McCormick: Still Not Developing A Taste For This Stock (NYSE:MKC)

In September, I called shares of McCormick (NYSE:MKC) too spicy. The long-term value creator has been hit by slower growth, impact of inflation, as high valuation multiples have created a tougher set-up, certainly in a higher interest rate environment.

With earnings actually under pressure, shares have moved in line with earnings trends, resulting in still continued demanding valuations, certainly as 2023 is not shaping up to become a very strong year.

A Recap

McCormick has been quite active with regard to dealmaking in the past, notably with a $4.2 billion deal in 2017 to acquire Frank’s RedHot sauce, mustard, barbecue and sauce business (from Reckitt Benckiser). The deal did not come cheap at 7 times sales, albeit that a high multiple was in part explained by high margins, although a 20 times EBITDA multiple was quite demanding as well.

This deal, in part paid for in stock, made that net debt had risen to $5.3 billion, while the pro forma operations posted sales just in excess of $5 billion and generated nearly a billion in EBITDA. This made that leverage would increase quite a bit, towards a 5 times leverage ratio, with earnings trending around $3.50-$4.00 per share, depending on the anticipated accretion from the deal (as well as anticipated synergies).

At the time a $90 stock, shares had fallen to $80 in September 2022, but this comes after a two-for-one stock split in 2020. The company announced a few more bolt-on deals over time, including an $800 million deal for Cholula Hot Sauce and a $710 million deal for FONA, both transactions executed at sales multiples between 6 and 8 times sales.

These deals and some organic growth made that sales rose to $5.6 billion in 2020 on which net earnings were posted at $747 million, equal to $2.78 per share (in excess of $5.50 per share pre-split). Dealmaking through 2020 and some deals made that 2021 sales rose in a rather spectacular fashion, up 13% to $6.3 billion with earnings flattish at $2.80 per share, albeit that adjusted earnings per share were up 8% to $3.05 per share.

The company initially guided for 2022 earnings to rise to $3.17-$3.22 per share, but the company cut the guidance in a huge way alongside the preliminary third quarter results, seeing earnings at just $2.63-$2.68 per share. Hence, it is not too surprising to see shares of McCormick fall from $100 at the start of 2022 to the $80 mark in September and October.

Based on reported earnings around $3.25 per share, shares started trading the year around 30 times earnings, as the reduced earnings power made that the multiple has been pretty similar at $80, as both earnings estimates and shares have fallen some 20%. With debt still quite apparent and the degree of the earnings shortfall being shocking given the defensive nature of the business, I did not automatically see appeal just yet, certainly not in a higher interest rate environment.

Tough Times

After voicing a cautious tone in September around the $80 mark, shares have traded in a $70-$85 per share range ever since, now exchanging hands at $75 per share. The company posted a 3% increase in third quarter sales, or 6% in constant currency growth. However, adjusted for a divestment, the actual reported sales growth was less than a percent, as the company maintained the already reduced guidance.

In November, the company announced a two penny increase in the quarterly dividend to $0.39 per share, boosting the yield to just over 2% at these levels. The company ended the year on a soft note as fourth quarter revenues fell 2% in reported dollar terms, with constant currency growth of 2% hinting towards volume declines, in fact reported at 4%, offset by price hikes in this inflationary environment. Adjusted earnings fell eleven cents to $0.73 per share, as the full year adjusted number fell from $3.05 to $2.56 per share.

For the year, sales were pretty stable just over $6.3 billion on which net earnings of $682 million were reported, with GAAP earnings pretty equal to adjusted earnings based on a share count of 270 million shares. Net debt of $4.8 billion translates into a 4 times leverage ratio if I construct EBITDA around $1.2 billion.

For 2023, the company guides for a 5-7% increase in sales and adjusted operating earnings rose to between 9 and 11%, indicating that operating earnings should show meaningful growth. This is however offset by higher taxes and interest costs, with adjusted earnings per share only seen at $2.56-$2.61 per share, only coming in a couple of pennies ahead of the 2022 results at $2.53 per share.

The truth is that 2022 has been a tough year with Covid-19 lockdowns in China hitting the business hard, as exposure to Russia certainly did not help either, as the outlook for 2023 is not too convincing, certainly not given continued inflation and the reopening in China.

Concluding Remarks

With the company guiding for essentially flattish earnings in 2023, amidst modest topline sales growth and margins stabilization, it is clear that higher interest expenses and some actions are detrimental to earnings this year.

This sets the company up for another soft year, keeping a 30 times earnings multiple in check, as even a recovery in earnings to $3 per share still works down to a 25 times multiple. Moreover, in both cases, leverage will remain high. All of this and lack of recent execution makes McCormick still a very easy avoid for me here.