When McCormick (MKC 0.23%) reported its fiscal third-quarter results in early October, it highlighted that its sales increased 6% year over year. But there was a caveat. The slow recovery in China was producing what it described as a 1 percentage point headwind. At first, that might not sound like a big deal, but when you step back and think about it, it really is. And the spice company isn't alone when it comes to the impact of the China story.
McCormick's China problem is sizable
At first blush, 1% seems like a tiny number. So why worry about a single percentage point headwind from China?
McCormick basically said that if its China segment had performed as expected, its top line would have grown by 7%. Going from 6% growth to 7% growth would have amounted to roughly 16.7% more actual sales growth. You have to consider the relative impact of that percentage point.
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This was important enough that McCormick actually included mention of it in the very first bullet point of its earnings release. It went on to discuss the China issue eight more times throughout the release, highlighting that the recovery from that country's zero-COVID lockdowns has been much less robust than expected. What's interesting about that, reading between the lines a little bit, is that McCormick likely based its expectations for recovery trends in China on how things had gone in other countries around the world. China clearly didn't follow the normal path.
This is a big issue because China is huge. Although it was recently surpassed by India as the most populous nation on the planet, there are still 1.4 billion people living there. And it remains the second-largest economy, behind the United States. Investors need to watch that market closely, particularly if the companies they own have significant exposure to it.
McCormick isn't alone in its troubles
McCormick is joined in its China troubles by food maker Hormel (HRL 0.14%). In its second-quarter earnings call, Hormel specifically noted that food service sales in the country were improving, but that the real headwind was on the consumer side. A year ago consumers in the giant nation were "pantry loading," which boosted sales. But with pandemic-related restrictions lifted, they haven't returned to buying as quickly as expected to replenish their food stockpiles.
And food isn't the only consumer staples category that's being impacted. Procter & Gamble (PG -0.78%), which makes products like toothpaste and paper towels, has also noted the difficult Chinese market. Notably, Procter & Gamble's organic sales in China were off by 6% versus the year-ago period. That's in contrast to 7% growth in the United States and 15% growth in Europe. Clearly, China is a material outlier.
It's worth highlighting that Hormel and Procter & Gamble have been basically at opposite ends of the performance spectrum lately. Hormel has been struggling to pass rising costs on to consumers, which has left margins weak. Procter & Gamble has been fairly successful in getting customers to pay more for its wares, and its margins now are better than they were when the pandemic hit. In fact, in its latest fiscal quarter, P&G's core margin improved 240 basis points year over year, which is a substantial uptick. The reason to note this is because it shows that even companies that are executing well are having trouble in China right now.
The big takeaway is to watch China
For investors looking at company earnings releases, the first thing to come away with here is that China is likely to be a negative for most companies. So don't be shocked if a stock you own highlights the weakness. In fact, you should probably be looking specifically to see how China is impacting the companies in which you invest. But that's not just a one quarter issue since China's size makes it a very important market both now and in future quarters.
In other words, you'll also want to watch the progress in future quarters from what appears to be a material and lingering weak point for companies today.
