McCormick (MKC) is not always a loved stock by most analysts. As many know, MKC manufactures, distributes, and markets spices and seasonings throughout the world. Rather than give the full business description and go into every aspect of their business, here are some highlights I think investors or potential investors should know about the company:
1. It has about a 50% market share in the spices world globally and operates in numerous countries (Source: MKC Analyst Day Presentation).
2. It is in "growth" mode according to CEO Alan Wilson, evidenced by the 10-plus acquisitions over the last decade. Some of the acquisitions and timing are listed below (with the red lines representing acquisitions and the green line representing a divestiture due to the government making MKC divest a brand). The additions of the Kohinoor joint venture, Kamis, and Kitchen Basics have been strong additions and better than management had expected (Source: Bloomberg).
Click to enlarge images.
3. Management is looking into acquisitions in Brazil and China, and just acquired Wuhan Asia-Pacific Condiments for $141 million. This company has annual sales of $115 million.
4. It is targeting 15% of sales from new products compared to 9% currently.
5. It is looking to generate 20% of sales from emerging markets, much like H.J. Heinz's (HNZ) 25% strategy. Food in emerging markets is expected to grow by double digits in the coming years.
6. The Comprehensive Continuous Improvement Program (CCI) is expected to save the company at least $45 million annually in cost savings initiatives.
7. Management's estimates over the last few years have been conservative.
8. It operates in two segments: consumer and industrial.
9. It is focused on being EVA positive, producing strong ROIC, and rewarding shareholders. Acquisitions are expected to be EVA positive in their second year with the company, which, due to timing of an acquisition, is why EVA "dipped" in some years.
10. The company clearly rewards shareholders via dividends, acquisitions, and buybacks.
There are some negatives about the company out there that could be a potential sign of weakness. In fact, c5966 commented on this high-quality article about MKC recently:
Are you kidding me?! How on God's green Earth is this company even WORTHY of consideration for investment? The company has about $72 million in cash and over a BILLION dollars in long term debt. What's wrong? Weak balance sheet companies don't bother you or something?
I'd like to fully answer c5966's point here, given that this could be a huge risk. Simply put: Management does not like to leave cash on its balance sheet and will use it to acquire companies for long-term growth, pay back shareholders, reinvest in the business, or pay down debt.
This is evidenced by the following four graphs that show: 1. debt as a percentage of revenue (with MKC's debt one should also include the pension plan, which was closed to new employees on Jan. 1, 2012); 2. retained earnings; 3. debt payment schedule; and 4. dividends paid out (Source: Capital IQ, FactSet, Bloomberg, and MKC's 2011 10-K).
As shown, the debt levels are not a huge concern. Even if they were, given the low-interest rate environment MKC could issue new debt (as the debt outstanding is callable) at a lower interest rate. General Electric (GE) just did this with a $7 billion issue to cover $5 billion.
To me, the real concerns should be focused on Goodwill and Intangible assets as well as the inventory levels. Management has focused on both acquisitions and maintaining strategic inventory levels due to rising materials costs. The following graphs show the amount of goodwill and intangible assets as a percentage of revenue, and the amounts of raw materials and finished goods as a percentage of revenue:
This level of goodwill and intangible assets would be a concern to me if the acquisitions were not EVA positive. Acquisitions are clearly generating economic value for shareholders at this point, but should be monitored in case of a needed asset writedown. I do not think this is likely in the future, but it is possible. Inventory levels are at the high end of MKC's historical average due to management strategically buying raw material inventory ahead of a potential rise in materials cost. Currently, it is focusing on depleting this level, which will generate positive cash flow for the firm.
Analysts have not been correct so far on this company, and I feel as if I've done a better job getting price targets correct since I've been following MKC. Last year at this time, the price targets by the analysts were as follows (Source: Bloomberg):
Price on Rating Date
Alton K. Stump
Davenport & Co
Ann H. Gurkin
Gabelli & Company
Janney Montgomery Scott
Mitchell B. Pinheiro
Christopher R. Growe
Wells Fargo Securities
Keybanc Capital Markets
Akshay S. Jagdale
Deutsche Bank Research
In other words, the price targets ranged from $48 to a high of $60, and a consensus of ~$53.50. MKC reported earnings two more times before it hit that "12-month price target." So far, it has not looked back since. In other words, analysts have not appreciated what MKC has done over the last year, especially the add-ons of Kamis and Kohinoor.
I'll admit my $60.25 price target is just below the current intraday trading price on Nov. 1, 2012, of $61.50, but my DPS for 2012 is dead-on. The first question I'd expect anyone to ask is something along the lines of: "How did you get that price target?" or "How can I believe you aren't just making this up?" Simply put, I used a dividend discount model that was the following based on the information at the time:
Dividend Discount Model
Expected Dividend (M)
TV 2016 (Using P/E)
PV @ 7.64%
*** Target Dividend approaching 40% ***
Terminal Value (PE method)
*Forward P/E based on Industry Average plus a slight premium due to past history of MKC trading at higher P/E than average
The most obvious question I'd expect to get based on this is about the 7.64% discount rate. However, if you look at the chart below, you can see that the Bloomberg average WACC over the last decade has been 7.391% (Source: Bloomberg):
Since my time as a student, I've matured in my valuation approach by using FCFF, DDM, and market multiples. Currently, my price target is $69, which would present ~12% upside and a dividend of about 2%. This is historically in line with MKC's average return to shareholders. Since 1979 (the year it was almost acquired by Sandoz Pharmaceutical), it has a stock price compound annual growth rate more than its peers and of 13%.
Anyone who knows me knows I do a base, bear, and bull price target to more or less get a range of where I expect the stock to be trading. The following are some statistics on my price range:
|DCF||$ 63.21||$ 67.35||$ 71.88|
|DDM||$ 52.97||$ 59.76||$ 68.37|
|P/E||$ 59.48||$ 67.40||$ 77.44|
|Total||$ 58.55||$ 64.84||$ 72.56|
|Base Avg||$ 64.84|
|Bear Avg||$ 58.55|
|Bull Avg||$ 72.56|
I believe that my estimates for my FCFF approach are conservative. I used an 8.3% WACC. For my base case, I assume 5% long-term growth and a terminal value of $12 billion in five years. For my bear case, I assume 4% long-term growth and a terminal value of $11.4 billion. For my bull case, I assume 6% long-term growth and a terminal value of $12.75 billion. The growth rates are based on management's guidance, which tends to be conservative.
I don't believe my bear case is relevant, but more or less offers downside protection. The reason I don't think my base case applies is because MKC is in "growth" mode and I wouldn't be surprised by another acquisition to further promote growth. This is why I took an average of my base and bull targets to arrive at my $69 price target by this time next year. Given that the 11.71% return is greater than my WACC, MKC looks like a potential buy here.
Additional disclosure: I also am a manager of a fund that I presented a full-detailed analysis on MKC last year. The fund made the purchase due to my recommendation and has seen its shares appreciate in value. I may or may not initiate a long position in the next week.