J. M. Smucker’s (SJM) Pet Food Deal Was Good- Earnings Quality Not as Much

A look at some unsustainable benefits in SJM’s last quarter

The J.M. Smucker (SJM) company was in the news last week with the announcement of the sale of the bulk of its pet business to Post Holdings (POST) for $1.2 billion. The brands sold include the Rachel Ray, 9Lives, Nature’s Recipe, and Gravy Train brands, along with another private label business. We have pointed out to our institutional clients in the past how disappointing growth from these brands has already forced SJM to take more than $600 million in impairment charges to the associated goodwill and intangible assets generated from the acquisition of those brands and that rising discount rates were likely to result in more charges given the slim cushion between fair value and carrying value. SJM said the sale will reduce full-year EPS by 45 cps without consideration of any benefit from the use of the proceeds. This implies annual net income from those brands of roughly $50 million putting a PE on the deal of over 25. This plus the chance to jettison disappointing assets seems to us to slant the deal in SJM’s favor.

However, we are not as impressed by the earnings quality of SJM’s second quarter ended in October as SJM’s earnings and cash flows appear to have benefitted from some unsustainable benefits that we believe investors should be aware of. We will examine some of these below:

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