McCormick & Company (NYSE:MKC), the global leader in the flavor market, is currently trading at a slight premium based on multiple types of valuation analyses. The market expects rapid growth, but much of the current growth comes from past acquisitions. Do past performance, the state of the balance sheet and other factors like industry estimates and current acquisitions lead to a buy recommendation at this price point?
McCormick adequately addresses current trends in food consumption, such as the growing need for non-GMO, low-sodium, gluten-free and organic alternatives to traditional condiments, spices, seasonings and other flavor-related products. It also operates in a wide price range straddling everything from value-priced goods to premium offerings.
The higher-margin consumer segment brings in the lion’s share of the company’s revenues, accounting for 61% of sales in 2017, while the industrial segment accounted for the other 39%. The former accounted for nearly 72% of operating income during the period.
Source: McCormick
McCormick’s consumer brands have a well-established presence and reach customers in more than 150 countries around the world. Nearly half of all consumer segment sales are derived from spices, herbs and seasonings, a niche segment within the food industry. Though there are several competitors in the segment, the company’s focus on spices, herbs and seasonings differentiates it from much of the competition, and the outsized role that flavor plays in its overall earnings story will continue in the future as well.
Market Conditions
This niche focus has turned out to be a significant advantage for the company as current market conditions remain favorable for its future growth. According to data from McCormick the global demand for flavor products is expected to grow at a CAGR of 5% over the next five years.
Source: McCormick
How does that future stack up against the company’s historical performance?
Past Performance
With its products already reaching most parts of the world, McCormick’s revenue growth is not exactly going to set the charts on fire. Growth has been steady and stable over the last ten years, increasing from $3.19 billion in 2009 to $4.834 billion in 2017, while operating margins remained stable around the 14% mark.
MKC Operating Margin (Annual) data by YCharts
In 2017 the company reported a solid 9.6% increase in net sales, but nearly 6.5% of that growth was due to the impact of acquisitions in 2017 and 2016. The company has been growing its revenues at low single-digit rates over the last ten years, and I expect that trend to continue over the next five years and beyond.
For 2018 the company has forecasted sales growth of 12% to 14%, with the acquisition of On Reckitt Benckiser Food Division expected to account for 8% of that growth. Even then, a forecast of 4% to 6% growth excluding acquisitions is great news, and it clearly shows that McCormick is able to capture the positive momentum in the global consumer flavor segment.
Financial Health
The steady stream of acquisitions has increased the company’s long term debt from $875 million in 2009 to $4.443 billion in 2017.
McCormick ended 2017 with $186 million cash on hand against long term debt of $4.443 billion. Interest expense was $95.7 million for the fiscal, while operating income was $702.4 million. The company paid $237.6 million in dividends during the year, which is just 33.7% of operating income. As you can see, despite the sharp increase in long term debt, thanks to the steady stream of acquisitions in the last ten years, McCormick’s balance sheet remains fairly healthy, which will allow the company to keep paying and increasing dividends. And it is strong enough to support further acquisitions in the future as well.
Valuation
Favorable market conditions, a healthy balance sheet and the steady performance of the company over the last ten years have definitely had an influence on investor sentiment, which remains positive. So, it’s not a huge surprise that the stock is trading above 30 times earnings and 22 times forward earnings.
A quick Ben Graham intrinsic value calculation shows that the market expects McCormick to grow at around 8% over the long term, indicating a slight premium at the current price point.
A DCF calculation with 5% growth over the next ten years, with a discount rate of 10%, shows an intrinsic value of $87.22, a price point that I believe offers some margin of safety for investors.
Source: Free Cash Flow: Morningstar, Other Data: Company Filings
It’s a great company with products that will keep selling for many more decades. As long as we use spices in our homes McCormick will find a way to reach our kitchen cabinets and tables, and the company’s past performance shows that the management has the ability the execute. The only issue I have is the stock’s current price point, which I believe is at a slight premium. I would recommend investing during dips or during market corrections.
Alternatively, you could open a smaller position now; for example, 25% of what you think your full position might be, and then keep adding during sell-offs, dips and corrections. That's something I learned from one of my recent commenters: "NEVER wait to make your initial buy or you'll never get in." I think that makes a lot of sense.
