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Is McCormick a Buy Before Earnings?

By Justin Cardwell - Jan 22, 2020 at 8:30AM

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This spice and flavorings company is showing signs of a heavy valuation.

Shares of McCormick (MKC -9.27%) have increased 21.5% over the past 12 months, and an impressive 127.4% over a five-year period. A consumer staples giant selling spices, herbs, and flavorings, McCormick is expected to end fiscal 2019 with projected annual adjusted earnings per share between $5.30 and $5.35.

There are several factors investors need to keep in mind if they plan to purchase shares of McCormick before the fourth-quarter earnings release on Tuesday, Jan. 28.

raw piece of meat with the hand of a chef adding spices

Image source: Getty Images.

A low but growing dividend yield

McCormick is a Dividend Aristocrat, consecutively paying an increasing dividend for 33 years with a current forward dividend yield of 1.5%. McCormick's dividend yield isn't anything to write home about, as investors holding a low-cost S&P 500 index fund can receive a 1.7% dividend yield. McCormick's low dividend yield is largely due to a 127.4% share price increase over the last five years, lowering the dividend yield per share. As shares continue to rise, the dividend yield will keep getting lower unless McCormick management decides to increase dividend payouts, similar to the November announcement to increase dividends from $0.57 to $0.62 per share -- an 8.8% increase.

A five-year dividend compound annual growth rate (CAGR) of 9.1% in combination with a 46.34% payout ratio means that McCormick's dividend is growing and can keep growing with a low payout ratio. However, the dividend yield is relatively low and continues to get lower as shares continue to rise. As shares continue to rise, investors need to start looking at the current valuation of McCormick shares in addition to the long-term growth potential of the company.   

Consumer segment outpaces flavorings during the third-quarter

Total revenue between the consumer and flavorings segments during the third quarter was split 60% toward consumer and 40% flavorings -- $794.2 million and $535 million, respectively. The consumer segment reported growth in operating income, excluding special charges, of 16% year over year -- mainly from the 11% growth in the Asia-Pacific region. 

The flavorings segment growth was flat on a year-over-year basis, as operating income, excluding special charges, decreased 2%. McCormick stated that the decrease in the flavoring segment was caused by lower sales in combination with unfavorable foreign currency exchange rates. 

Growth from the consumer segment saved McCormick's third quarter, and investors need to keep an eye on the flavor segment during the fourth quarter. As the flavor segment makes up 40% of revenues, flatline growth will continue to hold back McCormick's overall growth each quarter. McCormick's President and CEO Lawrence E. Kurzius did not address concerns during the third quarter and stated that there is a rising interest with consumers globally to enhance the flavor of food and that McCormick is positioned to continue the current growth trajectory.   

RB Foods acquisition

McCormick has completed six acquisitions since 2015, building an impressive portfolio of products. Most notable was the $4.2 billion acquisition for Reckitt Benckiser Group, now known as RB Foods, in July 2017. This acquisition gave McCormick Frank's RedHot, the No. 1 hot sauce brand in the United States and Canada. Kurzius stated during the acquisition announcement that "the iconic French's and Frank's RedHot brands will become our No. 2 and No. 3 brands, respectively." 

The RB Foods acquisition has been stated to give McCormick cost synergies -- a fancy term for saving money -- of $50 million by 2020. In addition, McCormick expects a 50% increase in food-service sales in the U.S. and Canada with French's and Frank's RedHot, which has been showing over the past two years for McCormick, as the company has seen significant growth from the acquisition in 2017.

Debt from this acquisition is weighing McCormick's balance sheet down, as the company has a total debt of $4.7 billion. As debt is 4.1 times its EBITDA, the debt load undertaken has significantly affected the balance sheet -- but it hasn't put the company in dire straits. It has been two years since the acquisition, and McCormick has driven debt down $327 million from a total debt of $5.03 billion in 2017. Assuming profitability growth can continue, the debt level hasn't become a grave concern; however, investors need to keep a watchful eye on this debt load, as mismanagement can severely hinder potential shareholder growth.

Growth at a heavy valuation

McCormick's share price isn't cheap ahead of the fourth-quarter earnings release, with a forward price-to-earnings ratio of 31.52, a price-to-sales figure of 4.11, and a dividend yield below that of an S&P 500 index fund. Growth is a focal point for shareholders ahead of the next quarter's announcement, as McCormick expects to maintain the growth of the consumer segment in combination with a continued historical 4.97% annual revenue CAGR since 2014.

McCormick's market consensus earnings-per-share outlook for the fourth quarter sits at $1.61 per share, putting the expectation at the top of McCormick's projected earnings-per-share range of $5.30 to $5.35 for fiscal 2019. Purchasing shares of McCormick ahead of the next quarter assumes the company can meet the high end of projections in both revenue and earnings per share, which I believe it can. However, the share price multiples and low dividend yield aren't attractive enough to buy McCormick at the current price.  

Investors would be best served by keeping McCormick on a watchlist for now and waiting to buy shares during a pullback -- capturing a better valuation for a recession-resilient consumer-staples giant. 

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