McCormick & Company, Inc.(NYSE:MKC) is one of the best businesses in the country. The company benefits from a sustainable business model that includes heavy investment in research and development. As long as the company continues to innovate and manage its finances, it should do well over the long term.
1. Business Model:
McCormick is a global leader in the spices and flavor business. The company operates in two business segments, consumer and industrial. The business makes more money in the consumer business and has higher operating margins in it. Even though the company earns 40% of its revenue from the industrial business, its competitive advantage lies on the consumer side.
McCormick is the category leader in the consumer business. Its share in the total industry sales is between 40% and 60%. The company operates in an industry where over 250 brands are sold. This clearly demonstrates its hold over the consumer's palate. This leadership allows McCormick to invest in its research and development and strengthen its advantages.
McCormick focuses heavily on brand recognition and loyalty. It uses promotional programs and advertisements to attract more customers. Some of the leading brands at the company are McCormick®, Lawry's®, Club House®, Zatarain's®, & Thai Kitchen®.
McCormick's products are made from confidential formulas developed by the company. The customers benefit from research in sensory testing, culinary research, food safety and flavor application. Expenditure on research and development was $57.8 million in 2012. McCormick also funds a research institute that "supports scientific research and disseminates information on the health benefits of culinary herbs and spices to all stakeholders including consumers and health professionals." The institute's studies have been "designed and implemented at universities including UCLA, Johns Hopkins, the University of Georgia, Penn State and Purdue."
The company supports a good work environment too, as is evidenced by a listing in Fortune Magazine's "100 Best Companies To Work For" in 2010. Good relations with employees helps a company better serve its customers and inspire loyalty amongst the staff.
The company realizes the importance of presence in the emerging markets. Consequently, it recently invested in a joint venture with a company in India, and entered into an agreement to acquire another in China to strengthen its competitive position there. The company's CEO, Alan Wilson, is also optimistic about the company's fortunes abroad and believes that the company will have a bigger business outside the US than in the US in 10 years.
2. Cash Reserves:
The current ratio at the company is very low at 1.08. McCormick is dependent on short term borrowings for working capital items such as inventory. It has access to a revolving credit facility with a capacity of $600 million, which it regularly uses.
The company's low cash balance should be disappointing to long term investors who prefer extra safety over such risky business. The company's Return on assets is 8.87%, and Return on equity is 23.95%. The company can clearly afford to keep extra cash on its balance sheet. To go further, even if the company's ROA and ROE were much lower, a low current ratio would not be a solution to the problem. Low cash can and will eventually create needless funding problems for a company.
Thankfully, the long term debt to equity ratio at the company is low at .45. Even though the leverage is low and satisfactory, the company should improve its balance sheet by increasing its cash reserves.
3. Stock Price:
The company seems cheap at a PE ratio of 23.79. Relative to its growth potential and sustainability as a business, the market could have added an extra premium to the stock. Regardless, long term investors are advised to add this stock to their portfolio.
The company must continue to maintain its expenditures on research and development. Such innovation allows it to distinguish itself in the market and is its chief competitive advantage.
The company also must continue to carefully buy good companies in the emerging markets; not only to increase its market share, but to keep its larger competitors from gaining an edge in size.
Lastly, the company must improve its balance sheet by increasing the current ratio.
McCormick is a wonderful business. It has a good business model, low debt, and the opportunity to make a lot of key acquisitions. The company also sells at a relatively low price, making it a "BUY" for long term investors. This advice could change if the business model or the cash reserves of the company are adversely affected.