2023-08-22 23:33:53 ET
Summary
- McCormick & Company is a dividend aristocrat with close to 40 consecutive annual dividend hikes and has consistently outperformed the Consumer Staples ETF.
- The company's dividend yield is 1.9%, but it has shown consistent and elevated dividend growth over the past ten years.
- McCormick has a strong balance sheet and is expected to generate significant free cash flow, making it an attractive investment option at the right price.
Introduction
McCormick & Company ( MKC ) is a highly fascinating consumer staple dividend stock - for a number of reasons.
This producer of premium spices with a market cap of $22 billion isn't just a dividend aristocrat with close to 40 consecutive annual dividend hikes, but it is also an outperformer. While MKC shares have underperformed the S&P 500 over the past ten years, they have outperformed the Consumer Staples Select Sector SPDR Fund ETF ( XLP ) by a wide margin.
Before post-pandemic inflation hit defensive consumer stocks, MKC also consistently outperformed the S&P 500 with a highly favorable volatility profile.
While I haven't covered MKC since 2022, one of the most common complaints I've gotten from readers is that MKC isn't attractive in light of its 1.9% dividend yield, sub-10% long-term annual dividend growth, and its valuation, which always seems to be a bit lofty.
Although I cannot completely disagree with these complaints, I believe that the current environment could offer us buying opportunities in the months ahead.
Consumer staple companies are battling declining volumes as higher prices cause consumers to focus on essentials. McCormick is one of these companies that benefit from its pricing power while volumes are declining.
In this article, we'll discuss all of this, as I'm looking to buy MKC on potential weakness.
So, let's get to it!
MKC's Dividend
McCormick currently pays a $0.39 per share per quarter dividend. This translates to a yield of 1.9%.
- The SPDR S&P 500 Trust ETF ( SPY ) yields 1.4%.
- The Vanguard Dividend Appreciation Index Fund ETF Shares ( VIG ) yields 1.9%.
- The VanEck U.S. Dividend Equity ETF ( SCHD ) yields 3.4%.
In other words, based on its yield, we need to expect consistent and elevated dividend growth. If that's not the case, we may as well buy an ETF.
Since 2013, the VIG ETF has hiked its dividend by 7.9% per year, according to Seeking Alpha data . Over the past five years, that number has risen to 9.9%:
On average, McCormick has grown its dividend by 8.8% per year over the past ten years. On a five-year basis, that number is 8.7%.
On November 29, 2022, the company hiked its dividend by 5.4%.
In addition to strong dividend growth, the company has consistent dividend growth. MKC is a dividend aristocrat with more than 25 consecutive annual dividend hikes - in this case, 36.
Even better, these dividends are backed by consistent growth in free cash flow.
This year, the company is expected to generate $760 million in free cash flow, which is roughly 3.5% of its market cap. This implies a cash dividend payout ratio of 54%. That number is expected to fall to 46% after this year.
Leo Nelissen (Based on analyst estimates)
On top of that, the company has a stellar balance sheet, which means it does not need to prioritize debt holders over shareholders.
After all, even if companies have high free cash flow unless their balance sheets are healthy, there's no point in getting excited.
In the case of MKC, the company is expected to end this year with $4.6 billion in net debt, with an expected decline to $4.1 billion by 2025.
The net-leverage ratio is expected to fall from 3.8x in 2023E to 2.9x during this period. Hence, it has a BBB credit rating. I expect that to be hiked to BBB+ within three years.
Eventually, I believe that MKC has the potential to become A-rated.
Having said that, the reason why the dividend yield is so low isn't low dividend growth, as we already established. High capital gains are the reason why the yield is so low. That's not great for new investors but terrific for long-term investors who are now sitting on a juicy yield on cost.
Based on that context, I believe current market headwinds offer opportunities.
Stock Price Weakness: What's Up With MKC?
What I like to call yield plays are in turmoil. Not heavy turmoil, but the impact of high inflation and rising rates are clearly visible.
Stocks like utilities, consumer staples, and REITs tend to perform well when inflation and rates are low. In these environments, they can use debt to expand while customers/tenants aren't under stress from high inflation.
As the chart below shows, MKC shares are down 7% over the past 12 months, including dividends. The S&P 500 is up 5.8%.
As I wrote in a recent article , Wall Street is getting impatient with stocks hurt by high inflation - especially in the consumer staple space.
As reported by the Wall Street Journal , investors are now prioritizing volume growth over margin-protecting price hikes, challenging consumer-staples giants like Kimberly-Clark ( KMB ) and Colgate-Palmolive ( CL ).
The days of relying on price increases as a main driver for revenue growth are dwindling, pushing companies to shift their focus towards increasing unit sales.
Analysts pressed these companies on their plans for actual volume growth during conference calls.
McCormick is in the same boat.
The company has pricing power, but its volumes aren't keeping up.
In the second quarter, the company's top line showed constant currency sales growth of 10% compared to the prior-year quarter.
McCormick & Company McCormick & Company
This growth was primarily driven by an 11% increase in pricing, partially offset by a 1% decline in volume and mix.
Multiple factors impacted volume, including the China recovery, the divestiture of Kitchen Basics, the exit from the consumer business in Russia, and strategic decisions for portfolio profitability.
- In the Consumer segment, constant currency sales increased by 7%, propelled by pricing actions, though partially dampened by a 2% volume decline.
- The Americas Consumer sales rose by 4% in constant currency, with 8% from pricing but countered by volume decline due to the Kitchen Basics divestiture and other factors.
- EMEA's constant currency consumer sales increased by 9%, with strong pricing and sales growth across categories and markets, except for Russia.
- In the Asia Pacific region, consumer sales surged by 28%, largely influenced by China's recovery and pricing actions.
In other words, these results aren't bad. The problem is that hiking prices cannot go on indefinitely - at least not at this pace.
That's the biggest risk here and the reason why Wall Street is increasingly looking for companies able to grow volumes - or skipping this entire sector.
Having said that, the updated 2023 financial outlook remains positive, reflecting growth momentum, cost optimization, and increased profit realization.
As seen above, the company projects 5% to 7% top-line growth, with 10% to 12% growth in adjusted operating income.
The gross margin is projected to expand by 50 to 100 basis points compared to 2022.
Adjusted earnings per share are expected to increase by 3% to 5%, reaching $2.60 to $2.65, considering various discrete drivers and headwinds.
In light of economic challenges, the company intends to maintain a focus on growth, performance, and its workforce, supported by continuous growth investments and alignment with consumer trends.
According to the company, this positioning allows McCormick to anticipate long-term differentiated growth in both the consumer and flavor segments as the business environment gradually normalizes.
The emphasis remains on achieving robust sales growth and industry-leading total shareholder returns, underpinned by a commitment to ongoing growth initiatives and trend-driven strategies.
In other words, the company believes its brands are in a good position to maintain high sales growth - hopefully with increasing support from volumes as the business environment normalizes.
This brings me to the next part of this article.
Valuation
Right now, the market is telling McCormick that it doesn't believe in normalizing market conditions. This is based on a further rise in interest rates, sticky inflation, and the related fear that the expected consumer confidence rebound is going to be postponed. I agree with these expectations.
However, analysts agree with the company's positive comments. EBITDA growth is expected to remain strong, pushing the EV/EBITDA multiple down to 19x in 2025.
Using the longer-term median valuation, the company's fair value is roughly 15% above its current price.
Leo Nelissen (Based on analyst estimates)
The current consensus price target is $89, which is roughly 8% above the current price.
Having said that, I just put MKC on my watchlist, as I want a better price.
If (not when) the stock was to drop to $70, I think the valuation would be great (read: fantastic).
Everything above that, I'll likely opt for other dividend growth investments.
Takeaway
As a true dividend aristocrat with nearly four decades of annual dividend growth, MKC has proven itself to be a great source of income and capital growth.
While its yield may seem modest at 1.9%, it's the consistent, elevated dividend growth that paints a promising picture.
The company's prudent financials, balanced debt structure, and unwavering commitment to shareholders add to its attractiveness.
Amid shifting market fundamentals, MKC's pricing power shines, cushioning it against dwindling volumes.
As the landscape evolves, we might get better buying opportunities, as I'm not interested in buying MKC at current prices.
Other than its valuation, it's one of the best anti-cyclical dividend growth stocks on the market.
For further details see:
McCormick: A Dividend Gem Awaiting The Right Price