Add Some Spice to Your Food and Portfolio With This Stock

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McCormick (NYSE: MKC) is a global distributor and marketer of spices, seasoning mixes, and condiments and other flavorful products to both the consumer segment made up of retail customers; and the industrial segment comprising packaged food manufacturers & foodservice businesses.

Not your average commodity

While things like salt and pepper are as common as they can get, the same cannot be said of some of the other specialized spices and herbs that go into the manufacture of McCormick’s value added products. One example is paprika, mainly used as seasoning and coloring for stews and soups, which is sourced primarily from Kalocsa, Hungary. As the market leader in countries such as the U.S., Canada, the U.K., France, and Poland with more than 40% market share in spices and seasonings, it has the requisite scale and network of relationships to source its raw materials at competitive cost levels.

Low costs, high benefits

According to internal research by McCormick, its products usually represent about 10% of the cost of a meal, but account for 90% of the flavor. In addition, a survey by The Alcott Group indicated that 65% of Americans expressed the view that ‘flavor makes all the difference in their meals.’ This is largely a factor of the trend of dual income families, where ordinary Americans are having less time to prepare meals and are seeking convenient ways to make their food more palatable in the least amount of effort and time. This is where products by McCormick fill the gap.

Putting yourself in the shoes of a McCormick customer, you are unlikely to cut back on the amount of spice and condiments you buy in difficult times, or make a big fuss at the supermarket if prices are increased by 5%. As a result, McCormick exhibits revenue stability and pricing power, evidenced by its financial track record. McCormick grew revenue in every single year in the past decade, with gross margin staying within a narrow range of 40%-42% over the same period.

Growth drivers

In terms of geographical exposure, McCormick derived 14% of its fiscal 2012 sales from emerging markets, with a target of emerging markets generating one-fifth of revenue by 2015. This target is likely to be achieved with both organic growth and acquisitions. McCormick completed the acquisition of Wuhan Asia Pacific Condiment, a leading Central China player in bouillon/broth in May 2013.

This adds well-known DaQuiao and ChuSheLi brands, which will help increase the proportion of total sales from China to about 7%.McCormick also invested in new technical centers in South Africa and China in recent years to launch new products tailored to local tastes.

McCormick’s industrial segment is facing short-term headwinds because of weaker demand from quick service restaurants, but this is partially offset by stronger sales to food manufacturers. There is ample room for growth, given that the industrial segment accounted for 40% and 21% of fiscal 2012 sales and operating income, respectively. I am positive that McCormick’s shift from bulk ingredients towards more value-added products will drive margin expansion going forward.

McCormick expects fiscal 2013 sales and operating income to grow by 4%-6% and 5%-7% year-on-year, respectively. I am optimistic of McCormick meeting these targets, based on both organic and inorganic growth initiatives.

Peer comparison

McCormick’s peers include Mondelez International (NASDAQ: MDLZ) and TreeHouse Foods (NYSE: THS).

Mondelez is a global snacks company with notable brands such Cadbury chocolate and Oreo biscuits in its portfolio. It derived 40% of its fiscal 2012 revenue from emerging markets in key countries such as Brazil, Russia, and China. In June alone, it expanded its biscuit plant in Suzhou, China to double capacity; and inked an agreement with the Ivorian government to help farmers produce more cocoa.

Mondelez recently revised the lower end of its full year 2013 operating EPS guidance upwards from $1.52 to $1.55, on the back of a strong second-quarter financial performance. In the near-term, weak coffee pricing might hurt margins, with coffee accounting for about 10% of Mondelez’s sales.

TreeHouse Foods is a food manufacturer servicing primarily the retail groceries and foodservice companies, and it is the largest manufacturer of pickles and non-dairy powdered creamer, private label salad dressings, and instant hot cereals in the country. Given that it does not pay a dividend, it has sufficient free cash flow to support M&A; it recently acquired Cains Foods, a manufacturer of dressings and sauces in July 2013.

TreeHouse’s first-quarter results were within expectations and it maintained its original guidance of 2013 adjusted EPS of $3.00-$3.10, representing year-on-year growth rates of 7%-10%. I am negative on TreeHouse Foods, given its lack of emerging market exposure and significant customer concentration risk with its top ten customers accounting for more than half of sales.

Conclusion

I like McCormick for its global network of suppliers of diverse spices and herbs and the low price sensitivity of its customers. In addition, it has the potential to grow its business by increasing the sales of higher margin value-added products in its industrial segment and expanding further its share of emerging market revenue. However, McCormick is expensive at current valuations of 20 times forward P/E and 16 times trailing twelve months EV/EBITDA. I will advise investors to consider this stock in the event of a share price pullback.

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Mark Lin has no position in any stocks mentioned. The Motley Fool recommends McCormick. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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