More Certain About Smucker

After its tepid second-quarter earnings report, we anticipate reducing our $109 per share valuation for narrow-moat

We are encouraged by Smucker’s first-half coffee segment profitability, as the unit posted a 34% profit margin in each of the last two quarters. The results are ahead of our 29% 2017 target and indicate the firm has been able to benefit from a low commodity price environment through premiumization and optimization of unit sizes. While we still expect results to soften somewhat in the second half, we plan on boosting our full-year target to the low-30s. As commodity prices normalize, we continue to expect segment margins averaging 28% long term.

While our long-term outlook has not changed, we plan to revise our uncertainty rating down from high to medium. As Smucker has quickly reduced leverage from over 4 times adjusted EBITDA after the March 2015 Big Heart acquisition to 3.4 as of the end of the quarter and the integration has progressed well, we are now increasingly comfortable with the company’s financial flexibility and ability to manage the execution risk associated with the latter stages of the combination. However, the change does not diminish our assessment of Smucker’s long-term exposure to rapidly changing center-store category dynamics and intense competition, factors that still lead us to believe that the firm’s competitive advantages are deteriorating.

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