Choosy Investors Choose J.M. Smucker and The Dividend Adds Value
The J.M. Smucker Company (SJM) is a “Dividend Contender” that has increased its dividend for 20 consecutive years. After being overvalued for most of fiscal year 2017 (fiscal year ends in April) the company has since fallen into attractive valuation territory. As a result, the company is available at a low P/E ratio relative to historical norms and offers a current dividend yield of 2.9%. Moreover, the company has consistently increased its dividend in line with its historical 10% earnings growth.
About The J.M. Smucker Company
The J. M. Smucker Company: Long business description courtesy S&P Capital IQ:
“The J. M. Smucker Company engages in manufacturing and marketing branded food and beverage products on a worldwide basis.
The majority of the company’s sales are in the U.S. Its operations outside the U.S. are principally in Canada, although products are exported to other countries as well. The company’s branded food and beverage products include a portfolio of primary brands that are sold to consumers through retail outlets in North America.
The company has three segments: U.S. Retail Coffee, U.S. Retail Consumer Foods, and U.S. Retail Pet Foods. The U.S. retail market segments represent a major portion of the company’s strategic focus – the sale of branded food and beverage products with primary positions to consumers through retail outlets in North America. Within the company’s segment results, International and Foodservice represents a combination of the strategic business areas not included in the U.S. retail market segments.
The company’s principal products are coffee, pet food, pet snacks, peanut butter, fruit spreads, shortening and oils, baking mixes and ready-to-spread frostings, frozen sandwiches, flour and baking ingredients, juices and beverages, and portion control products.
In the U.S. retail market segments, the company’s products are primarily sold through a combination of direct sales and brokers to food retailers, food wholesalers, drug stores, club stores, mass merchandisers, discount and dollar stores, military commissaries, natural foods stores and distributors, pet specialty stores, and online retailers. In International and Foodservice, the company’s products are distributed domestically and in foreign countries through retail channels and foodservice distributors and operators (restaurants, lodging, schools and universities, and health care operators).
Sales to Wal-Mart Stores, Inc. and subsidiaries amounted to 30 percent of net sales in 2017. These sales are primarily included in the U.S. retail market segments.
Trademarks and Patents
The company’s major trademarks are as follows:
U.S. Retail Coffee: Folgers, Dunkin’ Donuts, and Café Bustelo.
U.S. Retail Consumer Foods: Jif, Smucker’s, Crisco, Pillsbury, and Uncrustables.
U.S. Retail Pet Foods: Meow Mix, Milk-Bone, Natural Balance, Kibbles ‘n Bits, 9Lives, Pup-Peroni, and Nature’s Recipe.
International and Foodservice: Folgers and Smucker’s.
Slogans or designs considered to be primary trademarks include, without limitation, ‘With A Name Like Smucker’s, It Has To Be Good’; ‘The Best Part of Wakin’ Up Is Folgers In Your Cup’; ‘Choosy Moms Choose Jif’; ‘Purely The Finest’; ‘Goodness Gracious, It’s Good’; ‘The Only One Cats Ask For By Name’; ‘Say It With Milk-Bone’; the Smucker’s banner; the Crock Jar shape; the Gingham design; the Mountain Grown design; and the Smucker’s Strawberry, Milk-Bone, and 9Lives logos.
The U.S. Retail Coffee and U.S. Retail Consumer Foods segments are particularly seasonal around the Fall Bake and Holiday period, which results in higher sales and profits in the company’s second and third quarters (year ended April 2017). The company’s success in promoting and merchandising its coffee and baking brands during the Fall Bake and Holiday period has a major impact on its results for a fiscal year.
Research and Development
Amounts expensed for the company’s research and development were $58.1 million in 2017.
As of April 30, 2017, the company’s major competitors were as follows:
U.S. Retail Coffee: The Kraft Heinz Company; Massimo Zanetti Beverage Group; F. Gaviña & Sons, Inc.; JAB Holding Company; Starbucks Corporation; and Tata Global Beverages Limited.
U.S. Retail Consumer Foods: Hormel Foods Corporation; Ferrero SpA; Conagra Brands, Inc.; Welch Foods Inc.; General Mills, Inc.; and Pinnacle Foods Inc.
U.S. Retail Pet Foods: Nestle Purina PetCare Company; Mars, Incorporated; Ainsworth Pet Nutrition; Blue Buffalo Pet Products, Inc.; and Hill’s Pet Nutrition, Inc.
International and Foodservice: Societe des Produits Nestle S.A.; The Kraft Heinz Company; and Restaurant Brands International Inc.
The J. M. Smucker Company was founded in 1897. The company was incorporated in Ohio in 1921.”
Debunking the Dividends Don’t Add Value Myth
In my most recent article covering Costco found here there was a lively discussion debating whether dividends provide investors value or reduce it. Personally, I find these debates on the value of dividends unproductive and mostly off the mark. I’ve written about this extensively in the past, what follows next are excerpts of my past thoughts:
When competent management teams find themselves with cash that they don’t need to grow their business, it can be a wise decision to distribute it to their shareholders, and the act of doing so does not automatically reduced the value of the company. In fact, and I contend in most cases, it can have the effect of increasing future value, because it does not dilute the returns on invested capital that the company requires to grow.
Furthermore, there is no evidence supporting the notion that higher retained earnings will always result in higher expected future earnings. On the other hand, there are multitudes of evidence showing that companies that retained earnings they did not need often destroyed future shareholder value. This destruction of shareholder value often comes in the form of ill-advised acquisitions or investments that reduce returns on invested capital. Additionally, long-term shareholder destruction results when managements invest outside of their respective businesses’ core competencies.
With the above said, the primary point that this section of my article will address is the debunking of the “dividends don’t matter myth.” This myth is perpetuated by those who contend that dividends are irrelevant, because somehow in their mind’s eye a company has become permanently (emphasis added is mine) less valuable by precisely the amount of the dividend that they paid out to shareholders. Moreover, they primarily base this judgment on the fact that a company’s share price will be adjusted by the dividend amount on the ex-dividend date. To be fair, I submit that those that take this position are in some respects technically correct; however, as I will show later, there is also a practical side to this as well. Courtesy of the Securities and Exchange Commission, here is their explanation of ex-dividend dates:
When Are You Entitled to Stock and Cash Dividends
Have you ever bought a stock only to find out later that you were not entitled to the next cash or stock dividend paid by the company? To determine whether you should get cash and most stock dividends, you need to look at two important dates. They are the “record date” or “date of record” and the “ex-dividend date” or “ex-date.”
When a company declares a dividend, it sets a record date when you must be on the company’s books as a shareholder to receive the dividend. Companies also use this date to determine who is sent proxy statements, financial reports, and other information.
Once the company sets the record date, the stock exchanges or the National Association of Securities Dealers, Inc. fix the ex-dividend date. The ex-dividend date is normally set for stocks two business days before the record date. If you purchase a stock on its ex-dividend date or after, you will not receive the next dividend payment. Instead, the seller gets the dividend. If you purchase before the ex-dividend date, you get the dividend.”
Based on the above explanation, the fact that the dividend adjustment reduces the stock price is technically and mechanically correct. However, there is also the practical matter that needs to be considered and understood. Moreover, what is not precisely black and white is the notion that many hold that the payment of the dividend, theoretically at least, simultaneously reduces the earnings power and/or the intrinsic value of the company itself. In truth, this is only a theory that factually may or may not be true.
In the comment section of my Costco article Warren Buffett was often brought up. Therefore, as an aside, let’s see what the venerable Warren Buffett has to say on the subject of dividends taken from his 2012 letter to shareholders. Below are a few excerpts:
A number of Berkshire shareholders – including some of my good friends – would like Berkshire to pay a cash dividend. It puzzles them that we relish the dividends we receive from most of the stocks that Berkshire owns, but pay out nothing ourselves. So let’s examine when dividends do and don’t make sense for shareholders.
A profitable company can allocate its earnings in various ways (which are not mutually exclusive). A company’s management should first examine reinvestment possibilities offered by its current business – projects to become more efficient, expand territorially, extend and improve product lines or to otherwise widen the economic moat separating the company from its competitors.
I ask the managers of our subsidiaries to unendingly focus on moat-widening opportunities, and they find many that make economic sense. But sometimes our managers misfire. The usual cause of failure is that they start with the answer they want and then work backwards to find a supporting rationale. Of course, the process is subconscious; that’s what makes it so dangerous.”
At this point, Warren Buffett is telling us that not paying or paying a dividend to shareholders may or may not be beneficial to them or the company itself. Therefore, although in theory it might seem rational to believe that if the company did not pay out the dividend, they could grow faster or make their business more valuable longer term, in truth, this may or may not be the case; it all depends on the profit potential of the opportunities available to the respective business and/or its managers. Warren Buffett goes on to provide additional color on this subject as follows, and once again emphasis added is mine:
“Your chairman has not been free of this sin. In Berkshire’s 1986 annual report, I described how twenty years of management effort and capital improvements in our original textile business were an exercise in futility. I wanted the business to succeed and wished my way into a series of bad decisions. (I even bought another New England textile company.) But wishing makes dreams come true only in Disney movies; it’s poison in business.
Despite such past miscues, our first priority with available funds will always be to examine whether they can be intelligently deployed in our various businesses. Our record $12.1 billion of fixed-asset investments and bolt on acquisitions in 2012 demonstrate that this is a fertile field for capital allocation at Berkshire. And here we have an advantage: Because we operate in so many areas of the economy, we enjoy a range of choices far wider than that open to most corporations. In deciding what to do, we can water the flowers and skip over the weeds.”
Consequently, based on the above discussion, I contend that it is categorically incorrect to take the position that a dividend payment permanently reduces the value of a business. It may have some validity in theory, but not always, and certainly not absolutely. There are certain situations where paying the dividend when the cash is not needed to fund or facilitate future growth can actually enhance the future value of the business, as Warren Buffett described above. Conversely, it might actually hurt the business if appropriate and attractive investment opportunities are not readily available.
Theory may be useful in some academic settings, for example, as teaching points. However, in order to be useful, they must also apply in real-world situations. The above theory contending that dividends offer no true added value very often fails that test, as I will illustrate next.
The Practical Side and Benefit of Dividends
Personally, I believe that it is undeniable that dividend income, if any, represents an important component of the total return provided to shareholders of any publicly traded company. More importantly, I believe that the dividend received from a publicly traded company represents significant investment benefits.
First of all, and practically speaking, once I receive a dividend from a company I own, I have less money at risk precisely proportionate to the amount of my dividend check. Therefore, I understand that I simultaneously have reduced the risk of owning that stock simply because I now have less money at risk. Moreover, I did not have to sell any shares to receive that cash back, therefore, my beneficial ownership interest in the company remains intact. More simply stated, I still have all my shares.
Moreover, I believe that the dividend I receive also represents a return bonus. This belief is based on the reality that the payment of the dividend does not reduce the amount of earnings that the company reported on its last financial statements. Therefore, my experience indicates that “Mr. Market” will continue to capitalize the company’s future earnings in the aggregate, just as they always have and do. I have written extensively on the subject in the past – here are links to just two of my past articles. I stand by those articles and will let them elaborate on these last points.
Furthermore, in the analyze out loud video on The J.M. Smucker Company that follows I will provide real-world evidence supporting the reality that earnings and/or cash flows drive capital appreciation and dividends paid to shareholders provide an additional income component and effectively a return of original investment. The two combined, capital appreciation plus dividend income, represents the components that add up to total return.
The J.M. Smucker Company: FAST Graph Fundamental Analyze Out Loud Video
Source: F.A.S.T. Graphs Video
Summary and Conclusions
After being overvalued for most of fiscal year 2017 ending in April, the J.M. Smucker Company has moved into attractive valuation based on fundamentals. When a company is overvalued like J.M. Smucker was, it becomes very vulnerable to even a hint of bad news. J.M. Smucker’s most recent quarterly report and lowered guidance disappointed investors. However, I do not believe this company faces any threat of imminent demise.
It is a solid consumer staples company that produces strong and consistent earnings and cash flows. Future growth is expected to be lower than historical achievements, but I believe the current valuation compensates for that lower growth. Therefore, investors interested in a growing dividend income stream plus the potential for moderate capital appreciation might want to take a closer look at the J.M. Smucker Company.
Disclosure: No position at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.