DealTalk: J.M. Smucker needs M&A to fire up growth

By Mihir Dalal

BANGALORE (BestGrowthStock) – J.M. Smucker Co (SJM.N: ), which boasts a strong track record of buying and integrating top brands, needs fresh deals to drive growth amid rising input costs in a fiercely competitive U.S. food sector.

Smucker enjoyed a strong 2009 after buying Folgers coffee, but growth this year has been far more modest. Smucker stock, up 42 percent in 2009, has risen just 6 percent in 2010, lagging a 12 percent gain in the S&P Packaged Food Index (.GSPFOOD: ).

“Smucker will need acquisitions to contribute to about a third of its (fiscal 2011) sales growth target of 4 percent,” said Wells Fargo Securities analyst Eric Serotta.

Smucker, which started off in the local fruit business as the 19th century drew to a close, has a strategy of going after the leading brand in a business.

It then squeezes added profits from these brands by growing the topline through aggressive marketing and simultaneously driving supply-chain synergies.

Big buys in the past decade include dominant, though diverse, brands such as Folgers, Jif peanut butter and Crisco oils, all bought from Procter & Gamble (PG.N: ). Other Smucker brands include Crosse & Blackwell and Hungry Jack.

Its deals have tended to spur a rally in its share price and investors sense a deal is needed once again to prop up the stock.

Besides stable commodity prices, a catalyst for the stock will be a potential acquisition that could give Smucker an external leg of growth, said Eric Marshall, director of research at Hodges Capital Management, which owns Smucker stock.

Marshall sees a ‘meaningful’ buy, similar to the $2.95 billion Folgers deal in November 2008.

“It may be they will take a brand from one of the larger conglomerates like a Kraft (KFT.N: ) or Nestle (NESN.VX: ) — a brand that’s too small in those big companies but (which) may make a lot of sense within the scheme of Smucker’s,” he said.

However, Stephens analyst Farha Aslam said Smucker will spend $150-$250 million on smaller ‘bolt-on’ acquisitions rather than chase a ‘transformative’ deal.

“It will likely pay about 7-9 times EBITDA, and we estimate an acquisition of this nature will add 10-15 cents to earnings per share,” she said.

This year’s food sector deals include Diamond Foods’ (DMND.O: ) $615 million buy of potato chips maker Kettle Foods and Del Monte Foods’ (DLM.N: ) takeover by a group led by Kohlberg Kravis Roberts & Co (KKR.N: ) for about $4 billion.

Diamond paid almost 10 times EBITDA for Kettle, while KKR paid about 6.3 times estimated EBITDA for Del Monte.

Don Wordell, portfolio manager at RidgeWorth Mid Cap Value Fund, said strong competition and higher commodity prices, such as coffee, may actually favor Smucker’s deal prospects.

“Sellers’ price expectations are being rationalized by the very difficult industry conditions,” he said.

REVERSE PLAY?

So, where would Smucker go shopping?

“It may look at a center-of-store dry grocery brand, something to complement their baking products business,” said Wells Fargo’s Serotta. Its Pillsbury baking business saw volume declines in the latest quarter, along with Folgers and Crisco.

Marshall at Hodges Capital said that considering Smucker has a majority of its sales in the United States, it makes sense to expand its international presence.

Marshall does not rule out Smucker itself becoming an attractive target for foreign firms, given its strong portfolio in the U.S. market.

“It could itself be a good bolt-on acquisition for a larger international company that wanted to get into the U.S.,” he said.

And Smucker has a strong enough balance sheet to support large acquisitions and bring its dividend payout up to target, analysts said.

The Orrville, Ohio-based company had about $487.5 million in cash at end-October and long-term debt of $1.3 billion. It is expected to generate free cash flow of about $450 million in fiscal 2011, according to analysts.

“There’s room for both (acquisitions and raising dividend). The balance sheet is pretty underlevered,” said Serotta.

(Reporting by Mihir Dalal in Bangalore, Editing by S. John Tilak and Ian Geoghegan)

DealTalk: J.M. Smucker needs M&A to fire up growth