JM Smucker anticipates a $650m benefit to its top-line sales this year from the acquisition of sweet baked goods snacks maker Hostess Brands but scepticism still hangs over the deal.
Markets were greeted with a mixed bag yesterday (5 December) as JM Smucker reported a drop in second-quarter group sales but a more than 500 basis-point increase in the gross margin – the latter helped by a trimmed down pet-food portfolio following the disposal of brands to Post Holdings.
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Sales excluding the pet transaction were, however, higher than a year earlier. But JM Smucker also tweaked its fiscal 2024 guidance lower for sales and earnings per share to reflect the disposal of those assets and the divestiture of its Sahale Snacks fruit and nut snacks operation, both on the negative side. More positive, was the expected benefit from the Hostess Brands deal.
JM Smucker, which also owns the Uncrustables frozen sandwich snacks brand, a differentiator from Hostess Brands’ more indulgent offering such as Twinkies and Kazbars cakes, has previously flagged an annual sales benefit from that transaction of $1.5bn.
The Ohio-based food and coffee supplier yesterday pointed to $650m in sales in fiscal 2024 from the $5.6bn deal, with around $300m in quarter three. While the figure is off initial projections, the transaction was only finalised in November, having first being confirmed in September.
Post-completion, JM Smucker’s finance chief Tucker Marshall said Hostess Brands would be “immediately accretive” to operating margins. However, with the rise of the GLP-1 weight loss and appetite-suppressing drugs in the US, and the potential implications for food companies, analysts questioned the rationale behind the deal.
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By GlobalDataChairman, president and CEO Mark Smucker defended his call, noting on the one hand that consumers are still seeking to treat themselves with indulgent sweet snacks, even in hard times. And on the other, the fact Hostess Brands' presence in C-stores would bring another channel benefit to his business.
Hostess sceptics
Alexia Howard, an analyst at US investment bank AllianceBernstein, was quick out of the blocks in September to question the thinking related to the Hostess Brands acquisition, and she still holds onto to some reservations now.
Writing in a research note yesterday, Howard again expressed some “scepticism” but said: “Overall, Smucker’s core businesses seem to be performing well, but scepticism remains about the Hostess deal.
“The Uncrustables brand (>10% of companywide sales) goes from strength to strength with 22% growth driven by volume/mix as the company expands capacity and ramps up marketing.
“However, investors are likely to remain sceptical about the Hostess deal given relatively weak sales trends in measured channels, paired with concerns about what GLP-1 drugs could mean for Hostess’s sales trajectory over time.”
JM Smucker reported second-quarter sales to 31 October were down 12% at $1.94bn, reflecting the pet-food brands disposal completed in April. Net sales, excluding the pet divestiture and the impacts from foreign-currency fluctuations, increased 7%.
The Cloverhill honey buns brand owner lowered the top-end of its growth guidance for ‘comparable’ net sales in the current year to 8.5-9%, from the 8.5-9.5% outlined in June. The adjusted earnings per share outlook was cut to a range of $9.25 to $9.65, compared to a prior estimate of $9.45 to $9.85.
Adjusted EPS for the quarter rose 8% to $2.59.
Sales modelling
Marshall explained on a call with analysts: “Our updated guidance reflects total sales of $8.25bn [$8.5bn in fiscal 2023] at the mid-point of the range. Net sales are anticipated to decline approximately 3% to 3.5%, compared to the prior year, and includes a $1.5bn reduction in sales from the pet food and Sahale Snacks divestitures, and a $650m increase in sales from the Hostess acquisition.”
Mr Smucker reiterated that Hostess Brands will bring an extra $1.5bn in group sales to the table and will represent around 15% of the company’s total portfolio. The group’s second-quarter profit margin rose 520 basis points to 20.9%.
“With the addition of Hostess, we now have a significant presence and leadership position in the highly attractive snacking market. Within the snacking category, indulgent snacks have experienced faster growth compared to other snacking alternatives over the past three years,” he said.
Marshall added that third-quarter comparable net sales are expected to increase by mid-single digits, with Hostess Brands contributing about $300m.
Robert Moskow, an equity analyst at TD Cowen, a division of investment bank TD Securities, also voiced some reservations but with a balanced outlook.
“Softer near-term outlook, for Hostess,” Moscow wrote in a research bullet note.
He added: “Management acknowledged that Hostess has hit a speed bump owing to heightened competition and consumer elasticity. But this sounds addressable and not much different than the general malaise across packaged foods.”
Moskow also referenced getting ahead of Hostess Brands main US competitor McKee Foods, the owner of the Little Debbie and Drake’s snacks brands.
“Management expressed high confidence that Hostess can return to a 4% growth rate over time. However, our sense is that investors will need to see more details about Hostess' plans for product innovation, distribution, and keeping pace with the rejuvenated category leader, McKee, before fully re-engaging with the stock.”
Further out, Marshall expressed some confidence in getting back to that growth rate: “We expect long-term annual net sales growth for the sweet baked snacks business of approximately 4%.
“We anticipate expanded distribution for both Hostess and Smucker products through the complementary capabilities of the combined businesses supporting our long-term growth expectations.
The CFO added: “We also anticipate annual cost synergies of approximately $100m, half of which are expected to be realised in fiscal year 2025, with the full annualised amount to be achieved by the end of fiscal year 2026.”
Marshall explained that excluding the “dilution” from the Hostess Brands acquisition, adjusted EPS is expected to rise around 10% over the previous 12 months, including “an approximate 7% headwind related to the net impact of stranded overhead from the divestiture” of the pet-food brands.
Elsewhere in the business, JM Smucker’s pet-food sales fell 39% in the quarter to $464m but excluding $377.8m of non-comparable sales related to the divested brands, they increased 20%.
CEO Smucker added: “Our pet-segment results this quarter highlight the benefits of our recent pet-food divestiture, as profit margins improved over the prior year, driven by product mix. We anticipate margins will further improve over time after we fulfil contract manufacturing requirements [with Post Holdings] and remove stranded overhead costs related to the divestiture.”
For the business as a whole, JM Smucker expects an adjusted gross margin of 37.5% in fiscal 2024, below the second-quarter print of 38.7%, which Marshall described as “very strong”.
He added: “As we think about the third and the fourth quarter, the third quarter will be a bit softer than where we landed in the second quarter and then it will be a bit stronger in our fourth quarter in order to get you to our current outlook for gross profit for the full year.”
