When a company has paid dividends for the better part of a century, clearly it is doing something right. McCormick (NYSE:MKC) has a great business and management runs it well, but investor expectations run pretty hot for this leading spice company. While I can understand how investors may feel that overpaying for McCormick is preferable to taking a risk on a lesser company, I'd be cautious about paying so much relative to its growth potential.
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Not a Perfect Fiscal Q3
McCormick's fiscal third quarter was not bad, but I'm not sure this is the sort of performance investors really want to pay nearly 14 times trailing EBITDA to own. Revenue rose 6%, as reported, with organic growth a little less than 5%. Pricing was strong (up more than 4%), while volume eeked out a small gain. While reported growth in the consumer business came in at 9% (and 12% in local currency), organic growth was a more modest 4%. Industrial growth of 6% (organic) was pretty solid, as clients like PepsiCo (NYSE:PEP) continue to do well in snacks. Overall, McCormick came in about one or two points shy of the average sell-side revenue growth expectation - largely due to weaker consumer volume.
McCormick's profitabilty was not bad, but investors should appreciate that a large part of the company's reported earnings "beat" was due to lower-than-expected taxes. Gross margin did improve a half-point, while operating income rose 12%, fueling a 70 basis point operating margin improvement.
Do QSRs Offer Still More Potential?
While McCormick gets a lot of deserved credit for its sizable and near-dominating consumer spices business, roughly 40% of sales go to industrial customers. Packaged food companies use McCormick's spices and seasonings in a variety of food products, but there are opportunities in quick-service restaurants (QSRs) as well. Popeye's, for instance, uses Zatarain's branded spices and the introduction of a Doritos-flavored taco shell has been a big winner for Yum Brands' (NYSE:YUM) Taco Bell. This is relevant to McCormick, as it has been the supplier to PepsiCo of Doritos' seasoning for a long, long time. Given the success of this product, and the breadth of Doritos' chip offerings, I would be surprised if there weren't follow-on seasoned taco shell introductions.
Maybe this is just the start of a trend - a lot of people in the Mid-Atlantic put Old Bay seasoning (also owned by McCormick) on almost everything, and would it really be so surprising to see some sort of Old Bay French fry product? With such a deep portfolio of familiar flavors, and the competition among QSRs to differentiate their offerings, I have to think there's more opportunity here over the years to come.
Consumer Still a Good Business - Especially Overseas
I have seen estimates out there that, between branded and private label, McCormick already has roughly two-thirds share in North America in categories such as spices and seasonings. That tells me that further consumer growth may depend upon follow-on product offerings, as well as more expansion into packaged meals and/or frozen/heat-and-eat products. As Heinz (NYSE:HNZ) has demonstrated recently, that's not always easier done than said.
Overseas, though, it's a different story. McCormick recently bought Chinese spice company Wuhan Asia-Pacific Condiments, and there remains significant growth opportunities in countries like China, India and Indonesia. Better distribution and margins are still important, but McCormick is off to a good start in these markets.
The Bottom Line
I like pretty much everything about McCormick except the price. I've been evaluating companies long enough to be surprised, though. Investors need only look at other quality names such as Coca-Cola (NYSE:KO), PepsiCo and so on to appreciate that there are very few freebies in consumer brands - well-run companies with good brands get robust valuations. It's hard to go deep into the $50s on valuation without projecting revenue growth and/or cash flow margin expansion well ahead of demonstrated capabilities at McCormick. Consequently, I don't see the value here. I'd love to buy these shares on a pullback, and I do like the long-term prospects, but it's difficult to pay so much for any company.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.