Stock Analysis

# Is The J. M. Smucker Company (NYSE:SJM) Trading At A 48% Discount?

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of The J. M. Smucker Company (NYSE:SJM) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out the opportunities and risks within the US Food industry.

## The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

#### 10-year free cash flow (FCF) forecast

 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Levered FCF (\$, Millions) US\$630.2m US\$956.3m US\$1.02b US\$1.26b US\$1.28b US\$1.30b US\$1.32b US\$1.34b US\$1.37b US\$1.39b Growth Rate Estimate Source Analyst x5 Analyst x4 Analyst x4 Analyst x1 Analyst x1 Est @ 1.56% Est @ 1.69% Est @ 1.77% Est @ 1.84% Est @ 1.88% Present Value (\$, Millions) Discounted @ 5.7% US\$596 US\$856 US\$863 US\$1.0k US\$966 US\$928 US\$893 US\$859 US\$828 US\$798

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US\$8.6b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 5.7%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US\$1.4b× (1 + 2.0%) ÷ (5.7%– 2.0%) = US\$38b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US\$38b÷ ( 1 + 5.7%)10= US\$22b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US\$30b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US\$148, the company appears quite undervalued at a 48% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

## Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at J. M. Smucker as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 5.7%, which is based on a levered beta of 0.800. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

### SWOT Analysis for J. M. Smucker

Strength
• Debt is well covered by earnings and cashflows.
• Dividends are covered by earnings and cash flows.
Weakness
• Earnings declined over the past year.
• Dividend is low compared to the top 25% of dividend payers in the Food market.
Opportunity
• Annual earnings are forecast to grow for the next 3 years.
• Trading below our estimate of fair value by more than 20%.
Threat
• Annual earnings are forecast to grow slower than the American market.

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a discount to intrinsic value? For J. M. Smucker, we've put together three essential aspects you should explore:

1. Risks: Every company has them, and we've spotted 2 warning signs for J. M. Smucker you should know about.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SJM's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

### Valuation is complex, but we're helping make it simple.

Find out whether J. M. Smucker is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.