Initiating Coverage

The J.M. Smucker Company - SJM- $103.38 Analyst Name: Alec Messino

Phone Number: (708) 548-7600

Recommendation: Buy Price Target: $120.00
Sector: Consumer Staples Industry: Packaged Foods Date: September 4th, 2018

Investment Thesis:
My 2018 price target of $120.00 represents a stock appreciation of 16% and a total investor return
of 19.3% through a strong dividend. I identify the following drivers behind the projected return:
 A commitment to growth in the pet category: As the largest center-of-store grocery category, pet food and
snacks is a$32 billion industry in the U.S. and growing. With the firm's recent acquisition of Ainsworth Pet Nutrition
LLC, Smucker's is increasing its presence in the premium segment and bolstering its total pet portfolio.
 A strong opportunity to pursue an even larger share of the popular one-cup and premium segments:
Smucker's leads the U.S. Retail Coffee Market with a 26 percent dollar share through a commanding position in the
mainstream, instant, and the one-cup and premium segments, which account for two-thirds of category sales.
 Opportunity for growth in International and Away From Home markets: Segment growth opportunities
continue through a strategic focus on broadening products offered in the markets we serve across our three key growth
categories: coffee, pet, and snacking.

Investment Risks:
 Intensification of price wars among competitors and the strong competition from private-label and niche brands
has the potential to diminish profit margins.
 Revenue growth in the International and Away From Home segment may not be significant enough in the near-
term to have an impact on J.M. Smucker's financial performance.
 Recent results, and potentially future earnings, were impacted by higher freight costs, which may weigh on the
company’s margins as it expects freight headwinds to linger into 2019.

Business Overview:
 The J.M. Smucker is an iconic American company founded in 1897. Guided by a vision to engage, delight, and
inspire consumers through trusted food and beverage brands that bring joy throughout their lives, Smucker has
grown to be a well-respected North American marketer and manufacturer. Smucker's has four reportable
segments: U.S. Retail Coffee, U.S. Retail Consumer Foods, U.S. Retail Pet Foods, and International and Away
From Home. The U.S. retail market segments in total comprised approximately 85 percent of net sales in 2018
and represent a major portion of our strategic focus – the sale of branded food and beverage products with
leadership positions to consumers through retail outlets in North America.
Current Environment
As the food industry continues to face unprecedented change, Smucker's is evolving to meet shifting consumer
preferences and behaviors. This past year, the firm experienced pricing pressure from retailers, strong
competition from private-label and niche brands, a continued shift toward e-commerce purchases, and input
cost inflation. However, the ability to adapt has long been a hallmark of the company and the firm remains
confident the actions they are taking to align their portfolio for growth are positioning the company to deliver
long-term shareholder value.

Strength of Leading Brands and Segments

Smucker's brands can be found in 92 percent of U.S. households, and they hold market leadership positions
through Smucker’s fruit spreads, Jif peanut butter, Folgers® coffee, and Milk-Bone dog snacks. The leading
brands are critical to fueling future growth and investments for the company, and it's evident that driving
growth from these well-established brands generates strong returns. Beyond individual brands, a significant
element of the firms strategy centers on strengthening the company’s overall, diversified portfolio with a
particular focus on the coffee, pet, and snacking categories.

Innovating to Align with Customer Trends

Smucker's innovation pipeline aligns well with shifting consumer trends. In coffee, the firm recently introduced
1850™ as a new premium coffee brand that will be the basis for a range of 1850 products. Inspired by the 170-
year heritage of the Folgers brand which originated in San Francisco during the Gold Rush, 1850 tells an
authentic story that resonates with premium coffee consumers of all ages.

Investing In Capabilities
The relentless pace of digital innovation is fundamentally changing the way consumers shop. In response,
Smucker's recently completed an organizational restructure with a significant commitment to marketing and
digital innovation, especially e-commerce. With more than 2 percent of sales coming from e-commerce today,
the company has ample opportunity for growth. The firm's expectation is that e-commerce will account for 5
percent of total net company sales by fiscal year 2020 as digital capabilities enable them to be more agile and
responsive to consumer needs. Additional supply chain flexibility and development of channel-exclusive offers
are expected to improve Smucker's current e-commerce margins.

Progress toward this goal is already evident. In fiscal year 2018, Smucker's total e-commerce sales increased
71 percent, with pet and coffee e-commerce sales up 64 percent and 154 percent, respectively. I believe both
categories are well-suited for a subscription model and hopefully the company is envisioning the same. In fact,
20 percent of Natural Balance® brand sales were generated through the e-commerce channel. As the firm
continues to build e-commerce capabilities, Smucker's is investing heavily in data analytics to enhance
decision-making in key areas such as site-specific search engine optimization, impulse purchasing, and pricing
strategies. I anticipate another year of strong e-commerce growth in fiscal year 2019.

Synergy and Cost Savings

Executing against the strategic road-map while maintaining earnings growth relies on cost management to
support innovation and investment activities. During fiscal year 2018, Smucker's achieved a targeted $140
million in incremental synergies and cost savings. This achievement keeps the firm on track to meet their goal
of $450 million in cost savings by fiscal year 2020.

Source: AT&T
Investment Thesis

J.M. Smucker's is a strong investment due to its reliable dividend, pet food and snacks expansion,
international diversification and growth, and innovation in the coffee segment. Smucker's dividend offers a
3.29% yield in 2018, far higher than the consumer goods average of 2.04%, which the company has
continually increased for 16 consecutive years. Strong cash flows and operating performance justify its ability
to fulfill its 40.4% payout ratio, yet presents the opportunity for further increases to come. In response to a
changing consumer goods landscape, JM Smucker's is venturing further into the e-commerce model, K-Cup
and instant coffee segments, and diversification abroad. Expansion into Canada, Mexico, the Carribean, and
Latin America geographically diversifies revenue, provides access to new customers, and paves the way for a
comprehensive North American supply and distribution network. Finally, the company's emphasis on
acquiring companies in the pet category segment and constantly innovating in the retail at-home coffee
segment via partnerships and premium brands to maximize the long-term development of a changing
consumer retail industry. Our thesis remains that Smucker’s portfolio of iconic and emerging food brands,
more robust innovation agenda, synergy, and cost management actions—countered in part by current mixed
retail food industry dynamics—support a solid long-term total shareholder return opportunity.

A Commitment to Growth in the Pet Category

Three years ago, Smucker's entered the growing pet food and snacks category with the acquisition of Big
Heart Pet Brands and have further demonstrated our commitment to this category with the recent
acquisition of Ainsworth Pet Nutrition.

Key Achievements

• Maintained the #1 market share position in dog snacks, the #2 position in dry cat food, and a strong
presence in premium pet food.

• Completed acquisition of Ainsworth Pet Nutrition in fiscal year 2019 and began integration.

• Increased presence in the premium pet segment through Rachael Ray Nutrish, complementing the success
of Nature’s Recipe with the Rachael Ray Nutrish’s wholesome, natural positioning and authentic recipe-
focused formulations.

• Strengthened dog food position in the mass channel, which drove an 8 percent increase for our dog food
brands in fiscal year 2018 sales, driven by 33 percent growth for Nature’s Recipe.

FISCAL YEAR 2018 PERFORMANCE

Segment Profit $493.9 $481.0 Segment Net Sales $2.3

$441.3 $2.1 $2.2
in millions in billions
Topline growth in key Investments in
segments, combined with the Nature’s Recipe,
scale and efficiencies from the Rachael Ray Nutrish
Ainsworth acquisition, and dog snack
should lead to segment innovation will drive
profit growth. ’16 ’17 ’18 topline growth. ’16 ’17 ’18

A PORTFOLIO MEETING DIVERSE PET PARENT NEEDS

Super Premium Premium Mainstream Value Snacks

• Natural Balance • Nature’s Recipe • Meow Mix • Gravy Train
® • Milk-Bone
• Rachael Ray • Kibbles ‘n Bits • 9Lives® • Rachael Ray
Nutrish • DAD’S Nutrish
• Pup-Peroni
• Canine Carry Outs®
• Milo’s Kitchen
 OPPORTUNITY FOR GROWTH IN PET CATEGORY

Pet ownership and spending is rapidly growing in the U.S. $32 BILLION
In fact, pet spending in the U.S. has grown 4.6% annually U.S. market
over the last 10 years, which is three times the growth of
total consumer spending. Not only that, total pet care spending
kept growing during the last three recessions. 60%+
American households
About 40% of that pet spending is for pet food, which is why we are pet families
believe that J.M. Smucker is opportunely positioned in this
segment with a diverse product mix of pet foods, including super U.S. RETAIL PET FOODS SEGMENT
premium, premium, mainstream, value, and snacks. This wide 33% PET SNACKS
range of offerings should help Smucker's reach every type of
customer at any price point, fueling consistent growth no matter 30% MAINSTREAM CAT FOOD
the economic environment. 23% MAINSTREAM DOG FOOD
14% PREMIUM PET FOOD
International Diversification

International and Away From Home businesses include domestic sales outside U.S. retail channels and foreign
sales, primarily in Canada, Mexico, and the Caribbean. We are also a preferred supplier of food and beverages
to North American foodservice operators, including casual and fine dining establishments, schools and
universities, hospitals, and business and industry customers.

Key Achievements
• Increased sales $32.4 million and profits by 9.1m, driven in large part by significant growth in Away From
Home and International.

• Outperformed year-one sales targets for the launch of the Jif brand in the Canadian market to meet consumer
demand.

• Experienced double-digit growth of the Smucker’s Uncrustables brand as an Away From Home snack that
consumers of all ages can enjoy.
FISCAL YEAR 2018 PERFORMANCE

Segment Net $1.1 $1.1 $1.1 $194.2

Segment Profit $179.0 $185.1
Sales in millions
in billions
Increased
Sales increased from profitability reflected
$1,062 million to continued efforts to
$1,094 million in refine our focus on
fiscal year 2018. ’16 ’17 ’18
key growth ’16 ’17 ’18
categories.

MARKET LEADERSHIP
Smucker Foods of Canada holds #1 share positions across 6 categories, including flour, pickles and
relish, fruit spreads, canned milk, shortening, and ice cream toppings. These brands represent
approximately 50% of net sales in Canada! The most important thing that I can note here is that
they are entering a lucrative market and the consumers in that market are responding well. I expect
that as Smucker's further enters markets such as Canada, Mexico, and the Caribbean, we will see
growth in some of the well-known brands while introducing some of the other many offerings that
the company has.
 OPPORTUNITY FOR GROWTH IN THE COFFEE SEGMENT

Segment growth opportunities continue through a strategic focus on broadening products offered in
the markets we serve across our three key growth categories: coffee, pet, and snacking.
• Coffee machine innovations should drive future growth in liquid coffee. The 1850 brand also will be
introduced in the Away From Home market to meet demand for more premium offerings. Excellence
Compact delivers a variety of specialty coffee beverages by way of our proprietary Select Brew liquid
coffee system and enables us to enter channels and locations such as offices and restaurants through
its sleek and modern design.

• With big plans on the horizon for innovations in pet snacks, confidence in the growth potential of pet
foods is strong. Sales increased 64 percent during fiscal year 2018, underscoring the potential of
subscription sales for pet food.

• The addition of new customers and increased sales from current customers, especially in portion-
control products, is driving growth. Snacking continues to be a major trend, with Smucker’s
Uncrustables and Sahale Snacks both gaining popularity in the Away From Home market.

Iconic Brands and Innovative New Platforms Fuel American Coffee Consumers

America’s love affair with coffee shows no signs of slowing, and Smucker's is innovating
and building on our already market-leading coffee portfolio to meet consumer demand.
Key Achievements

• Added largest investment in coffee with the recent launch of the innovative 1850 platform, serving as
the basis for a range of new 1850 products to drive growth for years to come.

• Continued to lead the mainstream and instant market segments with a 54 percent share and 27
percent share, respectively.

• Maintained Dunkin’ Donuts momentum, reaching$550 million in annual net sales and growing 10
percent in U.S. Retail Coffee.

• Increased sales of Café Bustelo by 9 percent, thanks to an ever-increasing consumer base drawn to its
authentic heritage and Latin roots.

• Expanded K-Cup® distribution under terms of new agreement with Keurig Green Mountain,
resulting in sales increases across all K-Cup® brands.

FISCAL YEAR 2018 PERFORMANCE

$2.2 $722.6
$2.1
Segment Net $2.1
Segment Profit
$682.4
$614.5
Sales in millions
in billions
Investments in brand
We are accelerating building and marketing
efforts to shift our are positioning our
portfolio to better coffee portfolio for the
align with consumer ’16 ’17 ’18 ’16 ’17 ’18
long term.
preferences.
 Smucker's leads the U.S. Retail Coffee Market with a 26 percent dollar share through a commanding position in the
mainstream and instant segments. Looking ahead, we see a strong opportunity to pursue an even larger share of the
increasingly popular one-cup and premium segments, which account for two-thirds of category sales.

Smucker's Coffee Market Share Total At-Home Coffee Category As previously noted, Smucker's holds a 26% share, in
dollars, of the overall at-home coffee market. That is
impressive, but there is further room for growth and a
15% 42% ONE-CUP turnaround in sales. On the innovation front, JM
One-cup 25% MAINSTREAM Smucker's is rolling out a new premium coffee
24% PREMIUM platform, named 1805 as inspired by the Folgers’

54% 9% INSTANT heritage, resonating with both core consumers and

millennials. A full media campaign is telling the story
Mainstream of 1850, highlighting 170 years of rich Folgers heritage
dating back to its origins in San Francisco during the
California Gold Rush.
15% In that same vein, Smucker's online coffee sales
Premium
increased 154 percent in fiscal year 2018, and the
category has strong potential for a subscription sales
model whereby you can automate deliveries straight to
27% your door monthly or on an ad-hoc presence, which is
Instant what newer generations are keen to.

Investment Risks

Higher Freight Costs a Worry, Stock Underperforms: Smucker's continues to bear the brunt of higher
freight expenses. As a result, gross margin contracted 40 basis points to 36.8% in the first quarter of fiscal
2019. Further, the company expects freight headwinds to linger into fiscal 2019, which remains a threat to
margins. Such headwinds have hurt investors’ sentiments, evident from the stock’s 17.8% decline in the past
six months compared with the industry’s 2.2% decline.

Lower Net Price Realization: The company’s top line was impacted by lower net price realization to the tune
of 1% in the first quarter. During the quarter, Smucker's witnessed lower net price realization in the coffee
segment due to increased trade spend. Also, sales in International and Away from Home were somewhat hurt
by lower net price realization.

High SG&A cost & Interest Expense: The company’s SG&A expenses witnessed 10% year over year growth
to $383.3 million during the first quarter owing to the addition of Ainsworth. Also, interest expenses rose
27.6% to $53.6 million due to costs related to the Ainsworth acquisition. We note that interest expenses went
up by 6.9% and 17.6% in the third and fourth quarter of fiscal 2018, respectively. Persistence of these trends
remains a concern for the company’s bottom line.

Currency Headwinds: Unfavorable currency fluctuations lower revenue growth prospects and therefore
remain a considerable headwind for Smucker's. Although currency impacts were neutral during the first
quarter, volatility in exchange rates pose formidable risks for the periods ahead, owing to the company’s
significant exposure to international markets.

Price Target

To finalize a price target for Smucker's an average was taken of three different share price calculations. Price
estimates used were derived from free cash flow analyses using perpetuity growth and exit multiple models as
well as applying my own 2019 EPS forecast to the consensus 2019 P/E. With a $12.89 estimated 2019 EPS
and consensus P/E ratio of 9.31x, we found our third and final price estimate of $120.00. An averaging of
these price targets provides us with a 2019 year-end price target of approximately $120.00.