McCormick Roars After Earnings
Up until Tuesday, shares of spice and seasoning maker McCormick and Co. Inc. (NYSE:MKC) had endured a very difficult year, with the stock losing almost 27%. The double whammy of inflationary pressures and currency exchange had weighed on the companys results for some time. Smaller impacts from McCormicks exit of its Russian business and Covid-19-related disruptions in China also impacted results.
But after releasing earnings, the stock surged almost 10% in Tuesday's trading session, placing the stocks one-year performance almost in line with the decline in the S&P 500 over this period of time.
Despite the gain in a single trading day, McCormick appears to be undervalued. Lets dig deeper to see why I believe investors can still expect upside going forward.
Earnings highlights
McCormick reported first-quarter results on March 28. Revenue improved almost 3% to $1.57 billion, topping analysts estimates by $20.5 million. Adjusted earnings per share of 59 cents compared unfavorably to 63 cents in the prior year, but was 9 cents above expectations.
Adjusting for currency exchange, net sales were up 5% year over year. Higher realized prices added 10.6% to results, which were partially offset by a 2% decline in volume and a 3% headwind from product mix.
The Consumer business fell 1.8% as volume and mix declines and divestures more than offset a nearly 9% contribution from pricing activities. By region, this segment had a 3.3% increase in the Americas, an 8.8% decrease in Europe, the Middle East and Africa and a decline of more than 15% in Asia-Pacific.
Flavor Solutions improved 10%, driven by a 13.5% increase in pricing, which was only partially offset by a small decrease in volume and mix. The Americas and Europe, the Middle East and Africa grew 12.7% and 6.8%, respectively, while Asia-Pacific fell just 1.1%.
Higher costs due to demand and supply chain issues did hamper margins slightly, as the gross margin contracted 80 basis points to 36%. That impact was felt most in the Flavor Solutions business as the company needed to spend in order to meet an increase in customer demand. This can be seen as a positive given where this business was during and shortly after the pandemic. Demand from customers has more than returned to pre-Covid levels, requiring additional materials and employees.
However, cost controls meant that selling, general and adminstrative expenses actually declined 40 basis points to 21.5%. Also aiding margins was the divesture of lower-margin businesses.
McCormick provided guidance for the year as well, with the company expecting adjusted earnings per share of $2.56 to $2.61 for 2023. For context, the company had $2.53 of adjusted earnings per share in 2022. Net sales are forecasted to improve 5% to 7%, ahead of consensus of 5.3%.
Takeaways
McCormick has almost been a tale of two companies over the past few years. The Consumer business reaped the benefit of customers being forced to prepare more meals at home during the worst of the Covid-19 pandemic. The growth rates seen during this period were often in the low-to-mid-double-digit range and as high as 35% for the first quarter of fiscal 2021, reflecting the increased number of meals cooked at home.
Juxtaposed to this is the Flavor Solutions business, which supplies products to the food service industry. This business struggled mightily during the pandemic with the closing of so many restaurants due to social distancing restrictions. The segments worst performance came during the second quarter of fiscal 2020, where the business fell nearly 19% from the prior year. Now this segment is returning to growth over the past few periods even as lockdowns in China had previously been a headwind.
With much of the world seeing a normalization to a pre-Covid-19 environment, the Consumer business has been more inconsistent. Some declines in the business should have been expected given the unprecedented demand for products.
The surprising part of this is the declines are not exactly massive or even present compared to periods of high growth. Year-over-year growth rates following the first quarter of 2021 never got worse than a decrease of 8.4%.
More recently, Consumer had seen decreases of 7.6%, an increase of 9.8%, an improvement of 0.7% and a decline of 8.4% in the four quarters of fiscal 2022.
The Flavor Solutions business' results show customers are eating out much more than they had been doing, but this has not translated to an exact corresponding decrease in the Consumer business.
McCormick is essentially getting the best of both worlds as Consumer segment sales remain at or above their best levels during the worst of the pandemic, while the Flavor Solutions business remains in high-growth mode.
Valuation analysis
McCormicks guidance came in higher than what analysts had anticipated, which, combined with the earnings and revenue beat, caused the stock to jump almost 10% in one day.
Using the midpoint of company guidance, McCormick is trading at more than 31 times forward earnings. This is not too far off the five-year average multiple of around 30 times earnings.
Looking at the GF Value chart, it appears that shares still have more upside potential based on its historical ratios, past financial performance and analysts' future earnings projections.
Currently, McCormicks GF Value is $97.65, giving the stock a price-to-GF Value ratio of 0.83. Reaching the GF Value would result in a further return of more than 20%, which is before factoring in the companys small but market-beating yield of 1.9%. McCormick earns a rating of modestly undervalued from GuruFocus.
Further bolstering my bullish thesis on the stock is that McCormick has a GF Score of 91 out of 100. Stocks with higher GF Scores often outperform those with lower scores according to GuruFocus research. McCormick receives top marks on growth, profitability and value and low scores on momentum and financial strength.
Final thoughts
After a very difficult year for the stock, shareholders enjoyed a strong rally on Tuesday. This was due to solid results in the business and guidance that was ahead of forecasts.
The Consumer business continues to oscillate between periods of growth and decline, but has retained many of the customers that it gained during 2020. Flavor Solutions continues to produce robust growth as pricing action has not had a severe negative consequence on demand. In fact, the company had to spend more to meet demand in the first quarter.
Shares of McCormick are not cheap on a forward basis, but they rarely have been over the medium term. Investors buying even after the spike in price could still be rewarded with more than 20% returns.
This article first appeared on GuruFocus.
