I appreciate why McCormick (NYSE:MKC) has almost always carried a premium valuation in the packaged food sector. The company holds effectively two-thirds of the U.S. market for spices, and has multiple opportunities to generate above-average growth in areas like dry dinners and frozen foods, and not just in North America. Even so, there is a fair price for every asset and McCormick's valuation seems well more than “fair” these days.Sluggish Performance In The Second QuarterRevenue rose just 2% this quarter, coming in slightly below sell-side expectations, with 3% organic growth. The consumer business was fairly solid, as revenue rose 5% in organic terms on growth in both volume and price. Relative to what we've seen very recently from General Mills (NYSE:GIS) and ConAgra (NYSE:CAG), that's a fine performance. Industrial revenue was not as strong, though, as sales were down about 1% as reported. SEE: How To Evaluate The Quality Of EPSMargins were also not so impressive this time around. Gross margin declined slightly (about 20bp) from last year, and missed the sell-side target by half a point. Operating income was down 1% on a reported basis, and more or less flat on an adjusted basis, with adjusted consumer segment earnings up about 3%.Sluggish Restaurant Traffic Hits IndustrialI have long believed the McCormick's industrial business doesn't get quite the attention it should. McCormick provides a variety of flavorings, seasonings, and other ingredients for restaurants, food service companies, and packaged food manufacturers. PepsiCo (NYSE:PEP) alone accounts for nearly 10% of the company's revenue, and McCormick is responsible for most of the flavorings that go on/into Pepsi's chips (including Doritos).McCormick is also a major supplier to restaurants like Yum! Brands (NYSE:YUM), McDonald's (NYSE:MCD), and Subway, and that exposure isn't helping the company right now. Traffic patterns at quick service restaurants in the U.S. have been fairly soft lately, and likewise McCormick is seeing the impact of significant declines in same-store sales in China (particularly at Yum! Brands' KFC chain).Rome Wasn't Built In A DayInvestors are also right to value McCormick for the emphasis management has placed on growing the business globally. It's not practical to assume that McCormick is going to establish the same sort of dominance in spices and seasonings in markets like Brazil, India, and China, but the company has already invested considerable resources in local/regional packaged meal brands – brands that can be expanded over time and used to leverage other McCormick brands over time.Still, this is going to take time. International growth in categories like dry dinners has been better than in the U.S. recently (almost flat over the last quarter, and not all that strong over the past year), but this is a multi-year project.The Bottom LineI realize that McCormick posts solid margins and returns on capital, and has likewise posted very good growth over the past decade (whether you measure that growth in sales, earnings, cash flow, owner earnings, et al). That alone merits some premium to the sector, particularly as McCormick looks like a share gainer against less dynamic rivals like Kraft (Nasdaq:KRFT). Still, there's a big difference between “some premium” and the premium McCormick gets.I don't think McCormick should trade at an EV/EBITDA almost 40% higher than General Mills. Likewise, a free cash flow analysis based on an estimated growth rate in the high single digits suggests fair value is closer to $60 than the going price of around $70. While I do believe McCormick will continue to show itself to be one of the better-run packaged food companies in the sector, my concern that the stock's valuation is way too high limits my enthusiasm for the shares today.

Related Articles
  1. Stock Analysis

    Will J.C. Penney Come Back in 2016? (JCP)

    J.C. Penney is without a doubt turning itself around, but that doesn't guarantee the stock will respond immediately.
  2. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  3. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  4. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  5. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  6. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  7. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  8. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  9. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  10. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center