Anyone who thought they'd spice up their portfolio by adding McCormick (MKC -0.63%) to the mix has been left with a bad taste in their mouth. The stock has lost more than a quarter of its value from the highs it hit last April.
Inflation, higher energy costs, rising interest rates, ongoing COVID disruptions in China, and a heavy debt load as a result of acquisitions have taken their toll on this consumer staple stalwart, causing McCormick to reduce its full-year outlook. Should investors have any hope this long-term best-in-class can turn it around in 2023?
With economic indicators all over the place, it's not a clear-cut case for growth, but there is every indication you still won't go wrong by buying the seasonings leader today.
Image source: McCormick.
A confluence of events
Some businesses were affected by inflation to a greater degree than others, and McCormick happened to be among those hit harder than some. Not even a series of price increases the spice company imposed could offset the rapid increase in costs it experienced last year.
Consumers found themselves pinched by higher prices and higher fuel costs, which caused them to tighten their belts, resulting in lower sales volumes for McCormick. It was further constrained by supply chain issues that not only made certain ingredients harder to come by, but also created a shortage of packaging materials that management doesn't see fully easing just yet.
When coupled with exiting a low-margin business in India, pulling out of Russia because of its invasion of Ukraine, and Beijing imposing extreme lockdown conditions in major Chinese cities -- China is McCormick's second biggest market -- the effect was disappointing returns, even if they were still better than pre-pandemic levels. On a three-year constant currency basis, McCormick grew revenue at 7% compounded annual growth compared to 2019.
That's part of the reason investors should be bullish about this food stock's future. While McCormick has been a growth company since its founding in 1889, the COVID pandemic helped change the dynamic of how people viewed their eating routines. Home-cooked meals are still largely more economical than dining out, even as greater mobility and increased travel make out-of-home cooking an essential component of the experience.
The worst is behind it
Now we're seeing inflation moderate, though it is still elevated, similar to the situation with energy costs, and the Federal Reserve is still talking about the potential for a soft landing with the economy.
McCormick intends to fully offset the effect inflation had on its costs over time, and the third round of price increases went into effect in the third quarter. While certain supply chain issues remain, other critical concerns for spices and packaging are resolving themselves or have been fixed, so that McCormick is in a better position to meet consumer demand.
And it's important to note that being in business for 134 years means McCormick has been through numerous economic conditions over that time -- depressions and recessions, world wars, and even pandemics. So it knows how to navigate the current environment. It has already implemented cost-savings programs, cut discretionary spending, and started paying down its debt while still realizing compounded growth, even during the pandemic.
Image source: Getty Images.
Ensuring shareholders share in its success
Also of note is McCormick's ability to continue paying and increasing its dividend. It has made a payment to shareholders every year since 1925 and has hiked the payout for the last 37 years. The dividend currently yields 2% annually.
McCormick hasn't been buying back much of its stock lately. It bought just $26 million worth in the third quarter, and has just under $550 million left on a $600 million share repurchase authorization approved in 2019. But it is committed to paying down its debt.
The spice maker has $3.9 billion in long-term debt and $1.4 billion in short-term borrowings. A portion of this was taken on with its acquisition of Reckitt Benckiser's food business that brought French's mustard, Frank's RedHot sauce, and other brands under its umbrella. Even so, it didn't expect to hit its targeted level of three times net debt to adjusted EBITDA by the end of 2022.
Management maintains that as its profit margins improve, its supply chain costs normalize, and its inventory levels return to equilibrium, it will be better able to reduce its debt load.
Paying up for quality
The stock is still premium priced even after having lost 29% of its value, but that is not unexpected for a quality consumer staple business like McCormick. As the global situation improves, it should be able to resume its traditional record of outperformance, making its current price level a good entry point.
