Spice and condiment company McCormick & Company (MKC -0.38%) recently announced a 5% dividend raise, its 37th consecutive year of giving more money per share to investors. McCormick still dominates the spices aisle at your local grocery store, so if a rising dividend is your top priority, by all means, enjoy the raise.
However, the company's fundamentals show some concerns that could undermine McCormick's total return potential over the next several years. It's OK to be picky -- you should strive to own the best stocks for your portfolio. Here are three reasons why McCormick stock doesn't cut the mustard right now.
1. A blockbuster acquisition -- at a hefty cost
McCormick has long been a leader in spices and seasonings. It made a bold acquisition in 2017, spending $4.2 billion to buy Reckitt Benckiser's food business, which included French's mustard and Frank's Red Hot sauce. These leading brands fit into McCormick's overall business, but the problem is the debt the deal added to McCormick's balance sheet.
You can see below that McCormick's $5.3 billion debt load is roughly unchanged from when the acquisition was made almost six years ago. The company's leverage is 4.6 times its EBITDA, which is higher than investors should want to see. For example, I look for companies levered at less than 3 times EBITDA.
MKC Cash and Short Term Investments (Quarterly) data by YCharts
Management's 5% dividend raise is a vote of confidence in the company's balance sheet, and I would also argue that McCormick remains financially intact. However, the balance sheet has about as much debt as one should feel comfortable with, and will limit the company's financial flexibility until a chunk of that debt's paid down.
2. Cash profits coming up short
A healthy balance sheet would ideally act like a financial safety net, helping the company when times get rough. McCormick hit some rough waters in 2022. Economic hurdles like inflation affected McCormick's business by shrinking margins and cash profits. You can see below that free cash flow is down significantly, pushing the dividend payout ratio higher.
MKC Free Cash Flow data by YCharts
Management discussed price increases to offset some of these headwinds on its third-quarter earnings call, so the dividend could get some breathing room back over the upcoming quarters. Still, this shows just how little cash McCormick has right now, which will only slow the company's efforts to pay down its debt.
3. A lofty valuation it might not deserve
McCormick's core business has proven resilient over the years, so the company should be fine over the long term. But that doesn't mean the stock is a buy today. McCormick carries too much debt and generates too little cash to do anything about it. That could slow earnings growth for a few years. Analysts believe that earnings per share (EPS) will grow by just 5% annually over the next three to five years.
Additionally, the stock carries a price-to-earnings ratio (P/E) of about 29. Can a company justify such a high valuation with mid-single-digit growth? Remember that the S&P 500 trades at a forward P/E of 17 and historically averages 10% returns. McCormick's median P/E over the past decade is 26, and one could argue that a bloated balance sheet warrants an even lower valuation.
Again, McCormick will probably recover over time and continue raising its dividend for years. But if you're trying to find the best places to park your hard-earned cash today, there are probably better places than McCormick stock.
