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Is This The Season For McCormick?

Posted: Sep 30, 2008 13:20 PM by Stephen Simpson

Tickers in this Article: MKC, GIS, HNZ, K, CAKE, PFCB, WMT, PEP

Food, glorious food! From General Mills (NYSE:GIS) to H.J. Heinz (NYSE:HNZ) to Kellogg (NYSE:K), food stocks have been something of a safe haven in the markets this year. It certainly makes sense; people need to eat, after all, and you can add McCormick (NYSE:MKC) to the list of solid performers as well. The big question now, though, is whether the love and adulation seen today is likely to continue long enough for new buyers to benefit.

Stay In And Shake On
One of the theses behind food stocks is that people will increasingly drive past the Cheesecake Factory (Nasdaq:CAKE) and P.F. Chang's (Nasdaq:PFCB) and on to Wal-Mart (NYSE:WMT), where they'll grab a bunch of ingredients to take home and cook for themselves.

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If you look at McCormick's latest earnings, you could think "yeah, maybe that's what is happening". Revenue in the consumer segment was up over 14% (up 10% in local currencies), and operating income after items was up more than 6%. Overall, McCormick did pretty well at the corporate level too - revenue was up about 9% (up 6% in local currency), gross margins were steady and operating income was up more than 3%. (Margins are important, so be sure to see The Bottom Line On Margins.)

So, why the difference between revenue growth and operating income growth? McCormick boosted marketing support for consumer business by about 30%. Company management said it is trying to raise awareness of flavored pepper products and "crusted blend products". Hmmm, perhaps they should spend a few more marketing dollars to come up with a better product description than "crusted blend products". That sounds more like a target for a pharmaceutical company than a consumer staple category.

Sugar Or Too Much Spice?
I'm willing to bet that McCormick will continue posting solid returns. The company has a diverse array of inputs, so it's not as susceptible to inflationary price spikes in specific categories (apart, maybe, from cheese-related products for PepsiCo's (NYSE:PEP) Frito-Lay business). Moreover, the company hasn't pushed pricing too hard yet (up 4% this quarter) and people seem to prefer foods with flavor.

But, and here's the inevitable "but" - at what price? McCormick seems to be rather well-regarded from a valuation standpoint already. The company does produce solid returns on capital, but you have to make some generous assumptions to reach an attractive target price via cash flow or returns on assets.

Bottom Line
What does that mean? I'm assuming I have a credible notion of the type of growth the company will produce and/or how risky McCormick's equity will be perceived by the Street. I trust myself, but you should do your own due diligence. And let's not forget a few other points - McCormick pays a decent dividend, it has a stable business, and even if the stock doesn't seem cheap, it may not be vulnerable to the gut-wrenching declines we've seen in other sectors so far this year. All in all, I'm not buying, but I can certainly understand why others might.

(Interested in dividends? Be sure to check out Dividend Facts You May Not Know.)

By Stephen Simpson

Stephen Simpson, CFA, has worked as an equity analyst for both sell-side and buy-side investment companies, and presently works as a sell-side equity research analyst. He has worked as a consultant for the healthcare sector, and has written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson is the editor of Kratisto Investing, a website devoted to financial analysis and personal commentary.

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