Over the past six months, two of my fellow Fools have described the earnings of spice king McCormick (NYSE:MKC) as being "zesty" and "spicy." And when Wednesday's fiscal 2003 earnings came out, I was busily looking for another synonym to employ, when I happened to glance at the company's recent cash flow statements.
Egads! I am afraid I must invoke the tradition of the Dueling Fools here, and take issue with the upbeat assessments of this company. McCormick is simply too hot.
Granted, McCormick performed admirably in 2003. Revenues increased 11% over 2002. Earnings rose 15%, an achievement due in part to the company's continuing effort to squeeze each penny of expense till it screams, which resulted in gross margins now up to 39.6%.
The company sold off two non-core divisions, its spice-packaging unit and its U.K. brokerage (A brokerage, really?), and replaced them with two better fits: Cajun-spice maker Zatarain's and European condiment-producer Uniqsauces.
McCormick bought back 2% of shares outstanding and increased its dividend by 27% (both shareholder-friendly moves), and made a savvy hedge against an expected shortfall in world vanilla bean supplies by making a large purchase for their reserves.
Stir it all together, and McCormick clearly has developed a prize-winning recipe for business success. The company is growing -- and expects to continue growing -- both sales and earnings at a sustainable rate of roughly 10% per annum.
But whether a company is a quality business does not in and of itself determine its attractiveness as an investment. Valuation matters, too.
And that is where I find McCormick too hot for my delicate investing palate. In 2003, the company produced $114 million in free cash flow. Since free cash flow was depressed this year as a result of the strategic purchase of vanilla beans, though, I double checked the company's results from 2000-2002 as well. Result: over the past four years, the company has generated an average of $117 million in free cash flow per annum.
Compare that number to McCormick's $4.9 billion market capitalization, and you have here a superbly run company valued at an enterprise value to free cash flow ratio of 42. At a little more than twice the EV/FCF ratio of the market at large, that is simply too rich for my taste.
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Rich Smith owns no shares in McCormick. The Motley Fool is investors writing for investors.
