Stable Volumes Support Premium Valuation For McCormick

By Stephen D. Simpson, CFA | June 25, 2012 AAA

If investors want to find a bargain in packaged food, they have little choice but to go with small up-and-comers that aren't fully appreciated yet or dip into the box of broken toys. Companies like Kellogg (NYSE:K) and Kraft Foods (NYSE:KFT) offer some potential on the basis of past missteps and/or restructuring potential, but a well-run company like McCormick (NYSE:MKC) doesn't come cheap these days. Although I believe there's still upside to the McCormick story, these shares aren't priced to permit many mistakes.

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Q2 Results on Track
McCormick's fiscal second quarter results were basically as expected, and that's OK given that the Street expected pretty solid performance. Revenue rose 11% on a reported basis, with about half of that coming from acquisitions.

SEE: Analyzing An Acquisition Announcement

McCormick's industrial business saw about 10% organic growth, with consumer growth of around 5% (again, organic) as the company saw mid-single digit price growth and minimal volume loss.

McCormick was a bit wobblier on the margin lines. Gross margin slipped about 20 basis points from last year and was a little weak relative to Street expectations. Likewise operating margin came in a little short of expectation (and dropped 10bp from last year), but 11% growth was still a solid outcome.

SEE: Understanding The Income Statement

Going Aggressive While Many Play Defense
McCormick is a curious company, in many respects; one example is the relative aggressiveness of management today. Not only is the company looking to build its geographic footprint (not really an unusual stance today), but it is also looking to enter markets like frozen foods at a time when players like ConAgra (NYSE:CAG) and Heinz (NYSE:HNZ) seem to be back on their heels a bit. The size of this market makes it a worthwhile target, though, and building a brand like Zatarain by covering more product categories, does make some sense.

McCormick is also actively looking to grow across the globe. While companies like General Mills (NYSE:GIS) and Kellogg are pretty focused on emerging market growth, McCormick is not forgetting about Europe. Still, emerging markets are a major focus and acquisitions like Kamis and Koohinor should help boost the company's presence in Eastern Europe and India.

The Bottom Line
If there's a big problem with McCormick, it's that Wall Street loves the name and expects quite a lot already. Trailing EV/EBITDA multiple is just one metric (and a limited one at that), but comparing McCormick to General Mills, Kellogg, Kraft and even Nestle shows McCormick to be one of the most highly-valued food stocks out there. This is backed up by cash flow as well, as McCormick would seem to have among the lowest appreciation potential, based on cash flow.

SEE: 5 Must-Have Metrics For Value Investors

I understand why McCormick is in favor. The company is holding onto volume at a time when many others are losing substantial volume and there aren't a lot of generic/private label options in the spices and seasonings aisle. What's more, management plays things pretty straight and hasn't given the Street any reason to really doubt them.

With all of that said, I understand why investors would hold onto these shares. While I do believe McCormick has good growth potential from international growth, new product introductions and brand extensions, I believe today's price already assumes that a lot of these go well. At a lower price I'd love to buy McCormick, but it looks like I'll have to wait a while for that to happen.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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