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McCormick: Becoming More Attractive

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- By Nathan Parsh

Shares of McCormick & Company (NYSE:MKC) have increased 45% over the last year as the company has benefited from its leadership position in the otherwise highly fragmented seasoning and spice industry. This sent the stock much higher and its price-earnings ratio was in the mid-30s for quite some time, which is a valuation usually reserved for high growth companies.


However, the stock has declined more than 12% over the last six months, which has brought the earnings multiple a little out of the stratosphere. This has made the stock appear slightly less overvalued. Let's examine the company's most recent earnings result, growth prospects, dividend and valuation to see if it could represent an attractive buy at current levels.

Recent earnings results and growth prospects

McCormick reported earnings results for the fourth-quarter and full year of 2020 on Jan. 28. The company had revenue of $1.56 for the quarter, which was a 4.9% improvement from the prior year and was narrowly ahead of Wall Street analysts' expectations. Adjusted earnings per share of 79 cents was 1.9% lower than the same quarter a year ago and 3 cents below estimates.

For 2020, McCormick's revenue improved 5% to $5.6 billion while adjusted earnings per share were higher by 5.6% to $2.83.

The consumer segment had 5.9% net sales growth in the fourth quarter, driven by a 3.7% improvement in volume and mix, a 1% increase in price and a small tailwind from currency exchange.

The Europe/Middle East/Africa region was the top performer as sales were up more than 15%. Volume and mix improved 8.4% as McCormick saw strength in all countries in the region. Branded spices and seasonings and homemade desserts were singled out as sources of strength.

The Americas segment grew 5.5%, mostly due to higher volumes. Frank's RedHot and French's Mustard, part of the portfolio of products acquired from Reckitt Benckiser Group (RBGLY) in 2017 for $4.2 billion, saw an improvement in market share. Zatarain's and Lawry's also had higher demand.

Asia/Pacific was down 6.5% as volumes fell nearly 10% year-over-year due to lower branded foodservice sales and a shift to a later Chinese New Year in 2021.

The Flavor Solutions segment returned to growth with sales improving 3.1%. This segment suffered during the height of the Covid-19 pandemic as demand from restaurants declined due to business closures and limited dining capacity.

Asia/Pacific was the top performer in this segment as sales were up 10.8%. Weaker pricing only partially offset an 8.5% improvement in volumes and mix and a 3.7% positive contribution from currency exchange. Performance in this region stands in stark contrast to the consumer segment as demand from quick service restaurant customers in China and Australia was very strong.

EMEA grew 6.6% due to better demand for snack seasonings. The Americas inched higher by 0.9% as currency and volume and mix nearly offset a 2.4% improvement in pricing.

McCormick's balance sheet looks to be in decent shape. The company ended its fiscal year on Nov. 30 with $12.1 billion of total assets, $2.1 billion of current assets and $427 million of cash and cash equivalents. Inventory was up 29% from 2019, though higher demand during the year might warrant this increase. Operating cash flow improved 10% to a record $1 billion.

The company had total liabilities of $8.1 billion, including current liabilities of $3 billion. Total debt was $4.9 billion, with $1.15 billion due within the next year. The company has just enough cash on hand and free cash flow production to meet its obligations, which means more borrowing may have to take place. It is likely that debt will be rolled over at a lower interest rate, which would save McCormick on interest expense.

Outlook

McCormick expects adjusted earnings per share in a range of $2.91 to $2.96 for the current year, which would be a 3.9% increase from 2019 at the midpoint. Considering the benefit that the company saw from Covid-19 causing more meals to be consumed at home last year, this would be a solid improvement.

McCormick is able to deliver such results because it has several catalysts for growth. First, the company controls approximately 20% of seasoning and spice space and has seen solid growth rates as consumers spent much of 2020 social distancing and eating more at home. This gives McCormick pricing power, size and scale that competitors cannot match. Due to the popularity of its products, the company is often afforded premium shelf space at grocery stores as well.

The company has made strategic acquisitions over the years. When the acquisition of RedHot, French's Mustard and other products was announced, the market initially balked at the purchase price. This was the largest deal in McCormick's history and required the taking on of additional debt. But the addition of the number one hot sauce and the top selling mustard have paid off for the company. More recently, McCormick added Cholula, a premium hot sauce maker, in late November of last year for $800 million.

McCormick has also invested heavily in its digital business. Expenses increased 180 basis points in the fourth-quarter as the company continues to build out its e-commerce business. This is already contributing to results as e-commerce sales surged 136% for the year. The company also had the top spot among all U.S. food brands in terms of digital customer connections.

With so many positives working in its favor, McCormick is likely to continue to thrive and grow its market leadership.

Dividend and valuation analysis

McCormick increased its dividend by 9.7% for the Jan. 11 payment date, which pushes the company's dividend growth streak to 35 years. McCormick is one of just 65 companies that qualify as a Dividend Aristocrat. Shares yield 1.6% today, just above the 1.5% average yield for the S&P 500.

The company's annualized dividend of $1.36 is projected to consume 46% of the midpoint of expected earnings per share for 2021. This is nearly in-line with the 10-year average payout ratio of 44%. McCormick has a remarkably tight payout range of 40% to 45% over this period of time. Dividends have a compound annual growth rate of 8.5% from 2011 through 2020, showing how consistent McCormick has been at managing its payout ratio while also offering a high single-digit dividend increase.

The free cash flow payout ratio shows a similar story. McCormick distributed dividends per share of $330 million last year while generating free cash flow of $816 million for a payout ratio of 40%. This matches the average payout ratio seen over the prior three years.

Using the current price of $86.65 and expected earnings per share of $2.94, McCormick has a forward price-earnings ratio of 29.5. The five- and 10-year average price-earnings ratios are 26 and 23.1, respectively, so the stock does appear expensive compared to its medium- and long-term valuations. As stated at the outset, the valuation has improved from even just a year ago.

McCormick also appears to be trading much closer to its intrinsic value according to the GuruFocus Value chart:

McCormick: Becoming More Attractive
McCormick: Becoming More Attractive

McCormick has a GF Value of $82.85, resulting in a price-to-GF-Value ratio of 1.05 and earning the stock a rating of fairly valued from GuruFocus. Shares would have to decline 4.4% from current levels to trade with the GF Value.

Final thoughts

Shares of McCormick have not fared well in the recent term and the stock sits approximately 17% off of its split adjusted all-time high. This puts the stock very close to bear market territory, but I believe that the market is underestimating the strengths of the company.

We first added McCormick to our portfolio following the steep selloff after the announced product purchase from Reckitt Benckiser Group. We felt then that the market was overreacting to the price of the acquisition and seemed to ignore how the addition of top selling brands would be a positive for McCormick.

It appears that the market might be making a similar mistake this time. The company had a good 2020 and leadership expects continued growth in 2021.

We are not yet ready to add to our position in McCormick as shares look expensive to us even after the drop in share price. However, as the stock moves more towards its long-term valuation and intrinsic value, we feel that McCormick, with its business model and history of dividend growth, could become a very attractive investment option.

Author disclosure: the author maintains a long position in McCormick & Company.

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This article first appeared on GuruFocus.