NEW YORK — Credit Suisse on April 16 downgraded its investment rating on Orrville, Ohio-based J.M. Smucker Co. to “underperform” from “neutral,” while also lowering its target price to $115 from $120.
“While the company has leading brands in two big, growing categories (coffee and pet food), the dynamic changes in consumer preferences have significantly devalued or commoditized its legacy brands and impaired its competitiveness,” Robert Moskow, research analyst, wrote in the report. “We expect margins to head lower as these pressures necessitate more reinvestment and promotional spending. For example, while some investors believe that Smucker stands to benefit from falling coffee commodity input costs, we believe that its Folgers brand (about 25% of profits) will need to lower its prices and its margin structure to defend its market share from private label incursion.”
In the report, Mr. Moskow offered insight into the company’s coffee division, noting that while the overall coffee category has grown at a 3% rate over the past three years, Smucker’s coffee sales have grown at only 0.5%, and market share has declined 2%.
One area of concern, Mr. Moskow said, has been the declining appeal of the Folgers brand.
“We view Folgers’ declining sales as the biggest threat to the company’s margin structure,” he wrote in the report. “Millennials view the brand as too stodgy and low in quality to add to their pantries. As the brand’s appeal declined, it became more commoditized in the eyes of consumers and more sensitive to private label. Walmart expanded its range of private label offerings and upgraded the quality of the product line to try to fend off competitive incursions by European hard discounters Aldi and Lidl.”
Mr. Moskow said Smucker also tried to raise the prices on its Folgers products in February 2017, when coffee input costs were rising modestly higher. However, when input costs fell, and private label lowered its prices, actions taken by Smucker to discount Folgers and bring it back into line to protect market share failed to fully stabilize the business.
“Smucker management itself says that it needs to monitor Folgers’ price gaps with private label more closely now than ever before,” Mr. Moskow said. “In our view, this signals significant commoditization of the brand. Our fear is that the Folgers brand will continue down this path of commoditization and lose its price premium to private label. Frankly, the packaging for store brands at Aldi and Lidl looks more compelling than Folgers and they sell at a lower price. If consumers keep trying these brands, their market shares will rise higher. Coffee is essentially a commodity business where roasters can very easily create a high quality product with specific roasting processes and different blends of beans to create a compelling brand."
Mr. Moskow said Credit Suisse also is concerned that Smucker’s response to the competitive threat of private label will “exacerbate” the commoditization of its Folgers brand. Smucker earlier this year launched a new version of Country Roast Folgers with a smaller package and price point below regular Folgers. He said the brand intentionally deemphasizes the Folgers brand on its label so that consumers do not perceive it as “regular Folgers.”
“In our view, this product increases Folgers’ association with cheaper private label options and poses a threat to Folgers’ price position,” he said.
Moving forward, Mr. Moskow said Credit Suisse sees the loss of Folgers’ pricing power reducing Smucker’s coffee division’s profit margins significantly.
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