Investors had modest expectations heading into McCormick's (MKC -0.70%) fourth-quarter earnings release. The spices and flavorings specialist isn't struggling with flat or declining sales like many of its peers in the consumer packaged-foods industry. However, revenue gains have been sluggish lately, leading many on Wall Street to question the company's ambitious target of roughly 5% organic growth over the long term.
On Tuesday, McCormick added to those worries by projecting a second straight year of underwhelming sales gains. The company also predicted spiking costs in 2020 that will keep a lid on profits.
Let's take a closer look.
Meeting low expectations
Sales growth trends didn't break from the generally weak results investors saw through most of 2019. Organic revenue was up 2% in the fourth quarter, matching the prior quarter's uptick. That modest boost ensured that gains landed at 3% for the year, or right at the low end of management's forecast range.
With sales rising 2% over the past six months, it's clear that McCormick's growth rate has slowed in key areas like its core U.S. retailing segment. That deceleration appears more tied to competitive offerings from grocery stores, too, rather than timing issues on major retailer orders.
On the bright side, McCormick notched several impressive financial wins. Cost cuts landed at $463 million, or well ahead of the initial $400 million annual goal. That success combined with higher prices to push profitability up. Gross profit margin and operating margin each improved by roughly 1 percentage point. Cash flow results were even better, with operating cash jumping 15% to mark an eighth consecutive year of record cash generation. As a result, CEO Lawrence Kurzius and his team had plenty of resources to direct toward growth initiatives like marketing and toward supporting the dividend, which they increased by 10% during the year.
A new strategy
McCormick's 2020 outlook doesn't threaten those core financial advantages, but it does suggest an unusually difficult year for the business ahead. Executives see sales growth landing between 2% and 4%, which is again well below the company's long-term goal of 5% annual growth.
Management also plans to significantly ramp up spending this year in what they call a "business transformation investment." That spending surge will limit earnings so that adjusted profit is roughly flat or even slightly lower, year over year. McCormick's long-term aim is to expand that figure by about 10% each year. The cash needs of the business also imply that McCormick isn't likely to have excess resources to devote to resuming stock buybacks.
Investors will likely have to wait until the second half of the year to judge whether these strategic shifts have succeeded in returning the consumer staples business to an annual expansion pace that's closer to 5% than the 3% management is targeting today.