This Food Company is Delivering but What about its Valuation?
Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The food sector has seen a number of challenges this year. A combination of rising commodity costs and an increasingly frugal consumer are pressuring top-line growth and margins across the board. As such, niche companies with the ability to pass on costs while retaining volumes are few and far between. One such company is McCormick & Company (NYSE: MKC) which has managed to generate double digit revenue growth for the last five quarters. The story is not lost on the market and the stock is up over 20% in 2012, but is the good news fully priced in or can the stock appreciate from here?
McCormick Continues to Generate Strong Growth
The latest results were very strong and outlined the ability of the company to maintain volumes whilst taking price increases. We can see this in the progression of revenues and gross margins.
The company appears to be firing on all cylinders and the latest 11.3% rise in net sales suggests that the stock deserves its premium valuation. However, I’m not so sure.
More than 50% of the rise in sales was due to acquisitions and specifically on the higher margin consumer side. Consumer sales make up around 60% of sales with industrial making up the rest. We can see the breakdown of how the segment sales are developing.
Again, the superficial picture is very positive. The consumer division is growing strongly and since consumer margins tend to be around double those of the industrial segment, the margin mix is moving in the right way. However looking at the underlying picture reveals a note of caution. For example, consumer sales increased 14% but acquisitions contributed 10.1% to that growth. In addition, volumes were only up .8%. In fact, the organic growth in the industrial segment was stronger at 7.9% with volumes being up 3.7%. McCormick has been able to achieve organic growth whilst others have floundered for a few key reasons.
How McCormick is Generating Organic Growth
On the consumer side, its products are relatively low ticket and seen as below the radar for shoppers when it comes to looking for items they can economize on. They are not as easily exposed to the kind of trading down to private label or value that has afflicted companies like Kellogg (NYSE: K). In common with consumer goods behemoths like Procter & Gamble (NYSE: PG) when Kellogg has tried to raise prices, it has lost volume. PG and Kellogg are simply too big and unwieldy in order to be restructured at short notice. McCormick is not, and it can defend market share and innovate much easier.
McCormick has been doing well on the industrial side too. As noted earlier, pricing is a significant issue for food companies and a common solution has been to try and generate sales via innovation by developing new ranges and flavors. This plays into the company’s hands as it can offer its spices and flavorings to customers that are actively seeking to innovate new taste sensations for their customers.
The key contributions from acquisitions were made in the European and Asian geographic regions. The Kamis acquisition led to strong growth in Poland and the Kohinoor acquisition in India led a significant amount of growth from Asia. In common with many other food companies like Heinz (NYSE: HNZ) and Campbell Soup Company (NYSE: CPB) it is trying to expand into emerging markets as a way to generate growth. The difference is that Heinz and Campbell are locked in highly competitive markets where consumers are proving highly reluctant to take pricing. Similarly, innovation and increased marketing and promotions are pressuring margins. McCormick is in a much more favorable position.
What Next for McCormick?
McCormick appears to be well placed but a lot of the growth has been coming from acquisitions in the higher margin consumer side. This is exactly what investors should want the company to do but is it already in the price? Frankly the stock looks expensive –on a relative and absolute basis- for every conceivable metric. Trading on a trailing PE ration of 21 and EV/Ebitda multiple of 13.9 times, it looks expensive compared to the sector. Investors are keen to avoid cyclical stocks in this environment so the food sector has fallen into vogue and few companies have been bid up as much as McCormick.
Investors will be looking for continued strong performance in order to justify holding at these levels and any disappointment with future volume growth could weigh heavily on the stock. On the other hand, McCormick has generated growth in difficult market conditions and has a number of favourable market drivers behind it. It’s definitely a stock worth monitoring but I suspect there are better risk/reward profiles out there in the food sector.
SaintGermain has no positions in the stocks mentioned above. The Motley Fool owns shares of The Procter & Gamble Company. Motley Fool newsletter services recommend H.J. Heinz Company, McCormick & Company, and The Procter & Gamble Company. 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.If you have questions about this post or the Fool’s blog network, click here for information.
