In the summer of 2017, I last had a look at McCormick (NYSE:MKC) which at the time was the ´winner´ of the Food business auction organized by Reckitt Benckiser (OTCPK:RBGPF, OTCPK:RBGLY). McCormick paid a high multiple for an attractive business, too high of a multiple given where margins were coming in at, as modest earnings accretion, significant incurred leverage, and a high valuation made me very cautious.
In 2017, McCormick acquired the food business from Reckitt Benckiser in a $4.2 billion deal in order to acquire Frank´s RedHot sauce, mustard, barbecue sauces, and other products. Adding $581 million in revenues, a 7.2 times sales multiple looked quite steep. While EBITDA margins of 37% are impressive, the reusing $215 million EBITDA contribution revealed that a near 20 times multiple has been paid on that basis, albeit that $50 million in synergies are seen by 2020, yet this is after incorporating $140 million in transaction costs and integration expenses.
A pre-deal net debt load of $1.6 billion would jump to $5.3 billion as the company would sell half a billion stock at $92, issuing more than 5 million shares to increase the share count to 132 million shares. McCormick itself posted sales of $4.5 billion and $770 million in EBITDA, as a pre-deal enterprise value of $14 billion worked down to just over 3 times sales and 18 times EBITDA, as the deal with Reckitt looked quite demanding if we compare the multiples.
Pro forma net debt will increase to 5 times as I only see $0.25 per share accretion to $3.75 per share, as synergies provide a roadmap for earnings at or above $4 per share. Investors did not applaud the deal at the time as shares fell $5 per share in response to the deal announcement, as investors believed the acquisition price was a bit too steep at 22 times earnings after factoring in synergies, while being mindful of leverage as well.
Fast forwarding five years in time, shares trade at $80, which looks like a disappointment but of course shares have been split on a two-for-one basis in 2020, indicating that shares nearly doubled, even after they fell from a level above the $100 mark earlier this year.
Fast forwarding to early 2020, sales rose to $5.3 billion, largely in line with the pro forma results at the time of the deal in 2017. The company kept on pursuing dealmaking that year including an $800 million deal for Cholula Hot Sauce at a premium valuation as the deal added just $96 million in sales. This deal was announced around the time when the company acquired FONA, a manufacturer of clean and natural favors in a $710 million deal set to add $114 million in sales. At 6-8 times sales, both these deals were quite demanding.
Despite these deals only contributing late in the year, the company grew 2020 sales to $5.6 billion as net earnings came in at $747 million, or $2.78 per share (after the two-for-one stock split) with earnings coming in at $5.50 per share on a pre-split basis (ahead of the promise in 2017). Net debt was reported at $4.5 billion, not having factoring in all the dealmaking late in 2020 yet.
This dealmaking and organic growth played out in 2021 with sales increasing 13% to $6.3 billion, yet operating earnings were nearly flat at $1.02 billion as earnings were flattish at $2.80 per share. Adjusted earnings did rise 8% to $3.05 per share, with the discrepancy largely related to restructuring charges. Net debt rose to $4.9 billion, still easily supported by the growing earnings power of the business.
The company guided for 2022 adjusted earnings to rise to $3.17-$3.22 per share, a 4-6% increase from 2021 with growth held back in part on the back of a higher effective tax rate. Following the second quarter results, the company guided for full-year earnings at $3.03-$3.08 per share, flat compared to the 2021 results. A strong dollar, inflation, and soft demand made that the company cut the guidance by another forty cents to just $2.63-$2.68 per share alongside the preliminary third quarter results, as the degree of the cut in the outlook is quite shocking, of course, with just two quarters to go this year.
The truth is that McCormick is a very defensive play, yet the degree of the earnings fall this year (to the tune of 15%) is quite shocking. With earnings power seen around $3.25 at the start of the year, valuations were stretched already at 30 times, ahead of rising interest rates and falling earnings.
With earnings power now seen quite a bit lower, the reality is that the decline in the share price from >$100 to $80 makes that the earnings multiple now is the same as at the start of the year. This comes as the retreat in the share price matches the decline in earnings per share, still resulting in a steep multiple (given the interest rates and valuation multiples in this environment) albeit that there is earlier room to the upside in terms of earnings in the long run, of course.
Nonetheless, and certainly in light of the uncertain market conditions, which create bargains in some areas of the market, I still think that it is far too early to get involved with McCormick here despite the fall in the share price.
This decline only coincides with the decline in earnings power, thereby leaving a premium of 30 times earnings multiple, which has still been awarded to the shares, a multiple high given the current interest rate environment and near-term uncertainties.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.