2023-07-16 23:34:47 ET
Summary
- McCormick has underperformed the market since our previous writing, with profitability still showing a downward trend despite a short-lived improvement in H2 2022 and the recent margin expansion in Q2.
- The company has reported significant sales and earnings growth, primarily driven by pricing and cost savings, and has raised its profit outlook for 2023.
- Despite a commitment to returning capital to shareholders through dividends, MKC stock remains unattractive due to its high valuation compared to industry peers.
- We maintain our "hold" rating.
McCormick & Company, Incorporated ( MKC ) manufactures, markets, and distributes spices, seasoning mixes, condiments, and other flavorful products to the food industry. It operates in two segments, Consumer and Flavor Solutions.
We have initiated coverage on the firm in Q4 2022 with a neutral rating. The reasons for this rating were:
- Challenging macroeconomic environment
- Elevated costs
- Contracting margins and lower net income
- Attractive dividends and dividend growth
Since our last writing, MKC's stock price has increased by about 16%, underperforming the broader market, which has gained slightly more than 23%.
Today, we are going to take a look once again how the firm's profitability has been changing in the previous quarters and what to expect going forward.
Key updates
Profitability
To gauge the firm's profitability, we will be focusing on two metrics here. The net profit margin and the operating margin. The following chart shows the development of there over the past five years.
In both instances, a clear downward trend is visible. While there has been a sharp jump in the second half of 2022, the improvement has been short-lived and the margins continue to remain below the 5Y average. To understand whether MKC can change this, we have to see how the firm has been delivering on its cost saving initiatives, and how the firm's financial performance has changed compared to the past year. This takes us to our next section, the latest earnings results.
Earnings results
Profitability is only one part of the puzzle (although it is a very important one), so we have to make sure that we take a broader look at the firm as a whole.
The firm has reported earnings at the end of June and they have painted a much more optimistic picture than it would be visible from the margin development only.
Q2 results (MKC)
The firm has achieved significant sales and earnings growth, which were primarily driven by pricing and cost savings. The pricing actions were enough to more than offset the cost inflation. On the other hand, volume/mix and the FX environment have negatively impacted the sales figures in the second quarter. The firm has provided the following reasons to explain the volume decline: " [...] the Kitchen Basics divestiture, and the exit of the consumer business in Russia. The volume drop also included a 1% decline from the company's strategic decision to discontinue low margin businesses. "
In our opinion, these results prove that MKC is executing on its promises to drive growth and improve profitability. This is further supported by the fact that they have even raised the profit outlook for 2023.
Dividend
One of the reasons we liked MKC's stock previously was the firm's commitment to returning capital to shareholders in the form of dividend payments. This commitment has not changed in the past quarters and recently the firm has declared a quarterly dividend of $0.39 per share, equivalent to an annual yield of 1.8%. While we believe that these payments remain safe and sustainable, we have to note that the dividend payout ratio has increased substantially in the past year.
In the future, we would like to see this figure coming back to its longer term average, although payout ratios around 60% are not uncommon in the packaged foods and meats industry.
Valuation
In our previous article we have highlighted that MKC appears to be trading at a substantial premium compared to its peers. As of today, we maintain this view. The follow table compares a set of valuation metrics across firms in the packaged foods and meats industry.
We can see that most metrics, including P/E ratios, the P/S ratio, EV/EBITDA, indicate that MKC's stock is one of the most expensive across this group.
While we saw some growth in the previous growth quarter, we still do not believe that this premium is justified.
Conclusions
MKC has beaten analyst estimates in term of EPS and achieved revenue in-line with consensus estimates in the second quarter. The revenue growth year-over-year has been primarily fuelled by the pricing action, while the improving EPS has been a result of improving margins due to the firm's cost saving efforts.
The company has remained committed to return value to its shareholders in the form of quarterly dividend payments. Most recently they have declared a quarterly dividend of $0.39 per share equivalent to an annual yield of 1.8%.
In our opinion, MKC's stock remains unattractive from a valuation point of view, as it seems to be trading at a significant premium compared to its peers in the industry.
For these reasons, we maintain our neutral view on the stock. We would consider upgrading to a "buy" only, if the profitability measures would show a meaningful improvement and valuation would come down by 15% to 20%.
For further details see:
McCormick: Raised FY23 Profit Outlook, But High Valuation