Buying low-beta stocks isn't usually an exhilarating experience. By definition, they are less volatile in either direction than most of their publicly traded peers, so they likely won't ever deliver high-flying growth. However, they provide stability in spades, and can be the bedrock of your portfolio.
Spice-maker McCormick & Company (MKC 0.23%) is a perfect example of a low-beta stock. However, this usually rock-solid dividend grower has been in a rare tailspin lately. It's now down by more than 30% from its 52-week high.
So, has this stable operator lost its way, or could this discount be a blessing in disguise for new investors? Here's why I'm thinking the latter.
McCormick dominates the spice industry
Down 33% from its 52-week highs, this magnificent S&P 500 dividend stock may be one of the world's most flavorful businesses. Operating in two business segments -- consumer (59% of sales) and flavor solutions (41% of sales) -- McCormick's products go a long way to making our food taste great. And that's despite accounting for only a small portion of a meal's overall cost.
In the company's consumer segment, beyond its ubiquitous namesake brand of individual spices and seasonings, it has leadership positions in its market with these brands:
- French's mustard
- Old Bay, Lawry's, and McCormick seasoning blends
- Frank's RedHot and Cholula hot sauces
- Zatarain's Cajun seasoning blends
- Club House, Kamis, and Ducros spices and seasonings
Generating roughly two-thirds of its consumer sales from spices, seasonings, condiments, and sauces, McCormick controls around 40% of the flavor-enhancing market in the United States.
Meanwhile, its flavor solutions unit also provides culinary research to food manufacturers -- among them, Pepsi, its largest customer in this segment. McCormick helps provide flavors used across the snacking, beverage, beverage, bakery, savory, and even health (vitamins and gummies) products.
Inflation takes a bite
Given its dominance in its niche, why has McCormick's stock dropped? The company's recently reported third-quarter results likely hold the answer. Sales grew by a respectable 6%, but its net profit margin plummeted from 14% in 2022 to 10% this year. As a byproduct of this decline, McCormick's earnings per share (EPS) dropped by 23%, and its stock was punished accordingly.
However, there is a light at the end of the tunnel. Most of the pressure on its profitability was tied to high inflation worldwide. Note McCormick's deteriorating gross profit margin as inflation skyrocketed in 2022.
MKC Gross Profit Margin data by YCharts.
Input costs rose, forcing it to try catching up by raising prices on its contracts with customers like Walmart, Kroger, and Pepsi. While such price increases can take time to impact a company's financials, the chart above shows that McCormick's gross profit margin is finally starting to move in the right direction again. Management expects its fourth-quarter margin to be higher than the 37% it recorded in the third quarter.
Although this is not the quick recovery the company promised at an investor conference in February -- hence the discounted share price -- it shows that McCormick is making progress on the margin front. Over the next few quarters, investors will likely want to see that this margin improvement remains on track.
Why is now the right time to buy McCormick?
McCormick now trades at a price-to-sales (P/S) ratio of just 2.5, its lowest valuation by that metric since 2016. Using a P/S ratio to value a mature and profitable business like McCormick is a bit unusual. Still, I wanted to use sales to highlight its discounted valuation since its earnings are temporarily depressed.
MKC PS Ratio data by YCharts.
For example, if the company were to raise its net profit margin from its current 9.8% back to its 2020 levels of 13%, it would only be trading at 19 times earnings. That would be an enticing discount to the S&P 500's average price-to-earnings (P/E) ratio of 23, especially considering that outside of the last three months, McCormick has historically been an incredibly safe investment.
For investors who are also seeking passive income, this discounted valuation is especially intriguing as the falling stock price has pushed its dividend yield up to 2.5% -- the highest it has been since 2010. And given that it's only using 64% of its net income to fund its dividend despite its earnings decline, look for McCormick to extend its 36-year streak of consecutive dividend increases far into the future.
MKC Dividend Yield data by YCharts.
With the company maintaining a dominant position in a spice industry that is expected to grow by 6% annually through 2030, its stock looks primed to return to its less-volatile state as its profitability rebounds -- and to continue rewarding shareholders along the way.
