Despite Pullback, Smucker Still Overvalued

We do not plan to significantly alter our $107 per share valuation for narrow-moat

Smucker’s volatile U.S. Retail Pet Foods unit (29% of fiscal 2016 sales) posted a 6% quarterly sales decline, lagging as the rest of the firm mostly met expectations. Although mainstream brands drove much of the shortfall and account for almost half of segment sales, Smucker’s Natural Balance premium label also posted a double-digit pullback, and while some of the impact was due to a fiscal 2016 distribution gain, results were also hit by weakness in the pet superstore channel.

While we support Smucker’s efforts to premiumize pet food by introducing functional snacks and capitalizing on trends favoring natural and protein-rich items, the investments needed to develop and market such innovations will take time to build brand equity and meaningfully reduce reliance on lower-margin mainstream offerings. Until then, Smucker should remain especially dependent on specialty retailers for growth, as the channel is more receptive to innovative, unestablished items. Our long-term segment margin target (19.8% average over the next decade versus 17.4% in fiscal 2016) includes benefits from premiumization and innovation that we believe will outweigh higher input costs; however, continued challenges in Smucker’s premium offerings over the coming quarters may lead us to temper our expectations.

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