The demand for spices and flavorings has never been higher, both with consumers and at restaurant chains. McCormick's (MKC -0.65%) dominant market position is helping it benefit from that positive trend.
But growth has become harder to find, and less predictable, in this phase of the pandemic. And McCormick is struggling to raise prices quickly enough to offset soaring costs.
These factors helped convince the management team to dramatically reduce its 2022 earnings outlook, even as it projected continued strong sales growth ahead.
Sales updates
Sales trends were a slight disappointment. Rather than rising about 6% as expected, McCormick's sales fell 1% overall. That decline reflected uneven results across its two main sales categories. While the restaurant supply segment expanded by 10%, the consumer division shrank by nearly the same amount.
Higher demand is lifting sales at cafeterias and restaurants. However, McCormick's core retailing unit is being hurt by lower stock-up demand compared to a year ago.
Management tried to cut through the noise from that pandemic-related volatility by noting that sales are up 6% on a compound annual basis since 2019, reflecting a 4% increase in the consumer segment and an 8% spike in its restaurant unit. "We continue to capitalize on the long-term consumer trends that accelerated during the pandemic," CEO Lawrence Kurzius said in a press release.
Earnings pressures
The short-term earnings picture worsened significantly. McCormick posted a 5.5 percentage point drop in gross profit margin, which management blamed mainly on cost increases that ran well ahead of expectations.
Cost cuts in other areas of the business weren't enough to protect profitability, either. Adjusted pre-tax income landed at $173 million, down 33% compared to last year's $258 million. This slump was driven partly by rising costs, but also by supply chain bottlenecks, pandemic lockdowns in China, and the war in Ukraine.
MKC Operating Margin (TTM) data by YCharts
Price hikes across the portfolio only partly offset these factors. It might take more than a few quarters before McCormick is back to what shareholders might consider a more normal profit margin.
Looking to 2023
Kurzius and his team still expect to grow sales at a solid clip this year. Revenue is expected rise between 5% and 7% after adjusting for currency swings, which constitutes a slight upgrade to that core growth metric.
Yet, the faster growth will likely be powered by rising prices rather than increased sales volumes. The company typically prefers to target a balance of both key growth metrics. McCormick is also telling investors to brace for significantly lower profitability this year as adjusted earnings rise by between just 1% and 3%.
Over the longer term, McCormick aims for that profit increase to approach about 8% each year. Combined with a steadily rising dividend payment, shareholders hope to see roughly 10% annual returns from holding the stock.
It's clear that cost and supply chain issues will knock McCormick from that return path in 2022. It might take a few more quarters of results before it's clear whether the spice and flavorings giant will bounce right back in fiscal 2023.
