Packaged Food Company Smucker's Bets Big on Pet Food

J.M. Smucker  (SJM) bet big on pet food in early 2015, a move that diversified the jelly maker's offerings and cushioned it against swings in food input prices.

On February 3, 2015, Smucker announced that it would acquire pet food company Big Heart Pet Brands for $5.8 billion in cash, stock and assumed debt.

The target, formerly known as Del Monte, was previously acquired in a $5.3 billion leveraged buyout in 2010 by private equity firms including Kohlberg Kravis Roberts (KKR) , Vestar Capital PartnersCenterview Capital Holdings and AlpInvest Partners.

San Francisco-based Big Heart produces a variety of pet food brands, including Milk-Bone dog treats and Meow Mix cat food.

Best known for its eponymous jam products, Jif peanut butter and other lunchbox staples, Smucker acquired the suite of pet products to create a "third platform," along with food and beverages, its then-CEO Richard Smucker said on an analyst call after the acquisition.

"With approximately two-thirds of U.S. households having at least one family pet, we will now be able to serve the mealtime and snacking needs of the whole family," Smucker said in a statement. Big Heart "adds to the company's portfolio of leading brands and increases our consumer presence, while enabling us to capitalize on the growth of the pet food and snacks category."

And the bet looks like a smart one, with consumers spending more on their pets than ever. According to market researcher Packaged Facts, pet food sales were $28 billion in 2013 and are expected to hit $33 billion by 2018.

In its first fiscal year after closing the Big Heart acquisition, Smucker's sales increased $360.5 million in the fiscal year ending April 30, including a $336.9 million contribution from Big Heart. Excluding Big Heart, currency exchanges and the divestiture of its US canned milk business, net sales increased 5%, or $67.2 million.

Gross profit, including the Big Heart acquisition, rose 60%, or $257.4 million. Excluding Big Heart, gross profits also increased, although the company did not specify the magnitude of that increase. Big Heart also furnished an increase in operating income of $175.6 million, or 249%.

By contrast, some of Smucker's other offerings have caused a headache for the company. Last May, Smucker said it would decrease the price of coffee, of which it has a large market share, by 6%, less than a year after another 6% price cut. Coffee sales were robust last quarter, however, growing 9% to $512.6 million.

While the pet revenue results led to a strong earnings beat, including earnings per share beating estimates by 20%, analysts were especially pleased that the Big Heart acquisition is contributing to additional cost savings.

"The best news came from the $50 million increase in management's estimate for cost savings and synergies from the pet food acquisition (now at $250M) due to the announcement that it will close three plants (one coffee and two natural foods) and continue to redesign the organization," Credit Suisse analyst Robert Moskow wrote in a note.

Deutsche Bank's Mario Contreras highlighted further improvement in the pet division's performance. U.S. pet food sales grew roughly in line with expectations, with higher growth, in the mid-single digits, expected in fiscal 2017.

"In our view it is important that mainstream business has stabilized, with growth in cat food offsetting weakness in dry dog," he wrote. "Certainly mainstream dry dog remains a challenge, but recent actions including bonus bags are helping. Key competitors had already implemented the bonus strategy, so in effect Smucker is catching up to competitive actions."

Moskow assigned Smucker an "Outperform" rating and a $156 price target, while Contreras holds a "Buy" rating and $152 price target on the stock.

Smucker shares have risen more than 20% in 2016.  

And the company expects that growth to continue. Smucker predicted fiscal 2017 earnings of $7.60 to $7.75 per share, well above the consensus estimate of $6.37 per share.

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