Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Turns out, you can teach an old-dog company new tricks. But, at least for J.M. Smucker, new tricks can bring new troubles. 

The almost 120-year-old jam maker acquired Big Heart Pet Brands last year in an effort to boost sales growth rates above the lackluster levels that have plagued the packaged-food industry. The $5.8 billion deal --  Smucker's largest ever -- was pricey, but investors didn't seem to mind. With talk of 4 percent to 5 percent revenue growth each year, what wasn't to like? 

At the start of the week, Smucker was trading at an all-time high. Then came Tuesday, when Smucker reported its quarterly results and a 6 percent drop in pet-food sales. Even former bright spots like snacks and premium fare showed signs of losing steam, while mainstream products like Kibbles 'n Bits and Meow Mix continued to struggle.

The drop was enough to force the company to cut its full-year revenue guidance -- it now sees sales being flat to down 1 percent this year, versus a previous forecast for a 1 percent increase. The stock tumbled 8.1 percent on Tuesday and continued falling Wednesday and Thursday. 

Dog Days
Smucker shares took a steep tumble after declines in its pet-food business forced a rollback of the company's revenue guidance.
Source: Bloomberg

The reality is, what shareholders thought was a fast-growing pet-food business is actually not so fast-growing. Some of the disappointment can be traced back to difficult comparisons from the previous year. Smucker also pointed to a general slowdown in traffic at pet specialty stores and the process of sorting out pricing for some of its more mainstream brands like Kibbles 'n Bits amid increased competition.

Those kinds of things can in theory be remedied and the sales dropoff stabilized, although Smucker's plan to roll out new packaging and entice customers with bonus packs and new TV ads seems underwhelming and potentially damaging to margins. 

But the company's biggest problem is that its pet-food business is falling into the same rut as its people-food business. Consumers don't just want healthier, fresher food for themselves, they want the very best for their furry friends as well. And Smucker doesn't have much to offer them.

Addressing that shortcoming may end up eating into the cost savings that were also part of the appeal of the Big Heart acquisition. Smucker realized $32 million of synergies from the deal in the first quarter, keeping it on track to reap $200 million of savings by the end of fiscal 2018. And that's great, but it's increasingly likely that some of that money is going to have to be put toward beefing up the pet-food business with the kinds of natural-ingredient and protein-heavy meals that people want for their dogs and cats.

Another option is for Smucker to make another acquisition in the premium segment, which would inevitably be expensive and stress an already somewhat stretched balance sheet. The easiest way to get a bigger chunk of the premium pet food market would be through an acquisition of a leader in that segment such as Blue Buffalo, but that $5 billion company is trading at whopping 20 times it projected Ebitda for this year, versus Smucker at about 13.

It would be unfair (but fun from the standpoint of pet puns) to go so far as to say that Smucker was barking up the wrong tree with the Big Heart Pet deal. Analysts are still projecting Smucker sales will grow about 2.7 percent from last year's levels to about $8 billion in fiscal 2019. That's better than the outlook for other old-dog packaged food companies like General Mills and Kellogg. But there are a whole host of other food makers that are growing faster, making Smucker's premium valuation relative to its sales look suspect.

Overexcited?
Smucker isn't crazy expensive, but its valuation seems on the high side considering its growth prospects.
Source: Bloomberg
Peer group includes companies valued at more than $1 billion.

The majority of analysts who cover the stock  don't recommend buying it. Investors could be forgiven for holding off on rewarding Smucker with a higher valuation before it works on nailing its new tricks first.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net