Looking Under the Covers at McCormick's Gross Margins

The spice maker, McCormick (MKC 0.38%), has a thriving consumer segment selling through grocery chains. But it also has a large flavor-solutions segment that serves restaurants and food manufacturers. These two businesses have different cost structures and margins. The lower-margin consumer segment's growth has outstripped the company's flavor-solutions business as people increasingly ate their meals at home throughout the COVID-19 pandemic. On a Motley Fool Live video episode recorded on July 14, Fool contributors Toby Bordelon and Brian Withers discuss what investors should watch as McCormick deals with changing demand between its business segments.

Brian Withers: But I'm actually surprised looking at the quarter the consumer sales, so sales to like people like you and me in the grocery store grew 30 percent-plus in Q1, and its sales to restaurants only grew in the single-digits. Do you see that mix changing over the course of the year and how might that impact margins?

Toby Bordelon: Yeah. I think it does change. That's probably the big issue with this company right now, is looking at that sales mix.

I remember, we were still really in the pandemic for purposes of this recent report. So people were still eating out at home when running out, and they still are. We're slowly reopening, we're slowly getting back to restaurants. I think that's going to change over the course of the year. I don't know that we're going to get that mix back to pre-pandemic levels right away. It may take another year or more.

It does impact margins, like the costs are higher for that consumer segment, marketing costs especially are a little bit higher there. Your margins do come down a bit, and management talked about it in the earnings call, like if people were asking, what about commodity price increases? How is that impacting you? Management response was, "Yeah, that's an issue where we have pricing power, our bigger issue is this changing mix of consumer versus restaurants, that's the bigger impact on margin." So that is a concern for them and they recognize it.

But bigger picture, the good thing about McCormick, people have to eat regardless of whether you do it at home or in a restaurant, you got to eat. They have both the channels and they can adapt, they have adapted through the pandemic, they can adapt to wherever people are doing their dining through whatever channel and still sell product and they're selling product or selling more of it. So they continue to do well despite the changing circumstances.

Brian Withers: That makes sense that the restaurant segment has higher margins because you think you can deliver, instead of a small little container of spices, you can deliver a big container of spices, and maybe not even to individual grocery stores, you can deliver it to maybe a restaurants distribution center on a pallet. Certainly, the volume is different, bigger and I would think probably even more regular. I imagine this the pandemic really through a kink in the works there.

Toby Bordelon: Yeah. Distribution is easier, marketing is less because it's a more regular purchase like when I go the store to buy some basil, some dried basil. I may be tempted to buy what's ever on sale. I'm not necessarily looking for McCormick. If I'm a restaurant, I probably have a contract, like you deliver every month or however it is to meet this amount, and I'm not going to change that very often. Once you have me, you don't have to show up every couple of weeks and say, "Hey, we're McCormick, you should buy from us," it's already there. [laughs] From a consumer side, you have to do more of that. Your costs are a little bit lower for restaurants, definitely.

Brian Withers: That'll be something for investors to watch over the coming year. Thank you Toby.