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Despite a Compelling Dividend, McCormick Stock Is Overvalued

By Reuben Gregg Brewer - Mar 4, 2020 at 8:15AM

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Although the consumer goods company has a phenomenal record of dividend increases under its belt, now is not a great time to buy stock.

McCormick & Company (MKC -0.83%) may not be a household name like Kraft Heinz, but it is still produces some of the most iconic packaged foods in the grocery store and its stock has an enviable track record. Highlighting the company's success is its streak of 34 consecutive annual dividend increases, with an annualized dividend growth rate of nearly 10% over the past decade. That sounds like the kind of stock a dividend investor could easily fall in love with.

Unfortunately for potential new investors, that's exactly what's happened. Here's a look at why McCormick is such a great company and why now is not the time to buy it. 

A company that specializes in providing the basics

McCormick calls itself a flavor company, with strong positions in spices and sauces. If you recognize the McCormick name, you likely associate it with spices. Spices are important to the company's top and bottom line, but it is much bigger than that, with a diverse and global portfolio filled with local brands in many of the world's most important markets. In fact, the company estimates that it has a 20% share of the global spices and seasonings category, multiples of its next closest competitor. So not only is it the biggest player, but there's still plenty of room for growth. 

A hand drawing a scale weighing value vs price

Image source: Getty Images

Highlighting that last point is McCormick's purchase of the French's and Red Hot brands in 2017 for around $4.2 billion. That deal expanded the company's brand portfolio, and also allowed it to show off its capabilities. Since being acquired, Red Hot's growth has accelerated, and French's sales have shifted back into the growth column. Being a part of McCormick's global distribution machine has clearly been a huge benefit to these brands. That's the type of acquisition success that an investor likes to see. And it accentuates the norm here, really, with McCormick's top line up around 5% annually over the past decade, and its earnings higher by nearly 9%, on average over the span. Those are impressive numbers in the slow-growth packaged food space. 

The French's and Red Hot deal also highlights another fact about McCormick that's important: financial strength. Following the purchase, the company's financial debt-to-equity ratio spiked to a bit over 0.4 times. That's actually a pretty reasonable number, but exceptionally high for fiscally conservative McCormick. By the end of 2019, that ratio had fallen to roughly 0.2 times. Although that's still kind of high for the company, it is low on an absolute basis and relative to many of McCormick's packaged food peers. The company covers its interest expenses by a solid six times or so -- again, lower than before the acquisition, but hardly a worrying number. All in all, McCormick used its rock-solid balance sheet to ink what appears to have been a very good acquisition. 

Add all of this to McCormick's long history of returning value to investors via fast-growing cash disbursements and you can see why dividend investors, particularly those focused on dividend growth, would love the spice maker. But that's the problem -- investors really, really love McCormick. 

Mr. Market has spoken

Benjamin Graham, the famed value investor who helped train Warren Buffett, used a wonderful example to explain how investors should view stock buying and selling. He said that the stock market was like a business partner called Mr. Market who would vacillate between periods of euphoria and depression. When excited, Mr. Market would offer to buy you out for huge premiums, and when moribund he would offer to sell you his stake for pennies on the dollar. Mr. Market's moods very often had little to do with the actual performance of the business. Right now, when it comes to McCormick Mr. Market is particularly ebullient. 

To put some numbers on that, McCormick's price-to-sales, price-to-earnings, and price-to-cash-flow ratios are all above their five-year averages today. The price-to-forward-earnings ratio, which looks at analyst estimates, is also above the longer-term average for that metric. The only valuation number that is below its five-year average is price to book value. All in all, McCormick looks expensive today.

MKC Chart

MKC data by YCharts

That's backed up by the fact that the stock price, even after the COVID-19-related market sell-off, is still fairly close to its all-time highs. In fact, the valuation metrics noted above are actually better than they were just a short while ago! The stock's yield, meanwhile, is hovering near its lowest levels over the past 30 years at roughly 1.7% (for reference, it is also below the yield of the S&P 500 Index). Equally telling, despite a 15% drop from its recent highs, the stock price has declined much further in past market downturns. In the deep 2007 to 2009 recession, for example, McCormick's shares fell nearly 40%. If history is a guide, investors willing to wait could find a much more attractive entry point when a full-blown recession eventually shows up. 

Not time yet

To paraphrase Benjamin Graham, a good company can be a bad investment if you pay too much for it. Although McCormick's price has come down lately, it still looks expensive today. There's no question it is a well-run company -- you don't manage to increase dividends for more than three decades without being well run. But patient, dividend-focused investors should keep this name on the wish list for now. If there's a full-blown recession, Mr. Market might give you an opportunity to buy McCormick on the cheap, but today he's still a bit too excited.

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