Company Reports

As the leading player in the $19 billion global spices and herbs market—with nearly 20% share, 4 times the next-largest operator, according to Euromonitor—McCormick is a valuable partner for retailers. However, competitive and macro headwinds abound. For one, McCormick continues to face cost pressure (related to select raw materials, transportation, and labor) that have ensnarled firms of all stripes. Further, we think consumers (particularly those with lower incomes and/or on a fixed budget) have tightened their spending, given stepped up prices at the grocery store as well as elevated interest rates and gas prices, which could serve to constrain its results if consumers trade down or out of the category.

The market found favor with wide-moat McCormick’s second-quarter marks of 20 basis points of adjusted operating margin expansion to 14.4% despite a 1% downdraft in organic sales, sending shares up by a mid-single-digit percentage. However, we don’t see much to warrant a material change to our $67 per share fair value estimate (as results through the first six months of the year are tracking our projections) or long-term outlook (3%-4% annual sales growth and high-teens operating margins), rendering shares a touch heated after the recent climb.

As the leading player in the $19 billion global spices and herbs market—with nearly 20% share, 4 times the next-largest operator, according to Euromonitor—McCormick is a valuable partner for retailers. However, competitive and macro headwinds abound. For one, McCormick continues to face cost pressure (related to select commodities, transportation, and labor) that have ensnarled firms of all stripes. Further, we think consumers (particularly those with lower incomes and/or on a fixed budget) are beginning to tighten spending, given stepped up prices at the grocery store as well as rising interest rates, which could serve to constrain its results if consumers trade down or out of the category.

Wide-moat McCormick’s first-quarter results have reinforced our confidence in the firm’s capacity to mitigate volume and market share erosion through stepped-up investments in innovation and marketing. In our view, this spending should ensure its mix better appeals to more budget-conscious consumers favoring home-cooked meals, at the expense of away-from-home food occasions. As evidence, organic sales popped 2%, driven by a 3% rise in prices, which was partially offset by a 1% drop in volumes—a decline attributable to the trimming of its less profitable segments, which we see as prudent. Impressively, this growth comes on the heels of numerous price hikes in recent years to blunt rising costs. From a profit perspective, McCormick’s efficiency initiatives and improved mix yielded a 140-basis-point expansion in the gross margin to 37.4% and a more muted 30-basis-point bump in the adjusted operating margin, reflecting higher levels of brand spending.

As the leading player in the $19 billion global spices and herbs market—with nearly 20% share, 4 times the next-largest operator, according to Euromonitor—McCormick is a valuable partner for retailers. However, competitive and macro headwinds abound. For one, McCormick continues to face cost pressure (related select commodities, transportation, and labor) that have ensnarled firms of all stripes. Further, we think consumers (particularly those with lower incomes and/or on a fixed budget) are beginning to tighten spending, given stepped up prices at the grocery store as well as rising interest rates, which could serve to constrain its results if consumers trade down or out of the category.

McCormick sought to quell concerns that competition is denting its competitive standing in conjunction with its fourth-quarter earnings report. Results were fair, as organic sales edged up 2% (as 5% higher prices was partially offset by a 3% downdraft in volumes), while gross margin jumped 320 basis points to 40%. This included volume pressure in its mustard, prepared foods, and recipe mix lineups—reflecting widening price gaps and a more value-conscious consumer—which contributed to a 6% volume shortfall in its domestic consumer business.

As the leading player in the $11 billion global spices and seasoning market—with 20% share, 4 times the next-largest operator—McCormick is a valuable partner for retailers. However, competitive and macro headwinds abound. For one, McCormick continues to face heated costs (related to commodities, packaging, freight, and labor, which management has alluded to as being the highest in the past decade or two) that have ensnarled firms of all stripes. Further, we think consumers (particularly those with lower incomes and/or on a fixed budget) are beginning to tighten spending, given stepped up prices at the grocery store as well as rising interest rates, which could serve to pressure its results if consumers trade down or out of the category.

We don’t foresee a material change to our $63 fair value estimate after McCormick cooked up 6% organic sales growth and 150 basis points of adjusted gross margin expansion to 37% in its fiscal third quarter. However, the market soured on shares, sending the stock down at a high-single-digit percentage clip on the print (which we attribute to softness in China and an unchanged operating income outlook, despite the uptick in gross margins). As such, the stock trades just a touch above our intrinsic valuation; we think investors should keep an eye on this wide-moat name, which rarely trades at a discount to our valuation (not seen since 2017).

As the leading player in the $11 billion global spices and seasoning market—with 20% share, 4 times the next-largest operator—McCormick is a valuable partner for retailers. However, competitive and macro headwinds abound. For one, McCormick continues to face heated costs (related to commodities, packaging, freight, and labor, which management has alluded to as being the highest in the past decade or two) that have ensnarled firms of all stripes. Further, we think consumers (particularly those with lower incomes and/or on a fixed budget) are beginning to tighten spending, given stepped up prices at the grocery store as well as rising interest rates, which could serve to pressure its results if consumers trade down or out of the category.

The tide appears to be turning at wide-moat McCormick if second-quarter marks are a guide; the firm chalked up 10% organic sales growth (resulting from 11% higher prices and a 1% drawdown from lower volumes and unfavorable mix) while expanding adjusted gross margin by 310 basis points to 37.1%—a byproduct of efforts to raise prices, extracts costs, and prune lower-margins brands from its operations. This marks a shift for a business that has been struggling at the hand of supply chain disruptions and competitive angst. Although we perceived some of these pressures as transitory, we view its staunch commitment to investing in consumer-valued innovation and marketing as the impetus that should ensure its dominant competitive edge holds longer term. We forecast McCormick will expend around 5% of sales, $400 million annually, on research, development, and marketing to support its brand standing with consumers, retailers, restauranteurs, and packaged food behemoths.

As the leading player in the $11 billion global spices and seasoning market—with 20% share, 4 times the next-largest operator—McCormick is a valuable partner for retailers. However, competitive and macro headwinds abound. For one, McCormick continues to face heated costs (related to commodities, packaging, freight, and labor, which management has alluded to as being the highest in the past decade or two) that have ensnarled firms of all stripes. Further, we think consumers (particularly those with lower incomes and/or on a fixed budget) are beginning to tighten spending, given stepped up prices at the grocery store as well as rising interest rates, which could serve to pressure its results if consumers trade down or out of the category.

In recent quarters, we’ve opined that the rash of challenges plaguing McCormick would prove transitory (supply chain hiccups and COVID-19 restrictions in China), and first-quarter marks (6% organic sales growth, an 80-basis-point downdraft in adjusted gross margins to 36%, and a 40-basis-point shortfall in adjusted operating margins to 14.5%) give credence to our sentiment. This also struck the right note with the market, with shares up 10% on the print, though our fervor is more tempered; we expect to edge up our $62 fair value estimate by a low-single-digit percentage to account for time value. With shares trading 30% above our intrinsic valuation, implying a lofty low-30s times our fiscal 2023 earnings estimate, we think investors should await a more favorable risk/reward opportunity.

While McCormick posted a sour fourth quarter (2% underlying sales growth and 140 basis points of degradation in adjusted operating margin to 16.4%), management attempted to strike a more optimistic tone for the year ahead (calling for 5%-7% sales and 9%-11% adjusted operating income growth). We continue to believe that several of the forces that have weighed on recent performance (supply chain bottlenecks and COVID-19 disruptions in China) are unlikely to prove lasting. Further, we posit the company is judiciously focusing on the long-term health of the business—beefing up brand spending (we forecast 6% of sales, or $400 million annually), investing in capacity and capabilities, and unearthing inefficiencies (to the tune of an incremental $125 million).

As the leading player in the $11 billion global spices and seasoning market--with 20% share, 4 times the next-largest operator--McCormick is a valuable partner for retailers. However, competitive and macro headwinds abound. For one, McCormick is facing a pronounced acceleration in costs (related to commodities, packaging, freight, and labor, which management has alluded to as being the highest in the past decade or two) that has ensnarled firms of all stripes. Further, we think consumers (particularly those with lower incomes and/or on a fixed budget) will start to tighten spending, given stepped up prices at the grocery store and pump as well as rising interest rates, which could serve to pressure its results if consumers trade down or out of the category.

After McCormick’s Sept. 7 preannouncement, we think the impact of raging supply chain disruptions and rising costs was broadly understood, but less so how the firm intends to combat the onslaught of challenges. In our view, McCormick seems to be prudently pursuing a multipronged approach to ensure its competitive prowess proves unwavering.

Supply chain challenges, heightened costs, and tepid consumption are taking a more pronounced toll on McCormick than foreseen two months ago, prompting the wide-moat operator to slice its November-end fiscal 2022 sales and profit targets. Specifically, management now anticipates constant-currency sales growth of just 3%-5% (down from 5%-7%), 300-350 basis points of compression at the gross margin line, and adjusted EPS of $2.63-$2.68 (from $3.03-$3.08). Despite this, we don’t intend to alter our $62 fair value estimate, as more muted near-term estimates don't affect our long-term forecast (3%-4% long-term sales growth and high-teens operating margins) and the positive impact of time value.

As the leading player in the $11 billion global spices and seasoning market--with 20% share, 4 times the next-largest operator--McCormick is a valuable partner for retailers. However, competitive and macro headwinds abound. For one, McCormick is facing a pronounced acceleration in costs (related to commodities, packaging, freight, and labor, which management has alluded to as being the highest in the past decade or two) that has ensnarled firms of all stripes. Although it is still toeing the industry line that volumes are holding up, we think consumers (particularly those with lower incomes) will start to tighten spending, given the onslaught of unrelenting angst (including stepped up prices at the pump and rising interest rates).

McCormick’s tepid second-quarter results (flat organic sales growth and a 550-basis-point erosion in its adjusted gross margin to 34%, far worse than our 3.5% and 39.3% respective full-year marks) are evidence that the leading spices and seasoning manufacturer is fallible. A portion of the weakness is attributable to the usual suspects—inflation and supply chain disruptions—but this was exacerbated by lockdowns in China (though we view this as transitory) and the conflict in Ukraine. These challenges are reflected in its revised guidance as management trimmed its adjusted EPS forecast to $3.03-$3.08 from $3.17-$3.22. We intend to incorporate the firm’s year-to-date marks and near-term prognosis, but when juxtaposed with the benefit of time value, we see little to warrant materially altering our $63 fair value estimate. Even though shares pulled back marginally on the print, we view this wide-moat operator as rich, trading at more than a 30% premium to our intrinsic valuation and a forward P/E in the mid- to high-20s. We think the market has ascribed a lofty value to the name given its track record of consistent top-line growth but fails to consider the macro and competitive challenges that could forestall its trajectory.

As the leading player in the $11 billion global spices and seasoning market--with 20% share, 4 times the next-largest operator--McCormick is a valuable partner for retailers. However, competitive and macro headwinds abound. For one, despite management’s contention to the contrary, we surmise that its business will be challenged as the at-home eating trend during the pandemic cools. Further, McCormick is facing a pronounced acceleration in costs (related to commodities, packaging, freight, and labor, which management has alluded to as being the highest in the past decade or two) that has ensnarled firms of all stripes.

We don’t intend to materially alter our $63 fair value estimate or long-term outlook (3%-4% organic sales growth and 200 basis points of operating margin expansion to 19%) on wide-moat McCormick after digesting first-quarter results that tracked our full-year expectations. However, shares remain heated, trading at a more than 50% premium to our intrinsic valuation (a lofty low-30s P/E multiple), and we’d suggest investors refrain from building positions.