J. M. Smucker: Not A Sweet Deal

In February of this year I concluded that I was losing my taste in the case of The J. M. Smucker Company (NYSE:SJM). Shares enjoyed a re-rating since the pandemic, yet this re-rating left shares more than fairly valued in my opinion, with structural sales growth being hard to find. The market multiple and cheap divestment made me lean a bit cautious.

Fearing a buy high, sell now pattern on the M&A front, Smucker pursued a substantial and expensive deal for Hostess. This raised quite some questions on leverage and growth, as quite frankly I would like a bit more conservative practices.

Some perspective

In the fiscal year 2020, J.M. Smucker was a $7.8 billion diversified food business which posted solid profits with EBITDA reported at $1.7 billion that year, on which operating profits of $1.2 billion were reported. This was ahead of two small divestments, that of Crisco and Natural Balance, both announced towards the end of 2020. These deals made that leverage would fall towards the $4 billion mark, with leverage ratios seen in the mid 2s.

The company posted earnings around $8 per share, translating into reasonable multiples of 14 times earnings as shares traded in the $110s at the time. Since the pandemic year the company has been posting rather stable results, with revenues reported at $8.0 billion in the fiscal year 2021 and the fiscal year 2022 (which ended in the summer that year).

Performing Flattish

GAAP earnings actually fell a bit amidst inflationary trends, but mostly amortization charges. 2022 GAAP earnings came in at $5.84 per share, although adjusted earnings rose to $8.88 per share, due to a modest reduction in the share count over time. Net debt actually creeped up a bit to $4.3 billion, as EBITDA fell to $1.6 billion in 2022, resulting in leverage ratios moving up to 2.7 times.

Despite the sluggish performance, shares rose to a high of $160 around the start of 2023, trading at $150 when I looked at the shares in February. This meant that shares have re-rated from 14 to 17 times earnings, all while leverage rose a bit and growth was really not seen.

Even in the inflationary environment for the fiscal year 2023, the initial outlook was utterly underwhelming. While sales were seen up 4%, that is not that impressive in an inflationary environment. Adjusted earnings were seen at midpoint of $8.05 per share, although hurt by an estimated $0.90 per share impact from a JIF peanut butter product recall.

By February, the full year sales guidance was hiked towards 6%, with earnings seen at $8.55 per share. That looks good, but net debt rose to $4.6 billion, pushing up leverage above 3 times. Moreover, the company announced a $1.2 billion deal to sell several pet food brands to Post Holdings (POST), with the price tag looking soft as some $1.5 billion in sales would leave the door. In fact, the company anticipated about $0.45 per share in dilution as these activities are clearly not that profitable.

This would mean that sales would fall from $8.4 billion to $7.0 billion, all while leverage would fall to $3.4 billion (although that a big portion of the deal was paid in the form of Post stock). Given this I was quite cautious on Smucker, as it looked as if the business was engaging in buying high, selling low practices.

Trading Stagnant - Coming Down

Shares of Smucker have largely traded around the $150 mark since February, but they fell some $10 to $132 at the moment of writing on the back of a huge deal.

In June, Smucker posted its 2023 results with revenues up from $8.0 billion to $8.5 billion, with the Post deal closing just a few days before fiscal year-end. In connection to the sale, the company took a billion dollar impairment charge, as adjusted earnings for the year came in at $8.92 per share, topping original estimates. Adjusted EBITDA came in at $1.60 billion, but note that replicating such results was hard given the divestment of activities to Post.

That said, the 2024 outlook was impressive, with comparable sales seen up by 9% at the midpoint of the guidance, with adjusted earnings actually seen up to $9.20-$9.60 per share. Net debt was posted at nearly $3.7 billion, but this excludes the shares held in Post, as these have traded largely flattish since the announcement of the deal.

In August, Smucker posted first quarter results as the strong start to the year meant that the earnings guidance was hiked by a quarter of a dollar, on both the lower and higher end of the range. Amidst aggressive buybacks, net debt ticked up to nearly $4.1 billion, pushing up leverage a bit.

With 103 million shares trading at $142, the company commanded a $14.6 billion equity valuation, or $18.7 billion enterprise valuation. This is for a business generating about $7.5 billion in sales, $1.5 billion in EBITDA and earnings close to $10 per share.

A Huge Deal

in September, Smucker surprised its investors a bit as it announced a $5.6 billion deal to acquire Hostess Brands (TWNK). Known from sweet baked good brands like Hostess, Twinkies, CupCakes and others, the deal takes place at an elevated 17.2 times EBITDA multiple, suggesting a $325 million EBITDA contribution. After guiding for an estimated $100 million synergy number, (equal to nearly 7% of sales), this multiple falls towards 13.2 times. In comparison, Smucker trades around 13 times EBITDA itself.

In comparison, Hostess is set to add $1.5 billion in sales, the same as the activities divested to Post, although that deal only took place at a $1.2 billion valuation. Nonetheless, Sucker anticipates that the deal will be accretive in year one, which looks highly ambitious given the anticipated interest costs associates with the deal, suggesting that synergies are likely to be achieved fast.

The company anticipates that net debt will jump to $8.6 billion. This comes as current net debt stands at $4.1 billion, the deal is valued at $5.6 billion, but about $600 million of the purchase price will be paid for in Smucker stock (with $4.25 per share of the $34.25 per share offer being paid for in stock). The remainder is likely anticipated deleveraging ahead of deal closing.

The company sees pro forma leverage at 4.4 times which suggests that EBITDA is seen around $2.0 billion, or just shy of that. This looks quite upbeat with EBITDA trending around $1.5 billion for the acquired business and Hostess generating about $325 million in EBITDA. Even a full realization of synergies does not produce an EBITDA number close to $2.0 billion, likely as the company factors in some (earnings) growth until deal closure.

Final Word

The fact that The J. M. Smucker Company shares are down some $10 per share, or over a billion dollar terms, in response to the deal announcement clearly says that the market believes that Smucker overpaid for Hostess, and so do I. If the company can deliver on earnings per share accretion, which I doubt in year one, earnings are likely stuck around $9-10 per share. This results in a non-demanding multiples at $130, yet leverage is far higher than I am comfortable with, as I have doubts on the expected accretion comments.

The other big drawback is the positioning, as the products of Hostess do not really coincide with better-for-you brands, although there is still great demand for less healthy product, unfortunately.

Given all this, I completely understand why The J. M. Smucker Company investors are cautious as the price is rich, and leverage is very high, too high for my comfort, certainly in this interest rate environment.

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