Smucker Investors Hope for a Stronger Q2, but Pet Food Sales Look Ruff

Shares of J.M. Smucker (SJM) rose modestly mid-Wednesday afternoon, up 1.15% to $130.27, as the company prepares to release its latest batch of quarterly earnings, with management hoping to reassure investors that they were not barking up the wrong tree with a major pet food acquisition.

Smucker reports its earnings for the second quarter of fiscal 2017, ended in October, on Thursday morning before the opening bell. Analysts expect the Orville, OH-based company to report earnings of $1.93 per share on revenue of $1.995 billion.

Previously a jam specialist, Smucker made an M&A splash last year, paying $5.8 billion for private equity-backed Big Heart Pet Brands. While the acquisition was intended to prop up Smucker shares amid lagging sales across the U.S. packaged foods space, Big Heart has proved disappointing. After Smucker's last earnings release in August, when sluggish pet food sales forced the company to reduce its revenue guidance, shares tumbled almost 10% in a single day. The stock has not recouped its losses, currently trading about 17% below the August highs.  

"Though we remain comfortable that in the long run, SJM's strong cash flow generation and presence in healthy categories (pet food, coffee) will lead to better-than-average shareholder returns, the near-term outlook is cloudier," JP Morgan analyst Ken Goldman wrote recently.

According to Goldman Sachs analyst Jason English's analysis of Nielsen data, Smucker's pet food sales continued to decline, with volume falling 1.9% and sales down 3.5% in the month ending Nov. 5, well above declines across the category as a whole. Smucker's dog and cat food brands lost share to competitors including privately held Mars and Nestlé's (NSRGY) Purina.

"Although the pet business is facing greater challenges than anticipated, we still view the broader category as attractive on a long-term basis," Deutsche Bank analyst Mario Contreras wrote in a note. He holds a price target of $150 on the stock and expects Smucker will report earnings of $1.93 on revenues of $1.92 billion tomorrow.

Despite the obvious challenges in the division, Smucker's management expressed confidence in a meeting with JP Morgan's Goldman. For example, Goldman wrote in a note, CEO Mark Smucker "went out of his way to support" Barry Dunaway, who was appointed head of the pet food division last December. (Smucker, part of the fifth generation of the company's founding family, took the helm in May.)

"Some investors with whom we recently spoke expressed concern about the direction of the segment (which is understandable given its challenges), but the company is not planning on switching coaches anytime soon," Goldman wrote. Indeed, Smucker "blamed some of the Pet Food segment's issues on excessive 'turnover at the top' when the business was transitioned into SJM," providing "some hope that as the new leadership team settles in, improvements could take place."

Smucker also hinted, Goldman added, at introducing "mass premium" dog food. "There seems to be more noise than ever about a new product coming to market," he wrote, although significant profits would take at least a year to materialize "as marketing costs for new items usually are quite high."

Not all analysts share Smucker's optimism. Credit Suisse's Robert Moskow recently downgraded his Smucker price target to $138 from $145, a 15% discount relative to its peers, due to "the risk that the company will make a bigger investment in marketing or product quality to stabilize its pet food business."

Smucker will host an earnings call at 8:30 am eastern time on Thursday.

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