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

There are plenty of get-rich-quick schemes out there.

Do you know what kind of schemes don’t exist? 

Get-rich-slow schemes.

That’s because people lack patience; they want to get as rich as possible, as fast as possible.

However, I’d argue it’s a bit more than that.

I’d argue it’s also because people know, deep down, that getting rich, slowly doesn’t require any kind of scheme – getting rich, over the long term, is possible for just about anyone.

Indeed, I’ve proven that out.

I was broke at 27 years old, back in 2010.

Actually, it was worse than that. I was below broke: I was in debt.

But I adopted a get-rich-slow mentality, which involved old-school ideas like living below my means and investing in blue-chip dividend stocks.

Lo and behold, I was able to claw my way out of debt, build significant wealth, and even become financially independent and retired early (FIRE) in my early 30s.

That whole journey was recounted in my Early Retirement Blueprint.

My ability to achieve FIRE is underpinned by passive income. If you have enough passive income to pay your bills and cover your lifestyle without needing a job, you’re free.

More specifically, my passive income is comprised of the five-figure and growing passive dividend income my FIRE Fund (my real-life and real-money portfolio) generates on my behalf.

My portfolio is chock-full of high-quality dividend growth stocks.

I became a dividend growth investor because I knew I eventually wanted growing dividend income to cover my basic bills in life.

I view growing dividends as the simplest and most robust form of passive income in the entire world. 

Jason Fieber's Dividend Growth PortfolioThat’s because if you’re relying on growing dividends, you’re probably relying on some of the best businesses on the planet.

You can see what I mean by checking out the Dividend Champions, Contenders, and Challengers list, which is an incredible compilation of hundreds of US stocks that have raised their dividends each year for at least the last five consecutive years.

However, becoming a dividend growth investor and becoming FIRE involves a bit more than saving money and buying dividend growth stocks.

You have to perform a fundamental analysis, identify competitive advantages, and assess risk.

Perhaps most importantly, you also need to value a stock before you buy it.

While price tells you what a stock will cost, value tells you what you’re getting for your money.

If you’re able to buy a high-quality dividend growth stock when it’s undervalued (price is less than estimated intrinsic value), you’re likely setting yourself up for amazing results over the long run.

That’s because an undervalued dividend growth stock should offer an investor a higher yield, greater long-term total return potential, and less risk. 

This is all relative to what the same stock might otherwise offer you if it were fairly valued or overvalued.

The higher yield comes about due to the way price and yield are inversely correlated; all else equal, a lower price will result in a higher yield.

That higher yield goes on to positively affect total return because total return is composed of investment income (via dividends or distributions) and capital gain.

Since a higher yield means more investment income on the same dollar invested, you’re looking at greater long-term total return potential.

Furthermore, the other component – capital gain – is also given a possible boost by way of the “upside” that exists between price and intrinsic value.

While the market isn’t great at making sure price and value line up perfectly over the short term, price and value do tend to more or less reflect one another over the long run.

Taking advantage of any favorable disconnect in the short term sets you up for beneficial implications over the long run (more potential capital gain).

These dynamics have a way of reducing risk, too.

After all, it’s naturally less risky to pay less (versus more) for the same exact asset.

Maximizing upside should simultaneously minimize downside.

And you introduce a margin of safety, to protect your capital against any unforeseen issues that could negatively impact intrinsic value.

It’s fairly easy to see how undervaluation is advantageous for the long-term investor.

Fortunately, it’s also fairly easy to spot undervaluation.

Fellow contributor Dave Van Knapp has made it even easier by introducing a valuation system that can be applied to just about any dividend growth stock out there.

That system is part of an overarching series of “lessons” that are designed to educate and help dividend growth investors by expanding and refining their knowledge base.

The lesson that focuses on valuation specifically is Lesson 11: Valuation.

With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be 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.

This stock will certainly not show up under any get-rich-quick scheme.

It’s a company known by most for its peanut butter and jelly products.

Peanut butter and jelly? Making investors rich? 

Yep. This company has made shareholders rich over the long haul. The stock could be had for $15 in the summer of 2000; it now trades for over $100 per share.

So you were able to increase your wealth by more than six fold in under 20 years by investing in a very simple business model.

And it’s paid out growing dividends over that entire time, giving the investor back most of their initial investment in pure cash flow.

20 years isn’t quick. But we are getting rich here.

Let’s talk brands.

We’re looking at Jif peanut butter, Folger’s coffee, Meow Mix cat food, and the namesake Smucker’s fruit spreads, among other brands in the food, coffee, and pet food space.

These are go-to brands in go-to products that consumers consume every day.

Breaking down operations for FY 2018, its US sales were almost completely evenly spread out (at a bit over 28% apiece) across its retail coffee, consumer foods, and retail pet foods businesses. The other ~14% came from its international sales and food service exposure.

When I think about this company and its various businesses, it basically looks like this: 1/3 coffee, 1/3 food, 1/3 pet foods.

In each business lies strong brands that customers identify with.

And since I’m a dividend growth investor who identifies with big and growing dividends, this stock is right up my alley.

The company has increased its dividend for 21 consecutive years.

These aren’t small raises, either.

The 10-year dividend growth rate stands at 10%, which is quite substantial when you consider the stock also yields 3.17%.

That yield, by the way, is almost 90 basis points higher than the stock’s five-year average yield.

The sum of yield and dividend growth, assuming a static valuation, should equate to total return over the long run. So you can see that things are lined up really nicely here.

And that dividend is supported by a reasonable and sustainable payout ratio of 48.5%.

That payout ratio was calculated using the adjusted EPS result for Q3 2018, which factors out a large one-time gain related to US tax reform. However, the lower tax rate going forward should disproportionately help this business since most of its sales are in the US.

The dividend metrics are solid, if not excellent.

Of course, we need to know what to expect from the business moving forward if we’re going to put together a rational expectation of dividend growth (which will help us value the stock).

We’ll now look at what the company has done over the last decade in terms of top-line and bottom-line growth, and we’ll then compare that to a near-term professional forecast for profit growth.

Combining the known past and estimated future in this manner should tell us a lot about where this company is going, which should translate into having a good idea about where the dividend will go.

JM Smucker increased its revenue from $3.758 billion in FY 2009 to $7.357 billion in FY 2018. That’s a compound annual growth rate of 7.75%.

That’s a rather impressive growth rate for revenue; however, the company has been acquisitive over the last decade.

In particular, they built out their pet foods business through large moves like the 2015 $5.8 billion acquisition of Big Heart Pet Brands. A more recent (and smaller) acquisition of pet snacks company Ainsworth for $1.7 billion continues this trend.

As such, looking at profit growth on a per-share basis is even more important in this case, especially when keeping in mind that JM Smucker issued almost 18 million shares in relation to the financing of the Big Heart Pet Brands transaction.

JM Smucker increased its EPS from $3.11 to $7.96 over this same ten-year period, which is a CAGR of 11.01%.

I used adjusted EPS for FY 2018 in order to factor out the one-time gains that do not accurately reflect the company’s ongoing earnings power.

This is obviously very strong growth, but recent results have been muddied by acquisitions and tax reform.

Taking a deeper dive here, the most recent quarter (Q1 FY 2019) showed 4% YOY GAAP EPS growth.

For further perspective, CFRA is predicting that JM Smucker will compound its EPS at a 4% annual rate over the next three years, which would be right in line with the most recent quarter.

However, CFRA was predicting an 8% number as recently as five months ago, so I’m not sure it’s reasonable to cut that number in half without any significant negative change in the business or its near-term outlook.

In my view, the growth potential is probably somewhere in the middle here (6%+) over the near term, with perhaps a good chance for acceleration as their international exposure builds on the advantageous base of a lower tax rate moving forward.

Indeed, their relatively small international footprint allows for a pretty long runway of growth.

The company’s balance sheet is good, but it’s taken a bit of a hit in recent years in conjunction with the aforementioned acquisitions. The company has historically had a very strong balance sheet, so it’s relatively poorer today.

Still, the long-term debt/equity ratio is 0.59, while the interest coverage ratio is at almost 6.

The former number is more than acceptable, while the latter should improve markedly as the company works through its acquisitions and realizes synergies.

That said, the company would be wise to drastically reduce its M&A activity and focus on what it’s already built.

Profitability is fairly robust for the business model.

Over the last five years, the company has averaged annual net margin of 10.18% and annual return on equity of 10.60%.

This stock is pretty much a dividend growth investor’s dream.

You have recognizable and premium brands in basic goods, with more exposure to fast-growing pet foods.

There’s a long runway for international growth.

The lower tax rate should immensely help this business since it’s almost completely exposed to the US market.

And you’re looking at an attractive dividend that’s sustainable and growing.

Furthermore, it’s a low-risk, simple business model that shouldn’t face much disruption. People will still be drinking coffee, eating food, and feeding their pets 10 years from now.

However, the building out of the pet foods area of the business hasn’t panned out as well as they had planned, thus far. And the current lack of international sales is a bit of a drawback in terms of their potential global customer base and the cost to further build out that distribution network in the future.

At the right valuation, though, this could be a very compelling long-term investment.

Well, the valuation looks appealing right now…

The P/E ratio is sitting at 15.26 here (using adjusted TTM EPS).

That compares favorably to the broader market, obviously. It also compares favorably to the stock’s own five-year average P/E ratio of 24.3.

Every basic valuation metric (P/S, P/CF, etc.) is below its respective recent historical average.

And the yield, as noted earlier, is ~90 basis points higher than its five-year average.

The stock seems undervalued, but by how much? What would a reasonable estimate of intrinsic valuation look like?

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 DGR is well below the demonstrated 10-year dividend growth rate. It’s also well below the demonstrated 10-year EPS growth rate. And the company has a comfortable payout ratio that could even be expanded a bit.

Furthermore, the lower tax rate should mean the next decade will be better than the last decade.

However, I’m also looking at more recent YOY EPS growth and a balance sheet that’s been stretched a bit (which will limit flexibility).

I’m also taking into account the near-term forecast for EPS growth.

Overall, I think this is a pretty conservative look at future dividend growth, but I’d rather err on the side of caution.

The DDM analysis gives me a fair value of $146.20.

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 analysis shows a stock that clearly appears to be significantly undervalued, but my analysis is limited by my own perspective.

That’s why we’ll next look at where two professional stock analysis firms came out on this stock’s value, which adds depth to our conclusion.

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 4-star stock, with a fair value estimate of $129.00.

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 12-month target price of $110.00.

We all believe it’s undervalued, but there are varying degrees of that belief. Averaging the three numbers out gives us a final valuation of $128.40. That would indicate the stock is potentially 21% undervalued.

Bottom line: JM Smucker Co. (SJM) is a high-quality company with three distinct but complementary businesses. With recognizable and premium brands across a slate of everyday products that consumers love, this company is positioned to do well for many years to come. Dividend growth investors should love the attractive dividend, 21 years of dividend increases, double-digit dividend growth, sustainable payout ratio, and the possibility that shares are 21% undervalued.

-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 94. 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 and extremely unlikely to be cut. Learn more about Dividend Safety Scores here.

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