McCormick: Getting There

Prepared by Chris, CEO Quad 7 Capital and Team Leader At BAD BEAT Investing

McCormick & Co. (NYSE:MKC) is a name that we have felt was too expensive to buy at $200 and have been waiting for a sizable pullback. We have corrected nicely, with shares down 10% in recent weeks. We believe shares have been getting there into a buy range. We felt at least under $190 was a place to consider, but now we are approaching $180m and we think new money can start coming in, with plans to add in $5 increments on the way down to build a position. If you buy now, and it never goes down, well, that is a high-quality problem because it means you made money.

If you recall earlier this year, we recommended the name at the beginning of April. We felt there was potential for strong returns during the market turmoil under the thesis that “people have to eat.” It has not all been good news as McCormick took a hit from restaurant closures, or restaurants only being available for takeout/delivery, during the COVID-19 crisis, but more people were cooking at home. In our last column, we told you that we locked in sizable profit and kept a house money position. For now, we think new money can start buying. We will touch on performance in Q3 and the recent shareholder benefits in this column.

Sales

Our original stay-at-home thesis continues to play out. Sales in Q3 were impacted by COVID-19. Business sales dropped, while the everyday consumer drove sales. The company delivered some decent results. McCormick’s Q3 sales were up 8% compared to the year-ago period. In constant dollars, sales grew 9%. The consumer segment saw a 15% benefit, while currency impacted things slightly. What about regionally? In Asia/Pacific, consumer sales fell 9%. They rose in the Americas and EMEA. Consumer sales in the Americas jumped 17%. In EMEA, they spiked 23%. This was a result of the stay-at-home trend that we discussed in April.

Flavor Solutions saw sales fall 3%. Declines were entirely driven by business closures. Flavor Solutions continues to have strength if we back out the COVID-19 impacts. The company has pricing power and continues to innovate. COVID-19 was an issue, but be mindful competition remains tough. In this segment, sales in the Americas were down 4.7%, while EMEA saw a 1% drop. Despite the perceived impact of COVID-19, Flavor Solutions rose 4.9% in Asia/Pacific. Profit power expanded in Q3, and we like this.

Margin power

Sales have been good overall, but this is a real strength when we consider that expenses benefited thanks to cost savings initiatives. Margins jumped 70 basis points versus the year-ago period. This expansion was driven by the favorable product mix on top of the cost savings.

Overall in Q3, operating income increased to $273 million compared to $254 million in the year-ago period. From an EPS standpoint, the company missed our expectation by $0.02, but surpassed consensus by $0.01. It was a good quarter. We took issue with valuation, but even at $180, where we are just about now and think you can buy, is still a bit expensive.

Valued for more growth

For the year, we think EPS now hits $5.60-$5.70 depending on Q4. That puts valuation at nearly 35X-36X FWD EPS at $180. The stock has always had a stretched valuation, but this is pretty high. However this is much more attractive than the 39-40X FWD EPS we saw weeks ago.

Shareholder benefits

We also think the 2-for-1 stock split could attract some lower-dollar investment. Even though splits have no real impact on value, there is a perceived benefit often noted by investors, and shares will be below $100 post-split in a few weeks.

Given the big run-up in shares, the dividend yield is not impressive, but we like that it does pay a dividend. We really like that the dividend was just hiked 10%. The quarterly dividend is being increased to $0.68 per share. At $180, this is a 1.5% dividend yield annualized. This is relatively low yield, but still better than most bonds.

Looking ahead

Shares have come down markedly from recent highs. We think this is the level to start buying. As we look ahead with COVID spiking around the globe, over in the consumer segment, we think we see an overall increase in consumer demand during periods of pantry stocking. We saw pantry stocking with our defensive food stock plays, and we think we see increased cooking at home continue in 2020 into early 2021 as COVID kicks up again and new restrictions are put into place. In the Flavor Solutions segment, we also expect to see slowly increasing customer demand from packaged food companies in 2021 as vaccines become available and we flatten the curve again. We still see reduced but improving demand from restaurant and other foodservice customers as the year goes on, but see much better comps as likely in the second half of 2021. With the dividend hike and upcoming split, we think you can buy.

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Disclosure: I am/we are long MKC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.