McCormick’s Recent Pullback Is a Buying Opportunity

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Global spice vendor McCormick (NYSE: MKC  ) has underperformed the S&P 500 this year. Its share price gain of just 8.4% is way behind the 25% appreciation of the index. However, McCormick is a dividend investors' delight. It has consistently raised its dividend and is considered a "Dividend Aristocrat."

Even more impressive is the fact that McCormick draws 40% of its sales from industrial businesses, which include a few big clients like McDonald's, Yum! Brands (NYSE: YUM  ) , etc. In addition, McCormick relies heavily on sales channels under the control of PepsiCo and Wal-Mart (NYSE: WMT  ) , with Wal-Mart being its largest customer. The potential for McCormick is huge going forward.

It is expected that the global market for spices and seasonings will rise to 5.3 billion pounds by the year 2017 . In order to expand its footprint, McCormick has been growing its business in both developed and emerging markets through acquisitions. Emerging markets are expected to contribute approximately 15% of McCormick's sales in 2013. This is a significant increase from the 10% in 2011 driven by recent acquisitions such as that of Wuhan Asia-Pacific Condiments, or WAPC .

Spreading its wings
In June of this year, McCormick completed the acquisition of Chinese broth maker WAPC with the aim of expanding its presence in China. A series of acquisitions were completed in 2011, including U.S.-based Kitchen Basics, Poland-based Kamis S.A., and a joint venture with Kohinoor Foods in India as McCormick focuses on strengthening its portfolio.

These acquisitions and expansions into different markets are very important. McCormick needs to reduce its reliance on a small group of customers. For example, Yum! Brands' KFC has been going through one problem after another in China.

First, it was the issue of unacceptable levels of antibiotics in the chain's chicken supplies. When the company did manage to address these concerns, the avian flu outbreak in March derailed all plans of recovery. This resulted in Yum! reporting a steeper than anticipated drop of 13% in comps in China in July.

This also affected McCormick's sales and resulted in weak industrial sales in Asia. In the U.S., sales were weak because quick service restaurants focused on promoting menu items that were not flavored by McCormick.

A weakness to capitalize on
This is probably the reason why McCormick has been expanding and diversifying. On the back of strong performance from its acquisition of WAPC in the third quarter, the company reported an increase of 4% in revenue over last year to $1.01 billion. This, however, was not enough to beat consensus estimates. McCormick reported earnings in line with analyst estimates of $0.78 per share.

These results were disappointing. To make matters worse, McCormick indicated that its full-year earnings per share would be at the lower end of its $3.13 to $3.19 per share range. Also, its full-year adjusted operating income is now forecast to grow 3% to 5%, versus a prior forecast of 5% to 7%.

This weakness has dragged down the stock by about 13% from its high of around $75, which makes it an interesting proposition. The company has quite a moat because it controls 22% of the global seasonings & spices market where it is four times as large as the nearest competitor .

McCormick has a wide chain of distributors, and Wal-Mart is an important one. Wal-Mart's huge network of 11,000 stores in 27 countries augments McCormick's global expansion moves. Recent statements by Wal-Mart also point toward the fact that sales are expected to grow at the retail giant. Wal-Mart expects sales to be stronger next year on the back of changes such as openings of smaller stores in the U.S. and its move into the residential markets. As Wal-Mart expands its footprint, McCormick also stands to benefit because its products will reach more consumers .

China is also a big market for McCormick. Despite a lower GDP growth rate, the company has been growing its consumer base in double digits in the country. McCormick is looking to make the most of its WAPC acquisition, and as such it is undertaking aggressive marketing activity in three central Chinese provinces to achieve sales growth.

McCormick is also investing in India for long-term growth. Despite experiencing volatility in the Indian market, the company sees huge potential because per capita consumption of spices in India is almost five times greater than that of the U.S. The company has a target of generating 20% of revenue from the emerging markets by the end of 2015, and it is working aggressively toward that goal.

Bottom line
McCormick has pulled back after weak results. However, the company's leading position in the spices industry, its geographic reach, and its expansion into key markets such as India and China are worth considering. A trailing P/E ratio of 22.28 and a forward P/E ratio of 19.71 indicate that analysts anticipate earnings growth in the future. Investors should consider taking advantage of McCormick's recent pullback and buying some shares for their portfolios.

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Related Tickers

5/26/2016 4:02 PM
MKC $97.52 Up +0.80 +0.83%
McCormick CAPS Rating: ****
WMT $70.85 Up +0.37 +0.52%
Wal-Mart Stores CAPS Rating: ***
YUM $82.45 Down -0.15 -0.18%
Yum! Brands CAPS Rating: ****