Summary
- Driven by mid-teens consumer sales growth, helped in part by market share growth, McCormick beat revenue expectations in FQ3, but COVID-19 costs led to a $0.03/sh operating miss.
- McCormick believes that the trends toward more DIY food prep can endure, but I'm skeptical that COVID-19 will drive lasting changes in adult behavior.
- Management is ready to return to M&A; McCormick has been a generally good acquirer, but multiples have more than doubled over the past decade.
- It's hard to make sense of McCormick's valuation beyond an overall willingness to pay up for packaged food companies.
It's been a long, long time since the packaged foods category, was really thought of as a growth opportunity, but with COVID-19 leading to major changes in consumer behavior, that's what we have ... at least for the moment. Therein lies one of the key issues for McCormick & Company (MKC) ("McCormick") as an investment idea - how much of the shift from paying others to make food for you to doing it yourself will persist once COVID-19 has faded from view?
It always fascinates me when analysts more or less agree on the financial outlook for a company but come up with significantly different fair values, and that's the case here. The spreads between expectations for revenue, EBITDA, and free cash flow aren't all that wide over the next three years, but the spread between the Street-low price target ($134) and Street-high price target ($205) is wide indeed, with most of the analysts on the higher end basing their price targets on what the market is already paying for other packaged food companies.
Strong Consumer Demand, But Weaker Margins
McCormick had a mixed fiscal third quarter and guidance for the next quarter came up a little disappointing too. Revenue grew by almost 9% in the quarter, around 3% better than expected, but operating earnings came up about $0.03/share short of expectations on higher costs tied to COVID-19 and incentive compensation.
Within that 9% revenue growth, the Consumer business grew 15%, with business in the Americas up more than 17% and business in the EMEA region up almost 23%. The Asia-Pacific region was the notable outlier, falling 6%, though the year-over-year declines are shrinking sequentially (from down 28% in FQ1'20 to this 6% contraction). The restaurant-and-packaged food-driven Flavor Solutions business reported a 1% revenue decline, with Americas down 3%, EMEA up 1%, and Asia-Pacific up 7%.
Gross margin improved 70bp in the quarter, while EBITDA rose 5% and operating income rose 5%, with margin down 60bp. By segment, the Consumer business saw 18% profit growth (margin up 70bp to 22.9%), while Flavor Solutions declined 24% with margin down 350bp to 12.3%. Management called out COVID-19 mitigation efforts and incentive comp as margin headwinds, but with the company also pushing to expand capacity, I have to believe that played some role as well - McCormick is increasing its blending capacity both internally and via contracted third parties, and the capacity increase is equivalent to a new standalone plant.
