McCormick: One Fantastic Dividend Payer

Great investments can sometimes hide in plain sight -- or your pantry. One of the best examples of how plain-sight, boring-is-beautiful-style businesses can thump the market has been spice kingpin McCormick  (NYSE: MKC  ) . This quiet market dominator has probably been on your radar ever since you first visited a spice aisle, but it has largely flown under Wall Street's radar because of its size and lack of sizzle. Lucky us.

I recommended McCormick to Inside Value members back in October, but it wasn't until recently that I was able to visit its headquarters. I came away impressed with McCormick's people, process, and strategy and, as I'll explain, I am confident that this wide-moat dividend dealer has years more of great returns ahead.

Got spice?
McCormick is like a modern-day Dutch East India Company -- without the powdered wigs and tyranny. The 122-year-old company's branded spices, herbs, seasonings, and sauces can be found in nearly 100 countries. Odds are you have some on your pantry shelves, including Lawry's, Old Bay, and the eponymous McCormick brands.

The company's sales have held up well throughout the Great Recession thanks to the strength of its brand, consistent demand for its products, and a great value proposition. Spices pack a lot of flavor but cost only pennies per serving, making them among the last expenses people are likely to cut from their shopping lists. You might downgrade from a filet mignon to a sirloin, but you're probably not going to skimp on the salt and pepper.

Industrial chic
McCormick's dominance doesn't stop with your spice rack, though. Enjoy Cheerios? How about KFC or Doritos? About 40% of the company's sales come from industrial customers like General Mills (NYSE: GIS  ) , PepsiCo's  (NYSE: PEP  ) Frito Lay, and Yum! Brands' (NYSE: YUM  ) KFC, Taco Bell, and Pizza Hut. McCormick is the partner of choice for these large-scale flavor pushers thanks to its scale, breadth, expertise, and proven ability to help food and beverage companies put innovative twists on their brands.

The industrial side of McCormick's business offers lower margins than the consumer side, which led McCormick to drop the bottom third of its industrial customers since 2005. The strategy of trimming some customers and focusing on its top buyers has paid off, as McCormick's industrial sales have since risen more than 15%, with profit climbing even higher.

Even better, there's a quiet call option on the industrial side. As we gleaned on our tour of the company's R&D facilities, McCormick is able to leverage its systems, innovations, and insights from the industrial side in its own margin-rich consumer business. A perfect example is in China where McCormick is leveraging its experience and logistics in assisting Yum! Brands' voracious growth by selling its own branded consumer products.

The carving knife
McCormick's focus on fiscal discipline is paying dividends. Earnings growth has outpaced sales growth in the past several years because of the company's emphasis on cost-cutting and a bigger proportion of sales coming from the high-margin consumer business.

We got a great sense of the company's ongoing quest to cut costs and improve efficiency while on our tour of the company's Hunt Valley plant. The tidy facility, which smells like 1,000 simultaneous Thanksgiving dinners, has made huge strides in achieving capacity gains by automating an increasingly large slice of the production pie. McCormick should be able to retain a greater portion of that value creation because of its strong brands and high barriers to entry, especially on the consumer side.

One very interesting nugget was the new high-efficiency production lines purchased for the production of the Lawry's line, which the company scooped up from fellow foodstuffer Unilever (NYSE: UL  ) back in 2008. Some analysts (myself included) have been quick to point out that Lawry's products are higher-margin than the aggregate of the rest of McCormick's business and thus have the potential to surprise on the upside gross-margin-wise. What goes unappreciated, though, is that the actual lines producing Lawry's goods are also substantially more efficient and can produce at lower costs than the bulk of the rest of the production line, which amplifies the higher-margin profile of the Lawry's pick up.

Talkin' 'bout cash
We also had lunch with CFO Gordon Stetz, a 23-year veteran who knows the business cold. A lot of CFO's get painted as simply playing the role of Chief Number Jockey, but Stetz has a crystal clear view of McCormick's strengths and limitations.

Stetz views McCormick's brands as the company's greatest competitive advantage. Yes, its distribution capabilities, scale, people, expertise in flavors, and industrial relationships all have immense value. At the end of the day, though, it's a collection of trusted, well-known brands that allow for the company's wide margins. That's been reflected in the company's high-level strategy over the past few years, as it has opportunistically scooped up established brands that complement its existing portfolio and started turning away bad business in its industrial line. 

McCormick places a huge emphasis on R&D and innovation -- maybe a little surprising for a company that sells spices. But, as Stetz joked, a manager who gives a presentation to CEO Alan Wilson -- a former Procter & Gamble (NYSE: PG  ) manager well schooled in P&G's hard-driving focus on innovation, product development, and brand leveraging -- without the first slide being about what he or she is doing to innovate is due to get an earful. Perhaps not surprisingly, 15% of sales on the industrial side of the business stem from product developed in the past three years.

The power of that strategy shows up on the bottom line. McCormick's strong, consistent cash flow has driven 25 straight years of dividend hikes. Not too shabby, and neither is today's 2.2% yield that outclasses the payout on the 5-year Treasury. But while hysterical bond investors are handcuffing themselves to static payments and low returns, McCormick's dividend would rise by about 50% in the next decade if sales grow at just a 4% annualized clip. And while the shares aren't the bargain they were when I recommended them back in October, I still think they'll quietly drub the market over the next decade with a healthy, growing dividend to boot.

The Foolish bottom line
McCormick isn't a stock that will make your friends jealous at the next BBQ. However, be sure to thank them for funding your dividend check with the Lawry's Seasoned Salt they use to flavor the hamburgers. While you're at it, rub it in to them that you also scored access to our special free report, "13 High-Yielding Stocks to Buy Today." To get instant access to the names of these stocks, simply click here -- it's free. And pass the pepper.

Joe Magyer owns shares of PepsiCo and Procter & Gamble. You can follow his musings on stocks, markets, and pale ales on Twitter via @TMFInsideValue. Procter & Gamble, PepsiCo, and McCormick are recommendations of Motley Fool newsletters. The Motley Fool has a disclosure policy.


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