Smucker baking brands
J.M. Smucker earlier this month said it is exploring strategic options for its U.S. baking business.

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.”

Another area of concern cited by Mr. Moskow is the risk of earnings dilution from a possible sale of its baking business. The company earlier this month said it is exploring strategic options for its U.S. baking business, a review that includes its U.S. baking business that primarily encompasses products sold in U.S. retail channels under the Pillsbury, Martha White, Hungry Jack, White Lily and Jim Dandy brands, along with all relevant trademarks and licensing agreements. The review also includes the company’s manufacturing facility in Toledo, Ohio.

If Smucker is able to find a buyer for the baking business, Mr. Moskow said Credit Suisse anticipates as much as 25c of earnings dilution from a sale. Slowing the pace of share repurchase to pay down debt represents a potential drag on earnings-per-share growth as well, he said.

“This brand (Pillsbury) has lost significant market share to the market leader Pinnacle’s Duncan Hines, and the management team has not expressed an interest in putting more capital behind it to keep pace with Pinnacle’s extensive innovation,” Mr. Moskow noted in the report. “Retailers focusing on simplifying their shelves have been discontinuing third-tier brands like these to make room for private label.

“By our math, a divestiture would create significant earnings dilution of perhaps 25c, even if the business fetched an 8x EBITDA multiple. With the brand now declining at a double-digit pace, we doubt that a buyer would pay much more than that.”