The J. M. Smucker Company (SJM) Earnings Call Transcript & Summary

So our next presenter is the J.M. Smucker Company. First, please join me in thanking Smucker's for energizing us again this year by sponsoring the coffee bar for the entire week. Smucker's is focused on its 3 growth priorities of leading in the best categories, building brands consumers love and being everywhere. We're seeing Smucker accelerate innovation and transform its marketing model, all against a balanced portfolio of core growth brands in attractive categories. I'll turn it over to President and CEO, Mark Smucker, to give us some more insight on the company's strategy. Mark, thanks for being here.

Thanks for the introduction, Bryan. I'm recovering from a little bit of a cough. So I may be pausing to drink water today but just wanted to say, first of all, I really appreciate the opportunity, as always, to be back at CAGNY to provide an update on our company, the J.M. Smucker Company. Before we begin, please note that certain information that we will provide today is forward-looking based on current views and assumptions. Also the company uses non-GAAP results for purposes of evaluating performance internally. Details for both items can be found within today's presentation available on our Investor Relations website. Let me start by introducing the rest of the team here today. Mark Belgya, Vice Chair and Chief Financial Officer, will give an overview of our financial strategy and priorities. Also with us to participate in the Q&A session following our presentation is Tucker Marshall, Senior Vice President and Deputy CFO; and Rob Ferguson, Senior Vice President and Interim Leader of our Pet business. Aaron Broholm, Vice President of Investor Relations, is also on stage with us and will moderate Q&A. I would like to take this opportunity to recognize Mark Belgya, who will be retiring in September after 35 years with our company, 15 as the company's CFO. During his career, he has been instrumental in transforming a jams and jellies company with $230 million in net sales to the multicategory, over $7.5 billion company we are today. Thank you, Mark, for your leadership, friendship and commitment to the company. In addition to our Chief Financial Officer transition that will occur at the end of our April fiscal year, we are actively evaluating candidates for the other senior leadership positions that were announced in mid-November. We are pleased with the quality of candidates and are confident we will fill these critical positions with strong leaders who will strengthen our organization. Next Wednesday, we will report our third quarter earnings results. While we are not providing any details today, I am reaffirming our guidance that we established at the end of our second quarter, including full year net sales down 3% versus the prior year; adjusted earnings per share of $8.10 to $8.30; and free cash flow of $850 million. For full details on the quarter results, please join us for our earnings conference call next Wednesday morning. I will center today's discussion around the following themes: our vision and strategy; our purpose and how it drives progress against environmental and social goals; and an update on our key segments and the related growth drivers within each. We have a portfolio of products that allows us to engage, delight and inspire our consumers through trusted brands that these consumers know and love. In support of this vision, we have significantly transformed our portfolio over the last 11 years and are now the seventh largest branded shelf-stable food and beverage manufacturer within the $260 billion U.S. center of store industry. We have made investments that have begun to unlock the growth potential of our brands while maintaining financial discipline, and we remain confident these efforts will generate sustainable earnings growth and long-term shareholder value creation. That is why we remain committed to the execution of our strategic growth imperatives: lead in the best categories, build brands consumers love, and be everywhere. These 3 imperatives have guided our strategy and decision-making over the past few years and will continue to do so as we further unlock the growth potential within our portfolio. In leading in the best categories, the shifts in our portfolio have allowed us to strengthen our position in 3 attractive and growing categories: pet food and snacks, coffee, and snacking. Further, we have leadership positions in the majority of these categories, with approximately 75% of our net sales derived from categories where we hold either the #1 or #2 branded position across our U.S. retail business. In building brands consumers love, our brands are an essential part of everyday life for consumers and their pets. At least one of our products can be found in 90% of all U.S. households today, demonstrating the importance of our brands to today's consumer and the breadth of product choices we provide across the value spectrum. Over the last 2 years, we have significantly increased marketing investments to 6.5% to 7% of net sales versus 5% to 6% in prior years. We remain committed to sustained reinvestment in our brands, strengthening our efforts to grow brand relevancy and awareness. In fiscal 2020, we launched new advertising campaigns for 10 of our largest brands. We also focused on innovation to ensure our brands remain relevant with key launches in pet snacks, premium coffee and other strategic line extensions. Finally, in being everywhere, we are committed to ensuring that our brands are available whenever and wherever consumers shop. The way consumers shop and interact with brands has fundamentally changed over the last several years and we are adapting by increasing important interactions via digital and social media, and by expanding the availability of our products online and away from home. Approximately 5% of our total U.S. retail sales in fiscal 2020 will be attributable to pure-play online retailers versus just over 2% 2 years ago. Growth has been driven by the strength of the pet and coffee categories, which are 2 of the fastest-growing CPG categories online. We expect this channel to have significant runway for growth over the next several years. I'd like to turn to an area which is a critical component of managing our business and guides everything we do, our purpose. At the beginning of fiscal 2020, we introduced a new purpose to reflect a broader, more inclusive ambition for our company. We reestablished our purpose as feeding connections that help us thrive, life tastes better together. We know that meaningful connections are vital to a happy, healthy, fulfilling life, and we believe that when we connect, we are stronger and we are stronger, society thrives. Our thriving together philosophy is that we believe success is driving business growth while also helping those associated with our company thrive. For us to truly thrive, we must take an active role in helping our consumers, employees, supply chains, communities and the planet thrive as well. By incorporating this philosophy into our ESG initiatives, we are nurturing these connections across our constituents and across all our products, and we will ensure a bright future for our business. We continue to make strides in delivering on our environmental and sustainability goals. In our prior year corporate impact report, we shared that our 2020 goals for landfill diversion and water use intensity have already been met or exceeded. While we are still finalizing our 2019 results, I can report that we remain on track to achieve or exceed all current goals, including our greenhouse gas emissions intensity target by the end of 2020. Our greenhouse gas emissions are being reduced through a combination of ongoing activities to improve efficiency at our manufacturing locations and the start-up of the Plum Creek Wind Farm Project in Nebraska, which will address half of our total electricity use through renewable wind power. Infrastructure at the site is complete and we anticipate a commercial operation date this summer. Beyond our 2020 commitments, we are developing strategies to achieve our next generation of environmental and sustainability goals, with an emphasis on 3 critical platforms: responsible sourcing, operational excellence and packaging. With our teams working to finalize plans for our next set of goals, we will not share the entirety of our plans today. However, work across this area is currently centered on strengthening our full corporate impact, including reinforcing our commitment to animal welfare, human rights and living wages in our supply chain. We are also reviewing emissions outside of our own operations and evaluating science-based targets consistent with the Paris Agreement. For packaging, we have established new goals and are being more thoughtful in our approach to integrate sustainability into our product development and sourcing practices. By 2025, our aspirations include 100% recyclable, compostable or reusable packaging materials, make How2Recycle information available for all packaging and ensure that 100% of fiber-based packaging is from recycled or certified sources. Additionally, we will strive to use 30% post-consumer recycled or renewable resource materials in plastic packaging by 2030. Now turning to our segments. Our U.S. retail business consists of 3 strategic business units, which will collectively account for about 85% of total net sales and an even greater percentage of total profit. The remainder being driven by our international and away-from-home businesses. I'll start with our largest segment, U.S. retail pet foods, which realized net sales of $2.9 billion last fiscal year. The pet food and pet snacks category generates over $34 billion in annual retail sales and has grown at 4.5% annually over the past 5 years or nearly 2.5x the packaged food average. Dog food is our largest branded pet business and generates nearly 40% of pet sales. Pet snacks and cat food each account for just over 25% of our sales. The remainder of our portfolio is comprised of private label. While small in total sales and profit, it has been a near-term headwind to growth, accounting for $50 million in reduced sales this year, $30 million of which were planned exits from certain low-margin businesses. Looking at the total pet category, we are the market leader in dog snacks, with a 25% dollar share; second in the cat category with an 18% dollar share; and third in dog food with a 13% share in the total U.S. multioutlet channels. These channels account for about 70% of our sales, with the remaining portion primarily attributable to the pet specialty and online channels. We will drive growth by leveraging our leading position in pet snacks. Our portfolio is led by the iconic Milk-Bone brand, which accounts for about half of our pet snack sales. Pet snacks are a critical growth and profit driver for our business. While they account for just over 25% of our sales, pet snacks generate a much greater percentage of segment profit. Through a combination of brand building and innovation, we continue to assert our leadership position in this category. Through the first half of the fiscal year, pet snack net sales grew 3% and we project back half growth with new marketing campaigns launching for the Milk-Bone and Pup-Peroni brands in the fourth quarter. Let's take a look at some of this new advertising. [Presentation]

Our cat food portfolio is mostly comprised of the Meow Mix, 9Lives and Rachael Ray Nutrish brands. With 8 consecutive quarters of year-over-year growth, we have gained approximately 1.5 share points over the past 2 years. Our largest cat brand, Meow Mix, with nearly $420 million in net sales last year is the #1 dry cat brand in unit share and #2 in dollar share, and has delivered strong growth over the last 2 years, driven by successful innovation and breakthrough marketing. Within our dog food portfolio, premium and superpremium brands account for approximately 70% of dog food net sales, led by Nutrish, Natural Balance and Nature's Recipe. While we remain bullish on these areas over the long term, our performance in this high-growth segment performed below our expectations through the first half of the fiscal year, and we are starting to execute against the clear actions we communicated at the end of our second quarter. These actions to improve the value proposition for the Nutrish brand are beginning to show up in market now and are performing to our expectations with consistent household penetration growth over the past quarter. Through these actions and continued focus, we expect to return the brand to growth in fiscal 2021. These actions include: emphasizing Rachael Ray's connection with the brand, including in new advertising and increased media investment; improving value through sharper price points on trial-sized offerings in the more premium position sublines; innovating in natural functional dog food through our SuperMedley launch and upcoming products later in fiscal 2021; and consolidating sublines, new packaging and price tiers. Let me show you an example of the new advertising for Nutrish featuring Rachael that just began airing last week. [Presentation]

For Natural Balance, the brand is in the process of being repositioned as changing consumer preferences and an evolving landscape in the pet specialty channel has impacted brand performance. We believe that upcoming changes will improve sales trends in fiscal 2021. These actions include new and improved formulas to optimize the mix of grain-in and grain-free SKUs, refreshed marketing and more competitive pricing. We remain confident in growth opportunities for the total pet business, and with new leadership, we expect further refinements to our overall pet strategy, which we will share over the coming quarters. Now moving to coffee, where we are the leader in the total at-home coffee category, with a 25% dollar share. The at-home coffee category is approximately $14 billion and has been growing at an average rate of 2.5% over the last 5 years. 80% of Americans consume coffee, with 4 out of 5 cups of coffee consumed at home, making the at-home coffee category very important in consumers' lives. Lower coffee prices have impacted our net sales as we pass-through lower commodity prices to consumers. However, we have delivered year-over-year volume growth in 5 consecutive quarters while maintaining strong profit margins. Taking a step back, we have shifted our coffee portfolio over the last 5 years, more closely aligning to consumer trends by focusing on the faster growth, one cup and premium offerings, especially in K-Cups, where we have grown over 3x the category average in the last 52 weeks. Mainstream coffee remains our most significant segment, where consumers purchase the largest quantities of coffee. A Folgers red canister can still be found in one of every 3 consuming households. We continue to reinvest in the Folgers brand through our new marketing campaign, which begins to refresh the brand while incorporating the beloved jingle. While we expect modest volume declines to continue in mainstream, we remain well positioned as consumers continue to trade up to premium and single-serve offerings, where our portfolio of brands is outperforming category growth rates. The Dunkin' brand has been a fast-growing brand in the at-home coffee category, increasing sales at an average of nearly 14% over the last 5 years and now represents the #3 brand in the category. We have attracted new households, leveraging the equity of the brand, increasing awareness as Dunkin' shops have expanded across the country and through innovation, including the successful launches of K-Cups and the Dunkin' canister, all of which is being supported by new advertising that was launched in December. In the first quarter of the upcoming fiscal year, we will launch Dunkin' Espresso Style Coffee and Dunkin' Swirl Creamy Syrups. Espresso Style is an extra bold, rich and full-bodied coffee made to stand up to cream, sugar and syrups. Swirl aims to deliver coffee shop quality taste in a convenient and customizable format. These products capitalize on the growing trends in Dunkin' shops, where espresso style coffees grew 40% last year and approximately 1/3 of all coffee ordered included swirl. We also continue to invest in our fast-growing Café Bustelo brand. The brand has been the fastest-growing established brand in the coffee category, growing sales at an average of 14% over the last 5 years through expanded distribution and higher velocities, while doubling household penetration during this time. Having launched the first national marketing campaign highlighting its unique Latin positioning earlier this fiscal year, we expect awareness to build and growth to continue. We are leveraging the brand's Latin authenticity with 2 new product launches. Café Bustelo Origins features coffee from Brazil, Nicaragua and Colombia, aimed at capitalizing on consumers' desire for coffees sourced from a single origin. Building on the success of our initial sweet and creamy flavor platform launch, we are launching a dulce de leche variety in K-Cup, instant and ready-to-drink formats. I would like to finish the discussion of our coffee business with the 1850 brand. We are approaching the end of the second year of this platform launch. While trends have softened following initial distribution gains, we remain enthusiastic about the brand as sales have been incremental to both our portfolio and the category. Repeat purchase continues to be strong, and we are expanding trial with continued investment, including a new marketing campaign, innovation and refinement of our price and promotional strategy. 1850 is also an example of how we are executing on our Be Everywhere imperative. The brand is performing great online, with sales quadrupling over the past year. We have also extended the brand into the Canadian and away-from-home markets. 1850 also advances supply chain transparency and connection to consumers as we launch 1850 100% Colombian through our partnership with Farmer Connect. Utilizing blockchain technology, consumers will be able to follow the journey of the coffee beans from the communities where the beans were grown. Let me finish the coffee discussion by playing a short video highlighting all of the initiatives underway. [Presentation]

Now to our U.S. Consumer Foods segment. Over the past several years, we have taken actions to reshape our portfolio, emphasizing growth categories, including the strategic decision to divest the U.S. canned milk business in fiscal 2016 and the U.S. baking business in fiscal 2019. We now have a portfolio with iconic leading brands such as Jif, Smucker's and Crisco, reaching 2 out of every 3 households in the U.S. In conjunction, we have an on-trend, high-growth brands that include Smucker's Uncrustables, Sahale Snacks and Santa Cruz Organic, that extend our reach with consumers in new and relevant ways. As the leader in both the peanut butter and fruit spreads categories, we love PB&J. It continues to be the #1 lunch sandwich with over 11.4 million PB&Js eaten per day in the United States and it is a great example of consumers' desire for a balance of simple, delicious nutrition. The Jif brand captures the essence of all 3 strategic growth imperatives. The brand is the leader in the peanut butter category with a 40% share -- dollar share and in the latest 12 weeks has realized gains of 1.2 share points over the prior year. We continue to leverage the brand to be everywhere as we now offer Jif portion control cups in the away-from-home channel and the brand is seeing continued success in Canada, achieving a 6% share after launching only 2 years ago. Finally, consistent with our Build Brands Consumers Love imperative, Jif's Bunker spot was recognized as one of the top 25 advertisements in 2019. To further support the Jif brand, we are bringing 2 new products to market in the first quarter of fiscal 2021. The first is Jif Peanut Butter with No Added Sugar. Built on the insight, nearly 60% of peanut butter consumers are concerned with the amount of sugar in peanut butter, we are launching the first national no-stir offering with 0 added sugar. We are also bringing a convenient, squeezable container solution to market in fiscal 2021. While we are excited about the momentum of the Jif brand and the upcoming initiatives to reach new consumers, I do want to share that we have made the difficult decision to discontinue the Power Ups platform. We view the platform as being a success at attracting new consumers to the Jif brand. However, in the spirit of our financial discipline principles, we found it important to reallocate resources to areas of the portfolio that we believe will generate greater financial returns, which include the Jif innovation just discussed and our rapidly growing Smucker's Uncrustables business. The Uncrustables brand, which serves as the anchor of our snacking strategy, has delivered consistent, significant growth over the past 18 years, increasing at an average annual rate of 19%. This fiscal year, the brand is up 15% for the first 6 months versus a year ago and is expected to grow 25% in the back half, supported by the increased production capacity provided by our new facility in Longmont, Colorado. The Longmont facility was recently recognized as the Food Engineering Magazine Plant of the Year due to its size, technology and efficiency. In its current state, it is the largest single-line bakery in the world. Another line is starting up this year and Phase 2 expansion at the facility is underway, providing ample capacity to support demand in all channels of trade, including K-12. We remain on track to achieve our goal to grow net sales for the Uncrustables brand to over $500 million in fiscal 2023. We are excited to expand the Uncrustables brand by offering more lunch and snack options to the platform. The launch includes a line of thaw-and-eat roll-ups, including varieties of meat and cheese and a line of heat-and-eat bites featuring barbecue chicken and taco varieties. Found in the freezer section, these offerings are made with high-quality ingredients, are little to no prep and provide more choices for today's busy families. While sales from these launches are expected to be a small portion of the brand's overall growth next year, we are enthusiastic about the long-term prospects of leveraging the equity of the Smucker's Uncrustables brand. Here is a short video highlighting the efforts underway within the Consumer Foods segment. [Presentation]

In closing, we remain confident in our strategy and are making significant progress on our growth imperatives. We will continue to take decisive actions to improve performance and remain focused on executing against a clear set of priorities, including implementing our evolved leadership structure; strengthening key commercial and consumer-facing capabilities to ensure we continue to build competitive advantage; prioritizing company-wide resources to focus on key growth platforms, including premium pet food and snacks, premium coffee and Uncrustables; continuing reinvestment to build upon great progress we have made in reinvigorating some of our largest brands; and prioritizing strict financial discipline by optimizing investments in consumer-facing marketing while reducing discretionary spending. Thank you. And with that, I'll turn it over to Mark.

Thank you, Mark, and good morning, everyone. Before I begin, I want to thank Mark for his kind words. It's been an incredible journey with this company and to experience the growth over 35 years. I'm very grateful for all the great relationships, many with some of you in the room and of course, the memories that have been created. So thank you all very much. As Mark noted, we are reaffirming our current full year guidance for an approximate 3% decrease in net sales versus the prior year; adjusted earnings per share of $8.10 to $8.30; and free cash flow of $850 million. We look forward to discussing in more detail when we share our third quarter results next week. As we look ahead and with the upcoming CFO transition, I'm confident that we have put in place the building blocks to deliver against our financial priorities: one, consistent sales and earnings growth; two, an increase in free cash flow; three, balanced capital deployment currently centered on delevering our balance sheet and maintaining investment-grade status; and four, improving our return on invested capital. I will discuss the actions that we have taken and are taking to achieve each of these foundational elements. Starting with delivering consistent sales and earnings growth. Our 5-year average annual growth rates for reported net sales and adjusted EPS were 7% and 6%, respectively, through fiscal 2019. We recognized last fiscal year that we needed to make a multiyear commitment to increase the investment in our brands in order to attain a sustainable top line growth, which in turn will lead to consistent earnings growth in the future. This belief was critical foundational element of the Building Brands Consumers Love imperative and provided the basis for the stepped-up marketing investment and increased focus on innovation. Recent volume trends and brand health indicators are positive for many of our brands, and we expect our enhanced marketing support to contribute towards a return to sustainable top line growth as deflationary headwinds subside and corrective actions on our premium dog food brands take hold. We will not provide formal fiscal year 2021 guidance until our fourth quarter earnings call in June. However, at this point in our planning process, we would anticipate sales to be flat to slightly up over the prior year. As we think about net sales for next year, our top line would be supported by the following: the ongoing commitment to consumer-facing marketing, including the benefits of the new advertising campaigns; lapping deflationary pricing, particularly as it relates to coffee and peanut butter; comping of current year headwinds in the private label dog food area; and prioritization of resources to support key growth brands, including Smucker's Uncrustables, Rachael Ray Nutrish, Dunkin' and Café Bustelo. These would be offset somewhat by the planned discontinuation of Jif Power Ups and declines in Natural Balance. We are committed to ensuring that the top line then transitions to an increase in earnings per share. The fundamental guidelines to deliver this commitment are maintaining marketing investment around current levels, while maximizing the ROI on underlying programs, ongoing margin management programs to ensure operational savings both offset cost inflation and contribute to market gains -- to margin gains; and achieving improved asset productivity as increased sales volume raise economies of scale. One example of operational savings programs that we have implemented is the optimization of our pet food logistics network, which will result in the consolidation or exit of several distribution centers and third-party storage locations and the opening of 2 new, larger and more efficient distribution centers in Dallas, Texas and Carlisle, Pennsylvania. Achieving our current year fiscal year guidance, building momentum with balanced growth on both the top and bottom line in fiscal 2021 and consistently delivering on this model will be critical to strengthening our financial discipline. Further, this will serve as the foundation to achieve the other 3 building blocks to deliver on our financial priorities. The second building block of this strategy is free cash flow growth. Our company has a history of delivering consistent, strong free cash flow generation. And based on our fiscal 2020 guidance of $850 million, our current year free cash flow will have increased by approximately 9% over the prior year. And we see a path forward to free cash flow of $1 billion annually in the near future. This will be achieved through earnings growth, moderated CapEx spending and improvements in our net working capital. Our CapEx strategic target spend rate is 3.5% of net sales. However, in fiscal 2021, expenditures will continue to remain elevated due to the second phase of construction at the Longmont facility to expand Uncrustables production. This elevated investment level also allows for projects that support top line growth, enable cost improvements through efficiency and productivity gains and advance our technology strategy. Our third building block has been centered on prioritizing free cash flow to pay down debt as we have focused on delevering the balance sheet after our recent acquisition activity. In the 5 quarters since the Ainsworth acquisition, we have made net repayments of just over $1 billion and our leverage ratio has been reduced to 3.6x at the end of our recently ended second quarter. Following further planned repayments, we expect leverage to be below our long-term target of 3x by the end of fiscal 2021. This level of debt will support greater financial flexibility for capital deployment centered on balancing reinvestments and return. A more balanced capital deployment model in the future includes allocating approximately 50% of cash from operations for future growth through CapEx and strategic projects and returning approximately 50% of cash to shareholders through dividends, share repurchases and a reduction of debt over time. Within this deployment model, we expect the Board to maintain the company's current dividend policy, which is to return approximately 40% of our adjusted earnings per share to shareholders through dividend increases commensurate with earnings growth. We are pleased to have increased dividends for 18 consecutive years at an average rate of 10% over the past 10 years. We are included in certain dividend indices comprised of companies that have consistently increased dividends, and we'll seek to maintain this distinction. Continuation of our current policy delivers 2 to 3 percentage points of shareholder return annually through dividends. And the final building block is to drive improvement in the company's return on invested capital. In our efforts to improve asset returns, we have enhanced our capital deployment strategy to prioritize this metric in all of our decision-making processes. As acquisition activity over the last several years has significantly increased our balance sheet, it's imperative that we drive enhanced performance and consistent growth to improve returns on this asset base. Our strategy includes a review of all tangible and intangible assets to evaluate underperformers that need to be rationalized and also their strategic fit within our portfolio. For ongoing capital and strategic investments, we're taking a more disciplined approach to evaluate both long and short-term impact to our return on invested capital through enhanced modeling, data-driven insights and a comprehensive risk analysis. With that, I would like to conclude our formal comments by reiterating our commitment to our long-term strategy. We are a purpose-driven company, built on the principle of meaningful connections that ensure society and our business both will thrive. We will unlock the growth potential of our brands through the execution of our strategic growth imperatives: lead in the best categories, build brands consumers love, and be everywhere. And we are committed to disciplined capital management, prioritizing investments to foster growth while maintaining a focus on cost control and balanced capital allocation. While we recognize there is still much work to be done, we are confident in our ability to execute as we proceed down this path to sustainable long-term growth and shareholder value creation. Thank you for your time, and I'll turn it over to Aaron to lead us through a couple of Q&A.

Okay, it looks like we have got time for a few Q&A. Let's start with Andrew Lazar.