Thursday, April 12, 2018

McCormick & Company (MKC) Dividend Stock Analysis

McCormick & Company (MKC) engages in the manufacture, marketing, and distribution of spices, seasoning mixes, condiments, and other flavorful products to retail outlets, food manufacturers, and foodservice businesses. It operates in two segments, Consumer and Industrial. This dividend aristocrat has paid dividends since 1925 and has increased them for 32 years in a row.

The company’s latest dividend increase was announced in November 2017 when the Board of Directors approved a 10.60% increase in the quarterly annual dividend to 52 cents /share.

Over the past decade this dividend growth stock has delivered an annualized total return of 13.40% to its shareholders.

The company has managed to deliver an 8% average increase in annual EPS over the past decade. McCormick is expected to earn $4.92 per share in 2018 and $5.41 per share in 2019. In comparison, the company earned $3.72/share in 2017.

In addition, between 2008 and 2017, the number of shares decreased very slightly from 132 million to 128 million. Given the fact that shares are frequently overvalued, I would not want management to be repurchasing stock at rich prices. In 2017, McCormick acquired Reckitt Benckiser's food division for $4.5 billion, part of which was financed by issuing 6.35 million shares.

This wide-moat company is the leader in global spices and seasonings with over one fifth of the market, which ensures advantages of scale. It is four times larger than its next competitor. Besides scale, the company also has strong brand names such as McCormick and Lowry. The wide moat is derived from the strong portfolio of brand names, strong relationships with retailers, investment in R&D, and the advantages of scale. All of this translates into higher returns on investments and better positioning relative to the competition.

Revenues are derived from two segments, Consumer with 60% and Industrial with 40%. The Consumer segment offers spices, herbs, seasonings, and dessert items directly, as well as through distributors or wholesalers to various retail outlets, including grocery stores, mass merchandise stores, warehouse clubs, and discount and drug stores, as well as supplies private label items. The Industrial segment provides seasoning blends, natural spices and herbs, wet flavors, coating systems, and compound flavors directly, as well as through distributors to food manufacturers and foodservice customers. The largest customers are Wal-Mart Stores (WMT) and PepsiCo (PEP) with 11% of McCormick’s sales each. Other major customers include McDonald’s, Sysco, General Mills, Kraft Foods, Yum! Brands etc. Almost 55% of revenues are from the US, with the remaining 45 from the rest of the world.

Most of the company’s revenues are derived from its branded spices. Private label spices account for a low amount of revenues ( less than 10%), but can solidify relationships with retailers, and provide a foot in the door for the company. In order to differentiate itself and keep ahead of generic competition, McCormick invests in innovation, in an effort to bring new products to the marketplace.  The company does use its private label offerings to get a footing in new retailers, such as Dollar Tree and Dollar General. After that, it introduced a few higher margin branded products in this new distribution channel.

Future growth in earnings per share can be generated through organic growth, acquisitions, innovation, and cost saving initiatives. McCormick invests in its brands and has pricing power in them and also has the scale to be the lowest cost producer in its market. While spices are expensive, their cost relative to the price of a meal. The input costs for raw materials are difficult to hedge, which leads the company somewhat exposed to fluctuating input costs for commodities. However, the company has mitigated this effect by extracting costs out of operations and adjusting packaging.

The company has been active in the acquisitions front, in order to generate sales and expand its product and geographical reach. It acquired the food division of Reckitt Benckiser in 2017 for $4.5 billion, and thus bringing in $570 million in annual sales from brands such as  French's, Frank's RedHot, and Cattemen's.

The annual dividend payment has increased by 8.90% per year over the past decade, which is slightly higher than the growth in EPS.

A 9% growth in distributions translates into the dividend payment doubling every eight years on average. Since 1995, McCormick has managed to double dividends every eleven and a half years on average. Future dividend growth would have to track growth in earnings per share, and would likely be around 7% - 8% in annual growth.

The dividend payout ratio decreased from 46% in 2007 to almost 38% in 2010, before increasing to 51% in 2017. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently, the stock is slightly overvalued, as it trades at a forward P/E of 21.30 and yields 2%. I am analyzing the company because I believe it is quality dividend growth stock, which will be a very good investment on dips below $98, which is equivalent to a forward P/E of 20. For more conservative readers, a P/E of 20 using EPS for 2017 should result in an entry price below $75/share. A wonderful business like McCormick will compound earnings and dividends for its investors over time, which is why it is frequently overvalued. I always want to have some margin of safety in case things do not turn out as expected, as I try to avoid getting overly excited about any individual security.

I believe that this compounding machine will be able to grow and provide sustainable dividend growth in the future. I have also found it helpful to monitor quality companies I am interested in much better, when I have skin in the game. If the stock price keeps sliding down, I will keep adding.

Full Disclosure: Long MKC

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