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McCormick & Co. (NYSE:MKC) is the leading global manufacturer, marketer and distributor of spices, herbs and seasonings. It serves restaurants, retail grocery chains and food processors and has about 40% of its sales in international markets.

I added MKC to my investment pipeline after reading a Morningstar article on “Two Stellar Consumer Firms." MKC traded between $41 and $43.5 over the last month.

Please refer to the stock review explained post if you have questions on what I look for in this analysis.

1- Business Performance Risk (=) and intrinsic returns (-)

Metric

Status

FCF / Sales

Last 12 Months: 8.7%, in line with historical performance of between 5% and 10% (a little less in 2001/2003)

ROE

LTM: 26%, slightly ahead of the company's 5 year average of 24%

ROA

LTM: 10.7%, ahead of the company's average over the last 5 years of 8.8%

Revenue Growth

Over the last 5 years the company has been growing at close to 5% on average. This growth seems "stalled" with flat revenues both in 2009 and on a TTM basis. Over time MKC has been a bit volatile with years at 10%+ growth and a couple of negative growth years in 2002/2003

Cash distribution to shareholders

Dividend: MKC pays a 2.4% dividend yield on a payout of 35%-40%

Stock repurchases: Over the last 5 years, MKC bought back ~3% of its shares

Looking into what MCK has been doing with the rest of its cash, it seems that MKC has made a number of acquisitions over the years, including a $700M one in 2008 and has spent a lot of money buying back shares…probably to neutralize stock options since net buybacks appear to have been limited.

McCormick seems to enjoy a high level of cash generation and ROE for a company that is in what looks like a commodity business at first. While the ROA is a bit lower than what I usually like, I don’t think it’s a problem as long as it doesn’t indicate too high of a leverage (let’s see below). I'm a bit concerned about where the money is going in this business. The company pays a nice dividend, but also buys back a lot of shares, which seems to be the exercise of stock options either to management or acquired businesses.

In terms of intrinsic stock returns, an investor would receive:

- 2.4% dividend yield using about 40% of earnings

- Growth rate of 5% (may be optimistic), using 20% of earnings (based on 25% ROE)

- Buybacks of 2+% based on current earnings yield of 5.7% and using the remaining 40% of earnings

This leads to total intrinsic stock returns of slightly below 10% (on good growth assumptions), less than my minimum target of 10%.

2- Balance Sheet Risk (-)

Metric

Status

LT Debt / Equity

2.4x, much higher than my personal limit of 1.0x.

Current Ratio

1.2x, in line with previous years.

MKC’s leverage is much higher than my comfort zone.

3- Valuation Risk (+)

Metric

Status

Cash Return

4.1%

Price to earnings ratio

MKC currently trades at 17.6x earnings, higher than the S&P's average but lower than the company's 5 year average of 20.0x

While valuation is not stratospheric, it appears to be a bit high for a company’s whose growth seems to be stalled.

Conclusion

Overall I am a bit disappointed in MKC, which seems to have a decent underlying business but is using a lot of cash for acquisition and share buybacks, with yet to show real results for shareholders. Coupled with a high leverage and somewhat high valuation I think I will pass for now.

Disclosure: No position

Source: McCormick: Too Spicy for Investors?