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Inflation Bites Into McCormick's Q3 Earnings

By Demitri Kalogeropoulos – Oct 3, 2021 at 8:08AM

Key Points

  • Rising costs for the spice and flavorings maker should be temporary.
  • McCormick is still enjoying much higher demand than it saw before the pandemic.
  • The stock looks attractive after having sat out the market rally this year.

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The spice giant reduced profit targets while lifting its sales outlook.

The cook-at-home boom isn't over. McCormick (MKC -0.43%) last week announced surprisingly strong sales growth as consumers continued to prepare more meals at home than they did before the pandemic struck. That demand lift has persisted even as restaurants reopened and people returned to more normal mobility patterns.

Rising costs did pressure earnings for the spice and flavorings giant, leading to a lower short-term earnings outlook. But CEO Lawrence Kurzius and his team said in a press release that the profit hit is likely to be short-term.

Let's dive right in.

A mother and daughter cooking together.

Image source: Getty Images.

Keeping home chefs happy

The big-picture sales trends were strong. Revenue was up 5% after adjusting for currency exchange swings, which marked a slowdown compared to the previous quarter's 8% spike. Yet that increase was slightly higher than expected. It also translated into a much higher sales footprint since the pandemic started. McCormick's revenue is up 17% on a two-year basis.

Management credited its core offerings in the spice department, along with major new acquisitions like Cholula branded hot sauce, for driving industry-beating growth. "Our ... results continue to demonstrate the strength and breadth of McCormick's offering," Kurzius said.

Cost headwinds

The news wasn't as good regarding earnings. Gross profit margin slumped by 2.6 percentage points, mainly because of inflation. That's no surprise, but McCormick also noted a shift toward lower-margin products that investors will want to watch in case it becomes more of a drag on sales and profitability from here.

In the meantime, the company did a good job of offsetting the cost jump by cutting expenses elsewhere. Yet bottom-line profitability still dipped slightly. Adjusted operating income held steady even as sales rose 5%.

Looking ahead

Management reiterated its positive long-term outlook that sees at-home cooking trends staying fundamentally higher than in the pre-pandemic times. Executives noted a "sustained shift to cooking more at home ... and flavorful eating," trends that "have accelerated ... and are expected to persist beyond the pandemic."

In the meantime, the company issued a mostly positive update to its fiscal 2021 outlook. Sales received another upgrade and are now on track to rise by 9% to 10% after adjusting for currency shifts. Inflation is taking a bigger bite out of earnings, though, even though McCormick is planning to roll out more aggressive price hikes.

Operating earnings will rise by 4% to 6%, marking a downgrade from its prior forecast of 8% to 10%. The shift mainly reflects inflation and supply chain challenges. McCormick is also seeing some rare cash flow pressures as it loads up on inventory.

Executives say the financial pinch won't last long as cost pressures fade and rising prices start impacting the bottom line. To support this bright long-term view, they point out that sales and earnings have each grown roughly 20% compared to McCormick's 2019 levels.

Investors might want to look past the short-term challenges and bet on this business returning to its more normal cadence of rising profitability. The fact that this earnings and cash flow spike might not happen until 2022 has convinced Wall Street to keep this stock out of the market's rally this year. But that means a better buy-in price for investors willing to be patient while owning this strong growth business.

Demitri Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool recommends McCormick. The Motley Fool has a disclosure policy.

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