As you know, I believe that the best way to build a dividend growth portfolio is one stock at a time. I have not completely eschewed ETFs (I own 2), but I like to do targeted research that focuses on what I want out of a stock.
In looking at individual stocks, it is hard these days to find value. It is unmistakably true that the 9-year-long bull market has pulled stock prices up nearly across the board, often resulting in valuations that don’t seem to offer much upside from current prices.
But when you do that, you miss the individual values that may be available.
You can’t see them by looking only at the forest. You’ve got to look at individual tress.
Over the past few months, I have written about several “trees” that have not been following the general upward trend of the market.
In 2017, I have presented the 6 stocks below as Dividend Growth Stocks of the Month.
The chart shows price changes over the past 3 years. What do you notice?
Here’s what I notice: Their prices have remained about flat or even declined. You can buy them now for only a little more or quite a bit less than you would have paid 2-3 years ago.
In the meantime, each of those companies has been raising its dividend. Rising dividend + flat price = better value. Their dividend streams are not only higher than they were a couple of years ago, but the income streams cost less to purchase.
During that same time, here’s what “the market” has done:
The market hasn’t remained flat. In the past 3 years, it’s gone up 32%.
That’s why I like to look at the trees one at a time.
This month’s stock – JM Smucker (SJM) – follows the same pattern as the other 6 stocks depicted earlier: It’s price has not gone up with the market.
Let’s take a look and see whether Smucker is a promising dividend growth stock at its current price.
Smucker’s Dividend Record
This is a pretty good dividend resume. Its strongest points are the 3% yield, 20-year streak of increasing dividends, low payout ratios, and the excellent dividend safety score from Simply Safe Dividends. (For more insight on dividend safety, see Dividend Growth Investing Lesson 17.)
Smucker’s mediocre points relate to its dividend growth rate. This year’s 4% increase was a falloff from previous years. Here is its 2017 4% growth rate compared to earlier periods:
I’ve found no obvious reason for this year’s falloff; I surmise that the company is simply trying to improve its financial picture. I rate the falloff as OK rather than flagging it, because of the company’s comfortable payout ratios and strond dividend safety.
Smucker’s Business Model and Company Quality
Smucker is a mid-cap packaged food goods company. Its products include coffee, peanut butter, fruit jellies and spreads, shortening and oils, ice cream toppings, health and natural foods, and pet food. The company operates in 3 segments, each of which account for around 1/3 of sales.
• Consumer foods
• Pet foods
Most sales are in the USA and Canada. Smucker’s products are sold to food retailers and wholesalers, groceries, drug stores, club stores, mass merchandisers, discount and dollar stores, natural foods stores and distributors, pet specialty stores, and online retailers. Wal-Mart accounts for about 30% of domestic sales.
Smucker’s roots go back to 1897. Their headquarters is in Orrville, OH. The company was incorporated in 1921 and first offered stock to the public in 1961. Family members control more than 50% of the stock, and the company is headed by Mark Smucker, the 5th generation of the family to run the company.
Smucker’s strategy is summed up on the following display.
Smucker has a terrific portfolio of brands. Some of the most famous, besides Smucker itself, include Folgers, Dunkin’ Donuts, Crisco, Pillsbury, Jif, Hungry Jack, Crosse & Blackwell, Carnation, Natural Balance, 9 Lives, Meow Mix, Nature’s Recipe, and Milk Bone. The company estimates that 93% of all US households have at least 1 Smucker product inside.
Participation in excellent categories is exemplified by Smucker’s acquisition in 2015 of Big Heart Pet Brands. That made the company the leading maker of dog snacks (Milk-Bone) and dry cat food (Meow Mix).
Smucker’s innovation pipeline is illustrated by its acquisition of Big Heart and also by its recent tie-in with Dunkin’ Donuts. The latter involves the introduction of Dunkin-branded K-Cups, which should help position Smucker to benefit from K-Cups continued growth. The fact that Smucker holds popular brands in the mainstream and premium K-Cup segments makes the company an especially valuable partner for retailers and Keurig, which depends on its partner brand portfolio to spur ongoing single-cup growth. Morningstar gives Smucker a narrow moat rating (its 2nd-highest), based on:
• Smucker’s strong brand portfolio across its three operating segments (coffee, pet foods, and consumer foods)
• Its leading share positions and the resources it deploys to support its brands
• The company’s strong relationships with retailers, which allow it to gain shelf space for new products and line extensions
• Its expansion in the growing pet sector that came with the Big Heart acquisition
Like most packaged-food companies, Smucker faces headwinds from the changing tastes of millennial buyers. Smucker’s prepared products are generally sold in the “center of the store,” while buying habits may be trending toward the “perimeter of the store” where fresh goods are sold. The long-term impact of this apparent trend is hard to discern at this time.
Smucker has the most “OK” financial summary among all of the Dividend Growth Stocks of the Month.
Take a look at this.
This paints a picture of a solid, steady but unspectacular company, with relatively conservative financing and a middling growth record.
As shown below, Smucker’s earnings per share were generally rising annually until 2015. Then they fell (while remaining solidly positive), and they have been erratic (but positive) since then.
[Source of all yellow-bar graphs: Simply Safe Dividends]
Cash flow presents an erratic picture, but again it is always positive.
Smucker’s debt jumped in 2015 after being very moderate for years. Debt’s role in the capital structure has been declining since 2015.
Note that 2015 is the year that Smucker’s bought Big Heart. You can see that it impacted the company’s earnings and debt picture. While it opened a new area for expansion and strategic entry into a new segment, Smucker was criticized at the time for paying too much. It is in the process now of absorbing the acquisition and recovering financially from the move.
I believe that the impact of the acquisition has also played a role in the market’s valuation of Smucker. In this chart, notice how the pricing of Smucker and the S&P 500 run roughly in tandem until 2016. Then Smucker took a big jump up followed by a pretty steep price decline continuing to the present, while the market has continued upward.
I personally think the market has overreacted to whatever Smucker’s perceived problems are. It looks to me that Smucker has improved as a company while the market has been pricing it in the last year as if it were falling apart.
Let’s see whether the price drop has made Smucker into an attractive value.
Smucker’s Stock Valuation
You can buy a share of Smucker today for the same price as before the Big Heart acquisition in 2015. While that has meant poor total returns for investors who held the stock, they have nevertheless benefitted from Smucker’s annual dividend increases.
For new buyers, the good news is that now you can buy Smucker’s larger dividend for less than buyers in late 2014.
My 4-step process for valuing companies is described in Dividend Growth Investing Lesson 11: Valuation. Let’s go through the steps for Smucker.
Step 1: FASTGraphs Default. The first step is to compare the stock’s current price to FASTGraphs’ basic or default estimate of its fair value.
That basic estimate is based on a standard reference price-to-earnings (P/E) ratio of 15, which is shown by the orange line on the following chart. The black line shows Smucker’s actual price.
By this first valuation step, Smucker is undervalued. Its current P/E ratio of 13.5 is just 0.9, or 90%, times the reference fair-value P/E of 15.
Dividing the current price by 0.9 gives us an estimated fair price of about $116 compared to the stock’s actual price of about $104 per share.
Step 2: FASTGraphs Normalized. The second valuation step is to compare Smucker’s price to its own long-term average P/E ratio. This gives us a picture based on the stock’s long-term market valuation instead of the market’s long-term valuation.
Here, the fair value reference line is in dark blue. It is drawn at a value of P/E = 17.4, because that is Smucker’s long-term average valuation going back before the Great Recession.
Viewed from this perspective, Smucker is even more undervalued than in the first step. The degree of undervaluation is 13.5 / 17.4 = 0.78, or 22% undervalued. This suggests a fair price of $133.
Step 3: Morningstar Star Rating. Morningstar uses a discounted cash flow (DCF) process for valuation. Their approach is comprehensive and detailed. Many investors consider DCF to be the best method of assessing stock valuations.
In their approach, Morningstar makes a projection of all the company’s future profits. The sum of all those profits is discounted back to the present to reflect the time value of money. The resulting net present value of all future earnings is considered to be the fair price for the stock today.
Morningstar thinks Smucker is undervalued. On their 5-star system, they give the company 4 stars and calculate a fair price of $132.
Step 4: Current Yield vs. Historical Yield.
Last, we compare the stock’s current yield to its historical yield. This is an indirect way of calculating fair value, based on the idea that if a stock’s yield is higher than normal, it may indicate that its price is undervalued (and vice-versa).
According to Morningstar, Smucker’s 5-year average yield has been 2.2%. The current yield of 3.0% is 36% above that.
When I use this 4th method, I cut off the difference at 20%, because of the indirectness of the approach. Using 20%, the stock is undervalued, and I calculate a fair price of $130.
All 4 methods are pretty consistent in concluding that Smucker is undervalued.
Beta measures a stock’s price volatility relative to the S&P 500. I like to own stocks with low volatility, because they present fewer occasions to react emotionally to rapid price changes, especially price drops that can induce a sense of fear.
Smucker has been a low-volatility stock. Its 5-year beta is 0.6, meaning that it has been 40% less volatile than the market. This is a positive factor.
In their report on Smucker, CFRA did not provide detail about analysts’ recommendations. They did show that the summary of recommendations is to hold. This is a neutral factor.
Smucker experienced a significant increase in shares between fiscal 2008-2010. Since then the share count has held pretty steady. This is a neutral factor.
Here are Smucker’s positives:
• Good dividend resume: 3% yield, 20-year history of consecutive increases, moderate payout ratios, and strong dividend safety protected by solid cash flow.
• Good business model for a slow-growth company, with a narrow moat created mostly by its strong brands
• Decent if not spectacular financials. Positive cash flow generator.
• Low beta (price volatility).
• Stock is undervalued.
And here are its negatives:
• Low dividend increase this year of just 4% following years of increases in the 8-9% range.
• Long term business model may be weakening due to changing food-buying habits of ounger consumers.
As always, this is not a recommendation to buy, hold, or sell Smucker. Perform your own due diligence. And always be sure to match your stock picks to your financial goals.
— Dave Van Knapp
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