One theme I continue to circle back to when choosing an investment is how a company responds in a turbulent time.
Given that the Covid-19 pandemic is one of the most disruptive events in a long time, I am looking for companies that have performed well under such duress. One company that seems to be doing so is McCormick & Company (NYSE:MKC).
Company background and recent results
McCormick is one of the dominant forces in the seasoning and spice market. The company is estimated to account for 20% of this highly fragmented industry. McCormick operates in two segments: Consumer (which sells products to individuals) and Flavor Solutions (which sells products to restaurants and foodservice operators). Consumer accounts for ~61% sales and Flavor Solutions contributes the remainder. The company’s products include McCormick spices and herbs, Old Bay, Stubb’s and Zatarain’s. McCormick added Frank’s Red Hot and French’s Mustard in a 2017 acquisition. The company has annual sales of more than $5 billion and trades with a market capitalization of $23.7 billion as of the writing of this article.
McCormick reported its second quarter results for fiscal 2020 on June 25. The company showed strong growth rates from the prior year. Revenue increased 7.6% to $1.4 billion, which topped what Wall Street had been expecting by $30 million. Currency exchange reduced results by 2%. Adjusted earnings per share improved 27% to $1.47, which was 31 cents higher than anticipated.
While many companies have detailed struggles related to the coronavirus outbreak, McCormick appears to have succeeded in this environment.
Source: McCormick’s Second Quarter Earnings Presentation, slide 10.
McCormick was a beneficiary of consumers stocking up on food items to prepare meals at home. As a result, the company increased its market share in nine out 11 categories in which it has a presence. McCormick also outperformed the rest of the center isle of the grocery store as its sales growth rate was double that of the market. In addition, the company saw double-digit growth in repeat buyers and a mid-teen increase in household presentation. This is incredible growth for a company that has been around since 1889.
While a good portion of this growth is due to the pandemic, if McCormick can turn new customers into repeat customers, then the company is likely to improve its market share.
Source: McCormick’s Second Quarter Earnings Presentation, slide 15.
Overall, the Consumer division was up 26% even after a 2% headwind from currency exchange. This business saw volumes and mix improve 25.2% and higher pricing in the Americas and Europe, Middle East and Africa regions. Individualized and digital marketing was credited as a driving force for growth during the quarter. While some condiments saw revenues double or triple in China, lockdowns related to the pandemic led to a 17.9% decrease in net sales for the Asia/Pacific region. Volumes declined 12.5% while currency reduced results by more than 5%. Outside of China, growth was solid, especially in Australia and e-commerce.
On the other hand, Flavor Solutions struggled mightily, as should have been expected given the forced closures of dine-in restaurants throughout the world. Net sales decreased 18.5%, primarily due to a 17.7% decrease in volumes and mix and, to a lesser extent, currency exchange. Pricing offset this decline slightly. The Americas region had weakness in branded foodservice and quick service restaurants though sales to packaged food companies was up. The EMEA region was extremely weak as a 33% decline in volume and mix helped drive net sales lower by 34.3%. Again, branded foodservice and QSR was the main culprit for the decline. COVID-19 related lockdowns and currency change caused a 11.3% drop in sales in Asia/Pacific.
Wrapping up second quarter results, gross margins improved 230 basis points to 41.4% while operating margins were higher by 240 basis points to 18.4%. Selling, general & administrative expenses as a percentage of revenues was 22.8%, 20 basis points higher year-over-year. Positively impacting results was an adjusted income tax rate of 18% for the quarter compared to 18.9% in the year-ago quarter.
As for the rest of fiscal 2020, McCormick expects that the Consumer segment demand will continue to grow. Flavor solutions will see similar demand for packaged food customers while demand for away from home products will improve over time. Costs related to Covid-19 will also continue, and China is projected to be a slight headwind to overall sales.
Valuation and dividend
McCormick pulled its guidance following first quarter results. The company didn’t provide new guidance this time around, despite excellent second quarter results.
Yahoo finance states that the average analyst estimate is for $5.23 of EPS for the year. This would be a 2.2% decrease from the prior year and McCormick’s first year-over-year EPS decline in more than 15 years.
Matching analysts’ estimates would be quite a feat for the company, as only a slight decline in a difficult environment is impressive. Just as impressive is how consistent McCormick has been over the years. The number of shares out standing has remained relatively flat. The company had 136 million shares in 2004, and today it has 134.6 million according to the most recent quarterly report. At the same time, EPS improved from $1.51 in fiscal 2004 to $5.35 last fiscal year, which equates to a compound annual growth rate of nearly 9%. McCormick increased its EPS every single year during this period of time and without the benefit of a massive share repurchase program.
Net profit margin has also increased from 10.7% in 2010 to 13.4% in fiscal 2019. Net profit has compounded at an annual clip of 7.3% over that same period of time. Sales have increased at a rate of 4.8% over the last decade, showing that McCormick is doing a much better job of turning sales into profits.
With a yield of 1.4%, McCormick doesn’t offer much in the way of income, but the company does have a dividend growth streak of 34 years going. With an expected earnings payout ratio of 47% for the year, the dividend appears to be set to grow for years to come.
If there is some hair on shares of McCormick it is the stock’s valuation. Following a 3.6% increase following the release of second quarter results, shares trade at $178.54. Using expected EPS for the year, the stock has a forward price-earnings ratio of 34.1. This compares unfavorably to the stock’s five-year average price-earnings ratio of 20.1.
Final thoughts
In the face of a difficult worldwide environment, McCormick rocked its second quarter. Revenue and EPS growth was excellent, especially for a packaged food company. The company benefited from a stay at home consumer, but its quality of products also led to high percentage of repeat buyers as well as strong penetration numbers. This has McCormick poised to increase its market share if and when the world returns to a more normalized version of itself. Flavor Solutions was extremely weak, but not unexpected. This segment will likely benefit as food service providers and restaurants reopen.
There’s no doubt that investors buying today will be purchasing McCormick at an elevated valuation. Quality comes with a price. I am hesitant to add to my position at the current levels, but I am definitely not selling. Growth can be hard to come by in the packaged food space, and McCormick has plenty of room to grow, as illustrated by the most recent quarter.
Author disclosure: the author has a long position in McCormick & Company.
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This article first appeared on GuruFocus.