Dividend Aristocrats in Focus Part 42: McCormick - Sure Dividend Sure Dividend

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Dividend Aristocrats in Focus Part 42: McCormick


Updated on February 13th, 2019 by Nate Parsh

In order to become a Dividend Aristocrat, a company must have a strong brand and a dominant industry position.

The Dividend Aristocrats are a group of 57 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.

 

A perfect example of a Dividend Aristocrat with an industry-leading brand, is consumer products company McCormick & Company (MKC). McCormick has paid dividends each year since 1925, and has increased its dividend for 33 years in a row.

Its dividend growth streak is due to its high-quality business. McCormick is the global leader in food spices, seasonings, and flavors. The company controls nearly 20% of this highly fragmented industry.

This has fueled McCormick’s dividend growth for many years. The stock has a 1.8% dividend yield, which is slightly below the average yield of the S&P 500. However, its business model and growth prospects are anything but average. McCormick is an excellent choice for dividend growth.

Business Overview

McCormick was formed in 1889, when founder Willoughby M. McCormick started making flavors and extracts in his cellar, which he then sold door-to-door.

The business grew at a gradual pace. In 1896, McCormick entered spices by issuing its first McCormick’s Cookbook. Over time, the company has steadily built itself into the leading spices and seasonings company in the world.

Today, McCormick sells its products in more than 150 countries and has annual sales of approximately $5.4 billion. It manufactures and distributes a wide range of spices, seasoning mixes, and condiments.

MKC Overview

Source: Investor Presentation

Major brands include McCormick, Lawrys, Stubb’s, Club House, Ducros, Schwartz, Kamis, Kohinoor, Zatarains, Thai Kitchen, and Simply Asia.

McCormick operates in two segments. Its Consumer segment represents approximately 68% of annual sales, while the Flavor Solutions segment contributes approximately 32% of sales.

The business environment for McCormick is very strong. It is benefiting from changing trends. Consumers are cooking more at home, due in part to falling grocery prices.

To do this, consumers are using more spices, seasonings, and flavorings. This has created a favorable fundamental backdrop for McCormick, and as the industry leader, it has taken full advantage.

McCormick’s constant-currency sales were up 11% in 2018. Sales growth was due to a mix of volume growth, acquisitions and pricing increases. Adjusted earnings-per-share grew 17% last year.

Growth Prospects

Going forward, there is plenty of room for continued growth for McCormick, due to growth in the emerging markets, and acquisitions.

First, international growth is a strong catalyst for McCormick, particularly in emerging markets like China.

McCormick’s sales in the Asia/Pacific region, particularly in China, have improved dramatically in recent years thanks to its popular brands like Daqiao and others. This growth is evident primarily in the consumer segment, as sales grew 10.3% last year. Sales in Asia/Pacific were up 8.5% in the fourth quarter, largely due to 10% volume growth in China during the fourth quarter.

Economic growth in the emerging markets is higher than in developed nations. And, China is a huge opportunity for consumer products manufacturers like McCormick. China has a population of 1 billion, high economic growth, and a rapidly-expanding middle class.

Separately, acquisitions are a major part of McCormick’s growth strategy. Recent acquisitions include Frank’s RedHot, French’s, and Cattlemen’s.

MKC Acquisition

Source: Investor Presentation

In 2018, McCormick acquired Frank’s RedHot and French’s as part of a $4.2 billion purchase of RB Foods, the food division of consumer products giant Reckitt Benckiser (RGBLY). This was the largest deal in McCormick’s history, and is already a driver of growth for the company.

RB Foods added 8% to sales growth in 2018, and should continue to contribute to sales growth in the coming years.

For example, Frank’s RedHot is the leading hot sauce brand in the U.S., with double the market share of the next-closest competing brand. Meanwhile, French’s has four times the retail market share as the next closest mustard brand.

The common theme within McCormick’s M&A strategy is that it seeks out top brands that lead their respective categories, that can be easily scaled up.

For 2019, McCormick expects currency-neutral sales growth of 3%-5%. Earnings-per-share are expected in the range of $5.17 to $5.27. At the midpoint, this would represent 5% earnings per share growth. Negative currency translation will be a 2% to 4% headwind this year.

Competitive Advantages & Recession Performance

The two most important competitive advantage for McCormick are its brand strength and global scale.

McCormick is the top brand in the $11 billion global spices and seasonings industry, which is expected to grow at a 5% compound annual rate for the next five years. And, McCormick has market share of 20%, which makes it nearly four times the size of its next-largest competitor.

As a result, this gives McCormick leverage over retailers, and pricing power. These qualities help the company generate consistent profits each year, even when the economy enters recession.

McCormick managed to grow earnings-per-share each year during the last recession. Earnings-per-share during the Great Recession are below:

As you can see, McCormick & Company grew earnings-per-share every year through the Great Recession. Not only that, the company averaged double-digit annual growth each year, which was highly impressive and a very rare accomplishment, even for a Dividend Aristocrat.

Valuation & Expected Returns

At the midpoint of 2019 guidance, McCormick expects adjusted earnings-per-share of $5.22 this year. As a result, the stock trades for at a forward price-to-earnings ratio of 24.7. This is slightly above its 10-year average price-to-earnings ratio of 20.2.

McCormick’s valuation multiple has expanded considerably in recent years, as the company has turned in strong earnings growth. However, our fair value estimate is a price-to-earnings ratio of 21. In this case, we view the stock as overvalued.

If shares of McCormick trade down to our fair value estimate, investors would see annual returns reduced by 3.2% through 2024.

Fortunately, shareholder returns will be derived from expected earnings growth and dividends. McCormick has increased its earnings-per-share by 7% per year, over the past 10 years. It is worth noting that the past decade includes the Great Recession.

If the economy stays out of recession, the company should easily manage at least 8% earnings growth going forward. The company’s strong brand and multiple catalysts for future growth should add up to higher growth as well.

A potential breakdown of expected returns is below:

In all, we feel investors can expect total annual returns of 6.6% through 2024. The high valuation is putting a lid on our expected total return.

McCormick is a high-growth dividend stock. The company has increased its dividend by 9% per year over the past five years. Last November, it increased its dividend by 9.6%.

McCormick has a healthy dividend payout ratio, of 43.7% based on expected 2019 adjusted earnings-per-share. This means McCormick should continue its annual dividend increases for many years to come.

Final Thoughts

McCormick dominates the spices and seasonings category. Its strong brands provide the company with high profit margins and growth opportunities, both in the U.S. and the international markets.

Income investors may be turned off by McCormick’s 1.8% dividend yield. However, McCormick has a very strong dividend growth history.

That being said, the stock is not a screaming bargain right now. It has a premium valuation multiple, but it could be argued that a high-quality company such as McCormick deserves a relatively high stock valuation. Still, the high price-to-earnings ratio makes the stock a hold at the current price, rather than a buy.

That said, we would be buyers of McCormick on a meaningful pullback in the share price, which would result in a lower valuation and a higher dividend yield.

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