SJM.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.

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