4 Reasons to Buy this Coffee Company

Piyush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Shares of J.M. Smucker (NYSE: SJM) have appreciated nearly 40% over the last year. But unlike most food companies, its impressive financial performance has been totally driven by organic growth. Now that its shares appear to be fairly valued, the Street is questioning the sustainability of its rally. However, here are four reasons why J.M. Smucker appears to be a great investment, even at its current valuations.

Coffee bonanza

Thanks to the prolonged production bonanza and mounting stockpiles, coffee bean prices recently touched 33-month lows. As a result, coffee margins expanded, which eventually resulted in higher earnings. But instead retaining hefty margins, J.M. Smucker slashed its coffee prices by 6% in February, which resulted in its record quarterly revenues of $5.9 billion.

Now that coffee bean prices have further declined by 3.6%, J.M. Smucker again has the option of slashing its coffee prices. But since the price cut has already done its job, J.M. Smucker will most likely keep its prices unchanged. Its management expects the prices of coffee, peanuts and sweeteners to further decline in fiscal year 2014, which should expand J.M. Smucker’s gross margins by up to 200 basis points.

New growth avenues

J.M. Smucker directly benefits from the growth of Dunkin' Brands Group (NASDAQ: DNKN). J.M. Smucker produces packaged coffee for Dunkin' Brands, which retails in grocery and convenience stores with the name Dunkin' Donuts. For the recent quarter, Dunkin' Donuts’ coffee volumes rose by 29% along with a 10% increase in Folgers coffee.

Dunkin' Brands is also aggressively expanding in countries including India, China and Indonesia. These are some of the world’s fastest growing economies, offering tremendous growth prospects to almost all consumer goods companies. Dunkin' Brands stands to benefit here, but this also opens up new indirect growth avenues for J.M. Smucker.

Optimistic forward looking statements

J.M. Smucker also has an agreement with Green Mountain Coffee Rosters (NASDAQ: GMCR) to provide K-cups for its coffees. During the earnings conference, the management of Smucker mentioned that it would remain bullish on the growth of K-cups, and has plans to launch two new varieties of the cups during 2013.

Although Green Mountain Coffee produces coffee that rivals J.M. Smucker’s, its huge reliance on K-cups ensures a win-win situation for J.M. Smucker. But due to the maturing Keurig segment, J.M. Smucker expects the quarterly sales growth of single serve coffee from Keurig machines to slow down to 15%, down from 18%. The momentum may have slowed down, but that is still a healthy growth rate.

To offset the slowdown, J.M. Smucker will launch 100 new products in fiscal year 2014. Besides that, its marketing spending will go up by 10%, as J.M. Smucker is sponsoring the 2014 and 2016 Olympics. Altogether these factors point towards higher sales, which coupled with falling input costs, point towards higher earnings.

Investors’ delight

At the current price, shares of J.M. Smucker yield 2.06% with a modest payout ratio of 42%. It sports a dividend coverage ratio of 3.83 with cash and cash equivalents of $256.44 million, suggesting that J.M. Smucker can comfortably sustain its dividends. Furthermore, its operating cash flows have grown by 260.4% while its dividends have been hiked by 62.5% over the past five years. This adds a safety cushion for its existing payouts, and leaves room for a dividend hike of around 1.5 times.

By the end of the third quarter, the company had around 108.5 million shares outstanding with an authorization to buy back 6.9 million shares. And by the end of the fourth quarter, its shares outstanding totaled 107.192 million shares. This means that the company is yet to repurchase around 5.59 million of its shares, which accounts for 5.21% of its total shares outstanding. These pending share repurchases should boost its current yield to 2.17%.

Conclusion

Although shares of J.M Smucker appear to be fairly valued, Gabelli has recently upgraded the company to a buy rating. Analysts at the firm believe that falling input costs, coupled with ripe growth prospects, should yield higher earnings in the coming quarter. 

With Green Mountain as cheap as it's ever been, many investors are wondering whether this is the end of the former market darling, or the perfect entry point for an enormous rebound. You can find The Fool's recommendation for how to play the company in our premium research report. In it you'll find everything you need to know about Green Mountain, including whether it's a buy at today's prices. Click here for instant access.


Piyush Arora has no position in any stocks mentioned. The Motley Fool recommends Green Mountain Coffee Roasters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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