On January 24, 2013, McCormick (MKC) reported Q4 results. Analysts were looking for $1.15 EPS for Q4 and $3.08 for FY 2012. On a revenue basis, analysts were estimating for Q4 revenue of $1.174B and FY 2012 revenue of $4.035B. MKC reported EPS and revenue results of $3.04 and $4.014B, respectively (Source: Capital IQ). At the end of FY 2011, management had guided for the following results in FY 2012 (Source: MKC Q4 2011 Conference Call):
The results and important takeaways that MKC reported for FY 2012 are as follows:
- Revenue growth of 9% (meeting the high-end of expectations given the -2% currency reduction guidance). This is above the 4% to 6% long-term sales guidance.
- Operating income growth of 5% missed expectations due to supply chain issues with Hurricane Sandy and product quality issues from a supplier. Management expects to recuperate some of these losses in FY 2013.
- CCI savings came in at $56M against the at least $40M guidance
- Material costs increased about 10% against a high single-digit target
- Incremental brand marketing was $11M vs. at least $10M estimate
- The tax rate came in at 25.5% against the 30% expected tax rate
- Income from unconsolidated operations lagged guidance as it was only $21.4M
- EPS came in at $3.04 on a diluted basis, right in the middle of where management guided
- Cash flow from operations hit a new high at $455M, driven by flat inventory. It used $297M as a return to shareholders, a 25% increase Y/Y. This put shareholder return over $1B since 2008 (Source: MKC Q4 2012 Conference Call):
- Emerging markets sales grew 47% and were 14% of the year's sales. They were only 10% of 2011 sales.
- Launched over 250 new branded products, as its 2015 goal is to have new products account for ~15% of sales
- Witnessed a double-digit increase in online traffic in the US
- Sales were strong in the EMEA segment and Asia/Pacific Consumer segments
- Weakness in the year was in the Asia/Pacific Industrial and Americas segments due to retailer purchase patterns with the price increases and the supply chain issue. Customers like YUM! Brands (YUM) struggled with foot traffic and chicken problems in 2012 in China. This led to a weak supply chain.
- $137M out of $400M remains on the buyback plan
- In Q4, across all 3 geographic regions, the Consumer segment's operating income increased $13M Y/Y
- Industrial Americas segment grew due to food manufacturers but was weak due to quick service restaurants
- Industrial EMEA, however, grew sales 12% in local currency (7% from volume and mix) due to quick service restaurants and market share gains
- Paid down $85M in debt in Q4 to return to targeted debt level
- Closed US pension plan to new participants in 2012, and closed defined benefit plan in Canada in 2013
- In regards to emerging markets growth, CFO Stetz expects to gain market share, expand MKC's presence, and have emerging market operations' margins trend to MKC's overall
- When asked about acquisitions, management said:
CEO Wilson: "we have some good targets and continue conversations at expanding our footprint"
CFO Stetz: "given where we are with our targeted debt level and the amount of cash we generate, depending on the acquisition size, we've historically been able to do both share repurchase and acquisitions, and that's our intention as we go into this year"
- CEO Wilson believes that the new vendor managed inventory system improved visibility, leading to improvements in inventory
- Management sees spices and seasonings growing 3% to 8% in its main markets (Source: Q4 2012 Call)
Over the 2012 fiscal year, management did change some of the guidance for the full year but not by much. As one can see, management was pretty accurate in what they gave to investors during the 2011 Q4 conference call. What did they guide for FY 2013?
This management team for MKC is typically conservative. Even though the Wuhan acquisition is expected to close in mid-2013, management is not including it in the guidance despite them saying it would add about 1% to revenue. The acquisition would be slightly dilutive to earnings because of closing costs but good for long-term earnings. The sales growth values are 'healthier' for FY13 than FY12 as growth will be comprised more by volume and mix growth over pricing. Gross profits and income from unconsolidated operations will increase. Raw materials are estimated to increase 3%. The increase in retirement benefit expenses and tax rate hurt FY13's EPS by $0.11 and $0.12, respectively. If these items were similar to FY12, EPS would be 8% higher or above management's 9% to 11% long-term expectations for earnings.
MKC is one of the more profitable food manufacturers. Over the last few years, raw material costs have been a problem for all manufacturers. With a ROE above 24% and improving NPM due to CCI and other measures, MKC is a strong and profitable company. Compared to Sensient Technologies (SXT), International Flavors & Fragrances (IFF), and HJ Heinz (HNZ), MKC is more profitable. On top of that, MKC's NPM increased over the last 5 years. With higher net profit, MKC stands a better chance to grow cash flow, thus rewarding shareholders, acquiring more firms for future growth, or paying down debt (Source: Analyst):
MKC benefits from higher fixed asset and accounts receivables turnover ratios than most peers. Its inventory turnover is on the decline due to strategic inventory purchases given rising material costs (Source: Analyst):
Due to the higher than normal inventory levels, MKC has a lower quick ratio but still an above average and improving cash conversion cycle. The reason MKC has a better cash conversion cycle, especially over direct competitors SXT and IFF, is due to its lower days sales outstanding and days inventory, and its higher days payable outstanding (Source: Analyst):
MKC is less leveraged than its peers though as it has worked to lower its debt amounts. Readers of SA have expressed concern about MKC's debt level with its low cash levels. MKC likes to use its cash to reward shareholders, rather than store up large amounts of cash. In this low interest rate environment, it would make more sense for companies to use cash for higher return items. These items would include increasing capex, paying out a higher dividend, increasing repurchases, or acquiring other firms for future growth. With SXT's lower debt levels and market cap below $2B, it could be an acquisition target:
Growth is also an important factor. MKC outgrew the other three companies in 2012 (note: HNZ's fiscal year ends in April and IFF's values are ttm). MKC has superior revenue and income growth:
Given all of these stronger items for MKC, MKC trades at higher multiples than peers (Source: Capital IQ):
Most investors believe MKC is overvalued for where it is currently trading. Two ways of looking at this are on a multiples basis and on a present value of growth opportunities (PVGO). Over the last 5 years, the average P/E on a diluted basis and excluding one-time items was 18.1x. EV/EBITDA averaged 11.15x for MKC. Both of these averages are shown (Source: Capital IQ):
On a 10-year basis, this is a little bit different. It is more in line to where it has traded at over the last few months. The average P/E was 20.23x and the average EV/EBITDA was 11.58x (Source: Capital IQ):
On a PVGO basis, MKC appears to be factoring in more growth than normal. This could be due to the shift towards emerging markets as it is generating faster growth there. HNZ is doing a similar strategy for future growth. Assuming an 8% discount rate, the PVGOs over the last 5 years are shown below (Source: Analyst):
The takeaway should be clear: MKC is a higher growth company than most competitors that return capital to shareholders in a meaningful way, has stronger fundamentals, and thus supports a premium to the market as a whole. This premium got too much over the weeks leading up to the Q4 results and has come down closer to the normal levels that it should be trading at.
Last year, I published a 66-page report on MKC. Within it, I analyzed every aspect of the company, including its supply chain, dual-class share structure (and other corporate governance aspects), and acquisitions. I found the valuation compelling as my price targets were as follows (Source: Analyst, "McCormick Incorporated, 2011-2012):
The required rates of return for this valuation were 8%, 6.82%, and 5.64% (Aggressive, Price Target, and Conservative, respectively). The Mid-Level was the average of management's cost of capital of 8% and book value WACC of 5.64%. This 6.82% required rate of return, though low, is about at Bloomberg Finance's average WACC for MKC (Source: Bloomberg). As shown, the price target I used was $62, with a lower bound and upper bound of $57 and $66.50. MKC would quickly go past the $57 lower range. It would eventually reach a peak of $66.95 but came quickly back down to sub-$66.50. After the earnings release on January 24th, MKC finished at $62.37 or just about in-line with my price target. While I was writing my report, the analysts had established price targets of the following (Source: Analyst Report):
Thilo Wrede of Jefferies deserves the kudos on the stock, followed by Alton Stump and Mitchell Pinheiro.
In establishing my new price targets for MKC, I used management's guidance from above for my base case. I used 3 new WACCs of 6.54%, 7.27%, and 8%. Though some would argue this should be higher, it is the only required rate I would require for a company with less risk than the market. At a cost of capital of 8%, given the other inputs besides a cost of equity, the cost of equity would be approximately 13.3%! That is close to the valuation of a private company as opposed to a long-standing public company. For my bear case, I assumed COGS would remain inflated, and sales growth would only achieve the 4% long-term target. For my base case, I assumed COGS would slowly decline as a percentage of sales and sales growth would achieve the middle of the long-term range of 5%. For my bull case, I assumed COGS as a percentage of sales would decline at a faster rate and sales would grow at the high point of the long-term range of 6%. I also used a dividend discount model, P/E method, and P/CF method. Combining these methods and the various required rates of returns and different multiples, the new price targets for McCormick are:
Given that my required rate of return is 7.27% for the Mid-Value and that the projected gain is 7.92%, this is a hold or very weak buy. Investors should hold for now unless they firmly believe in a lower required rate of return and higher multiples for MKC. MKC is a great long-term pick that is transparent for investors. Analysts for this past earnings release were expecting earnings greater than what management guided. With the stock price haircut it took on January 24th and lower expectations, MKC has potentially set itself up for a great 2013. The company focuses on return to shareholders, steady growth, and creating value for shareholders. MKC should be a stock on everyone's radar for future investment.