Undervalued Dividend Growth Stock of the Week: JM Smucker Co. (SJM)

One of my favorite quotes is attributed to late United States Senator Paul Tsongas:

“Nobody on his deathbed ever said, “I wish I had spent more time at the office.””

When we’re all much older, we may look back on our lives with some measure of regret.

But I somehow doubt any of us will regret not spending more time at a job.

If you feel the same way, why not use that same logic to spend less time at the job?

Well, easier said than done.

Or is it? 

I’d actually say it’s not all that difficult at all.

Indeed, I took that logic and ran with it.

By living well below my means and investing the excess capital (my savings) into high-quality dividend growth stocks like those you’ll find on David Fish’s Dividend Champions, Contenders, and Challengers list, I was able to put myself in a position to never spend another day at the job.

How?

Jason Fieber's Dividend Growth PortfolioFinancial independence.

That’s right.

See, the five-figure and growing passive dividend income my real-life and real-money FIRE Fund generates on my behalf covers my basic personal expenses in life.

That position in life was achieved in about six years – going from below broke in 2010 to totally financially free in 2016.

I recounted the exact steps I used in my Early Retirement Blueprint.

But a key component of all of this – it’s how I’m able to live and pay my bills without showing up to the office – is the very investment strategy I’ve used and still use.

That strategy is dividend growth investing.

It’s such a simple but powerful long-term investment method.

It essentially involves buying up shares in high-quality businesses that reward their shareholders with growing dividends – and these growing dividends are funded by the growing profit these businesses are producing.

Doesn’t get much easier than that, folks.

But easy doesn’t make something a poor idea.

In fact, it’s usually quite the opposite: super complicated investment strategies tend to get people in trouble and cause them to lose money.

That said, dividend growth investing isn’t so simple that you can just buy random stocks off of Mr. Fish’s CCC list and forget about it.

A stock represents equity in a company. These are real-life businesses here. A stock isn’t just a piece of paper or digital ticker.

So you want to make sure you’re doing your due diligence and analyzing a business for quantitative and qualitative quality, while also assessing risks.

Investing your hard-earned capital in anything but the best businesses in the world doesn’t make a lot of sense, but it takes due diligence to separate the wheat from the chaff.

However, it doesn’t end at quantitative and qualitative analysis.

Perhaps most important, you want to also value a dividend growth stock.

Price is only what you pay for something, but value is what that something is actually worth.

The valuation at the time of investment will have a large impact on how that investment performs for you, especially in the short term.

An undervalued dividend growth stock should offer a higher yield, greater long-term total return prospects, and less risk. 

This is all relative to the dynamics the same stock might otherwise present if it were fairly valued or overvalued.

Price and yield are inversely correlated; a lower price will, all else equal, provide for a higher yield.

That higher yield should mean not just more short-term and long-term investment income, but it also means greater long-term total return prospects due to the fact that income (via dividends or distributions) is one of two components of total return.

Plus, capital gain, which is the other component, is also given a possible boost via the “upside” that exists between the price paid and the actual value of a stock (in an undervalued scenario).

While the market isn’t necessarily very good at valuing stocks over shorter periods of time, value and price tend to more closely correlate over the long haul.

Taking advantage of a mispricing in the short term could result in additional capital gain (and thus total return), which is on top of whatever organic capital gain is going to occur as a business naturally becomes worth more as it sells more products and/or services, increasing its profit, and becoming worth more.

This all has a way of reducing risk, too.

It should be fairly clear that paying less for the same asset is less risky (in terms of capital outlay/risk) than paying more.

That’s clear.

You’re risking less capital on a per-share basis when you pay less for a stock.

And you’re also building in a margin of safety, which protects you against unknowns (a management team not executing properly, some kind of scandal that comes out that reduces the value of a business, etc.)

Valuing a dividend growth stock might seem like a very complicated exercise, given the nature of the benefits, but it’s actually not.

Fellow contributor Dave Van Knapp set out to simplify that exercise even further, with his “lesson” on dividend growth stock valuation greatly demystifying the process of valuation.

With all of this in mind, you should be able to see why buying a high-quality dividend growth stock when it’s undervalued is a fantastic path toward greater wealth, more passive income, financial independence, and less days at the office.

So let’s take a look at a high-quality dividend growth stock that appears undervalued right now…

JM Smucker Co. (SJM)

JM Smucker Co. (SJM) manufactures and markets a variety of branded food products, beverages, pet foods, and pet snacks.

If you want to invest in the best companies in the world, it makes sense to start looking at companies with some of the most well-known and beloved brands in the world.

Well, JM Smucker lays claim to a number of such brands.

Think Jif, Folger’s, Crisco, Meow Mix, Kibbles ‘n Bits, and the namesake Smucker’s.

You almost can’t buy sandwich spreads, pet food, or coffee without running into this company’s venerable brands.

And that’s not a problem for many consumers, as these quality brands are often sought out on purpose.

While some consumers (and even investors) might at first glance think of this company as primarily a company that allows people to make a delicious PB&J sandwich, that’s actually not the case.

Looking at product categories, coffee generated the bulk (34%) of fiscal year 2017 sales. The pet food and pet snacks generated another 29% of sales. And then peanut butter and fruit spreads combined for 15%. The remainder was primarily baking products.

As such, JM Smucker is more a packaged coffee products company than anything else; however, I actually visualize this company as (approximately) 1/3 coffee, 1/3 pet foods, and 1/3 food products.

In my view, that’s a great mix – they’re exposed to different but exciting and growing categories.

That’s arguably especially true for coffee and pet foods.

Coffee has probably never been more popular than it is in 2018. Its a culture unto its own.

And people now care for their pets’ quality of life in a way I’ve never seen before.

JM Smucker’s management has clearly seen these trends unfold, and they’ve aggressively pivoted the company to take advantage.

This bodes well for their ability to pay and grow their dividend to shareholders.

Speaking of which, the company has already amassed an impressive track record in that record.

The company has increased its dividend for 20 consecutive years.

And with a payout ratio of just 49.6% (factoring out a massive one-time gain for Q3 FY 2018), the dividend looks very healthy and secure.

In fact, that payout ratio of ~50% is basically my idea of a “perfect” payout ratio, harmoniously balancing retaining earnings for growth and paying shareholders their fair share of profit.

The stock yields a pretty healthy 2.60% right now, which is above the broader market and the stock’s own five-year average yield of 2.3%.

With that yield comes a 10-year dividend growth rate of 10.0%.

So we’re looking at market-beating yield and market-beating dividend growth.

If you can pair a 2.5%+ yield with 10% dividend growth, you have the makings of an excellent long-term investment.

Assuming a static yield, the sum of dividend yield and dividend growth should approximate total return. We can see a case for double-digit annual total return here.

That said, dividend growth has decelerate in recent years, with the most recent dividend increase coming in at just 4%.

Still, the company has the capacity for strong, high-single-digit dividend growth, and that’s paired with that ~2.5% yield.

There’s a lot to like about the dividend.

But in order to build an expectation for future dividend growth, which will help us value the stock and company, we must first look at what kind of business growth JM Smucker is generating.

We’ll first look at what the company has done in terms of top-line and bottom-line growth over the last decade (using that as a proxy for the long haul).

And then we’ll compare that to a near-term expectation for bottom-line growth.

Combining and blending these numbers together should give us a pretty good idea as to what to expect from JM Smucker moving forward – and that’s speaking about both profit growth and dividend growth.

The company has grown its revenue from $2.525 billion in fiscal year 2008 to $7.392 billion in FY 2017. That’s a compound annual growth rate of 12.68%.

That’s well in excess of what I’d expect from a company like this. My expectation would actually be maxed out at top-line growth somewhere around 8%. A more reasonable expectation would be somewhere between 6% and 7%.

However, we have to keep in mind that JM Smucker made a number of acquisitions over the last decade, with the 2015 $5.8 billion acquisition of Big Heart Pet Brands the largest of them – that acquisition gave JM Smucker an immediate and massive presence in pet foods and pet snacks.

More recently, the company followed up on that by announcing that it intends to acquire Ainsworth Pet Nutrition for $1.9 billion.

Some of these acquisitions have resulted in additional debt and share dilution, which obviously must be factored in when looking at growth.

We’ll factor in that dilution by seeing what the company has done on its bottom line on a per-share basis over this same period.

JM Smucker increased its earnings per share from $3.00 to $5.10 over the last 10 fiscal years, which is a CAGR of 6.07%.

The bottom-line growth is a bit less than what top-line growth came in at; however, this is still a rather impressive rate of growth, in my view.

Looking forward, CFRA believes JM Smucker will compound its EPS at an annual rate of 8% over the next three years, citing increasing margins and a lower tax rate (due to recent tax reform in the US) as primary catalysts for that.

That kind of bottom-line growth should allow for like dividend growth.

Again, paring a 2.5%+ yield with 8% dividend growth paints a very nice picture in terms of both total return and aggregate dividend income over the long run.

But even if the company falls slightly short of that 8% forecast, there’s still room for very solid high-single-digit dividend growth, and that’s on a fairly low-risk, long-term business model.

One aspect that isn’t mentioned or focused on by CFRA in that forecast is JM Smucker’s huge runway for international growth.

Almost 90% of FY 2017 sales were in the US, meaning international sales make up a very small portion of the company’s revenue.

The company has grown at a more-than-acceptable rate over the last decade without expanding on this too much, but I think there’s a lot of potential for the company’s growth to accelerate. The world’s consumers are still relatively untapped for this company.

Moving over to the balance sheet, we see a company that’s leveraged but not overly so.

JM Smucker has historically had a rather strong balance sheet, but that took a hit with the Big Heart Pet Brands acquisition.

The long-term debt/equity ratio is 0.65, while the interest coverage ratio is a bit over 6.

Cash notably makes up a pretty small part of the balance sheet. And with the Ainsworth Pet Nutrition acquisition on the horizon, this probably won’t change too much in the near term.

I’d like to see the balance sheet improve, but I don’t think it’s worrisome.

Profitability is, in my view, a strength for the company, with robust numbers across the board.

Over the last five years, the company has averaged annual net margin of 8.41% and annual return on equity of 9.11%.

There’s a lot to like about this company.

Iconic brands across multiple product categories, with plenty of exposure to fast-growing coffee and pet foods.

The room for international sales expansion is immense.

The dividend is attractive, safe, and growing.

And there isn’t a lot of risk to the business model.

However, the areas in which they’ve been most aggressively expanding – pet foods and coffee – have only become more competitive, and the Big Hearts Pet Brands acquisition hasn’t turned out to be as successful as the company thought it would be, with an impairment charge during Q3 FY 2018 being particularly evident of that.

In addition, their lack of very much exposure to international markets/sales is a drawback.

While there’s a huge runway for growth, it takes time to scale up a distribution network and achieve greater saturation.

All that said, I think the pros outweigh the cons.

And I also believe the valuation is fairly attractive right now…

The P/E ratio (factoring out the one-time gain for last quarter) is sitting at 19.10 right now. That compares quite favorably to a five-year average P/E ratio of 24.3 for the stock. And that’s obviously well below the broader market.

Sales and cash flow multiples are also below their respective recent historical averages.

And the yield, as shown earlier, is above its five-year average.

So the stock does look cheap based on a quick glance. But how cheap might it be? 

I valued shares using a dividend discount model analysis.

I factored in a 10% discount rate and a long-term dividend growth rate of 7.5%.

That’s lower than the demonstrated long-term dividend growth rate. It’s also lower than the forecast for near-term EPS growth.

However, I also kept in mind the lower 10-year EPS growth rate. And recent dividend raises have been smaller. Plus, the company has debt to pay off.

I think this is a reasonable look at the long-term potential, although the short term may be a bit bumpy as that average plays out.

The DDM analysis gives me a fair value of $134.16.

The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.

The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.

It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.

I find it to be a fairly accurate way to value dividend growth stocks.

My valuation concludes the stock looks moderately undervalued. But my valuation is limited to my own perspective on the business.

That’s why it’s a valuable exercise to compare where I come out to what professional analysts have concluded, which adds depth.

Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.

1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.

Morningstar rates SJM as a 3-star stock, with a fair value estimate of $135.00.

CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.

They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.

CFRA rates SJM as a 3-star “HOLD”, with a fair value calculation of $145.01.

I came out the most conservative, but we have a pretty tight consensus here. Averaging out the three numbers gives us a final valuation of $138.06. That would indicate the stock is potentially 15% undervalued here.

Bottom line: JM Smucker Co. (SJM) allows long-term dividend growth investors to benefit from consumers’ preference for iconic brands across multiple growing and popular product categories. The international growth runway is incredible. And it’s a low-risk business model. With a 2.5%+ yield, double-digit long-term dividend growth, a very moderate payout ratio, and the possibility that shares are 15% undervalued, this is still one of my Top 10 Stocks for 2018 (and beyond).

— Jason Fieber

Note from DTA: How safe is SJM’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 97. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, SJM’s dividend appears very safe with an extremely unlikely risk of being cut. Learn more about Dividend Safety Scores here.

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