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McCormick & Company, Incorporated (MKC)

Established in 1889, McCormick (MCK) manufactures and distributes over 16,000 spices, seasoning mixes, condiments, and other flavorful products to the entire food industry – retail outlets, food manufacturers, and foodservice businesses. Some of the company's leading brands include McCormick, French's, Frank's RedHot, Lawry’s, Club House, Zatarain’s, Thai Kitchen, and Simply Asia.

McCormick has two business segments – consumer (62% of sales, 72% of operating income) and industrial flavor solutions (38% of sales, 28% of operating income).

The consumer business sells spice, herb and regional favorite brands to grocery stores, supercenters, discounters, convenience stores, and e-commerce players. 

The industrial flavor solutions business sells to each of the top 10 global packaged food and beverage companies and nine of the top 10 foodservice and restaurant chains. Its offerings include snack seasonings, sandwich sauces, and branded foodservice products.

By geography, 70% of the company's sales are generated in the Americas, 18% from Europe, the Middle East, and Africa, and 12% from Asia Pacific. Around 19% of sales are in developing markets. In total, the company sells its brands in approximately 150 countries around the world.

Business Analysis

McCormick’s more than 100-year history of success is largely driven by its strong portfolio of brands, continuous product innovation, marketing investments, and gradual expansion into new product categories and geographies with organic growth and acquisitions.

The company’s history dates back to the 19th century, building up over 100 years of customer recognition of its iconic brands and impressive scale. Today, McCormick is four times the size of its next largest global competitor, and the majority of the company’s consumer sales are from brands that have number one market share positions in their categories.

Thanks to its strengths in branding and product innovation, many of McCormick’s customer relationships have been active for decades.

The company’s range of products is one of the broadest in the industry and also covers practically every price point, keeping McCormick relevant regardless of the customer’s needs. Breaking up these relationships to secure shelf space is no small feat for new entrants.

McCormick’s focus on innovation is also remarkable, and many of its products are prepared from confidential formulas developed by its research laboratories and product development teams.

For example, since 2000 McCormick has done a comprehensive annual flavor forecast, in which it brings together top chefs, expert culinary professionals, sensory scientists, dietitians, trend trackers, marketing experts and food technologists to keep abreast of changing consumer preferences in spices and its specialty food products.

This is why McCormick was one of the first packaged food companies to recognize the increasing trend in healthier foods, especially of the organic variety, and as a result over 75% of its premium consumer spices are now organic.
Source: McCormick Investor Presentation
In addition, McCormick operates over 20 global technical innovation centers, where new products and flavors with maximal regional popularity are developed.

Meanwhile, the McCormick Science Institute funds numerous clinical trials at universities around the world to keep abreast of the latest scientific breakthroughs in the realm of nutrition, helping the firm stay ahead of its rivals in recognition of new dietary trends, such as increasing popularity of anti-oxidants and the benefits of a low carb, moderate protein, high fat diet (Paleo and Mediterranean diets) into which it can market its products.

All told, McCormick’s long-term investments into staying at the cutting edge of spice and flavor science allows it to expand its core brands, with new product offerings launched over the past three years representing 9% of sales in 2017.

And in its industrial segment, McCormick custom flavor solutions works closely with major food companies such as PepsiCo (PEP) and McDonald’s (MCD) in order to meet their steadily evolving needs in a world where increasing concerns about obesity and a push for healthier eating means that maintaining top quality taste can be challenging.

In fact, over 60% of product development projects for McCormick's U.S. industrial customers included health and wellness attributes like lowering sodium, artificial ingredients, or calories in 2017. 

While consumers increasingly want healthier, more natural, and simpler food, they still desire appetizing tastes and flavors. As a result, the global flavor market is projected to grow 5% annually in the years ahead, according to Euromonitor. 
McCormick has also continued to spend aggressively on marketing to maintain its top market share in its fastest growing and most profitable brands.

In 2017, advertising spending came in at $276 million, or 6% of revenue, with 53% focused on digital marketing, specifically in order to ensure that McCormick’s products continue to be well received by Millennials. 

While many consumer staples giants have pulled back on advertising spending to cut costs, McCormick's annual marketing investment has increased 39% over the past five years.

To help fund its product innovation and higher marketing budgets, as well as improve margins, McCormick has long relied on its disciplined and well-executed cost cutting efforts. Specifically, the company's Comprehensive & Continuous Improvement (CCI) initiative has taken advantage of McCormick's global supply chain and growing economies of scale to generate cost savings each year. 

Early in 2016, McCormick set a four-year objective to achieve $400 million of cost savings (about 2% of sales) with a total of $226 million delivered in the first two years. In other words, the business is well on track to meet its goal and continue generating above-average industry profitability.
Source: McCormick Investor Presentation
Besides maintaining a strong focus on organic growth and long-term cost cutting, McCormick also grows through acquisitions, including seven deals in the last three years. The company can quickly scale companies it acquires by plugging their new brands and product categories into its extensive distribution network.

With almost an endless number of flavor categories, McCormick can continue building its global growth platforms through acquisitions over the years.
Source: McCormick Investor Presentation
Most recently, McCormick made its largest ever acquisition, paying $4.2 billion to purchase Reckitt Benckiser's Food division, which adds well-known brands such as Frank’s RedHot sauces, French’s mustard and ketchup, and Cattleman’s BBQ sauce to McCormick’s portfolio. 

French's and Frank's RedHot became the company's No. 2 and No. 3 largest brands, respectively, and hold the No. 1 market share positions in hot sauce and mustard in the U.S. and Canada. As a result, McCormick jumped from being the No. 10 largest condiment player to the leader in the U.S. since  

The deal bolstered McCormick's North American branded foodservice business by over 50%, built the company's scale in key categories, and provides opportunity for long-term expansion of these brands into international markets (McCormick hopes to make Frank's RedHot the No. 1 hot sauce globally). 

In total, this latest purchase increased the company’s sales and EBITDA by about 13% and 28%, respectively. Once management completes its projected $50 million in annual synergistic cost savings by 2020, the deal is projected to become 10% accretive to EPS. For now, the integration and synergy goals are progressing as expected.
Source: McCormick Investor Presentation

McCormick's three-pronged strategy of steady organic growth, disciplined and well-executed acquisitions, and ongoing margin expansion is why management believes that the company can achieve its impressive long-term financial goals to create value for shareholders.
This kind of impressive and steady growth (especially for a packaged food company) bodes very well for McCormick’s future dividend growth potential, which isn’t surprising given the company’s strong dedication to payout growth for more than three decades.
Source: McCormick Investor Presentation

Key Risks

There are three main risks that current and potential McCormick investors need to understand.

First, the company’s margin expansion plans could run into headwinds if commodity prices (raw materials) increase or competition from lower-priced private label products and new brands become a real risk.

McCormick has demonstrated excellent pricing power over time, but this has also created a sizable gap in price between its spices and herbs and those sold under private labels.

The company does have its own private label line of products, but it is a small proportion of overall sales. Hopefully the company’s brand recognition and predictable flavor tastes are enough to hold market share against lower-priced options, but it’s worth monitoring volume trends, especially in mature food markets such as North America.

Many packaged food companies, especially those with a large presence in developed markets, have fallen on hard times recently. As consumer tastes and shopping habits evolve, organic, natural, and healthier products are taking more shelf space at virtually every retailer. Consumers are reading more labels and want to know what exactly they are putting in their bodies.

Fortunately, McCormick seems to face less risk than other players in this space because spices and herbs are not generally perceived to be health concerns with consumers. If anything, they are viewed as good ingredients to consume and can even serve as substitutes for sodium.

McCormick has also been investing heavily to combat this risk. Over 70% of its McCormick brand spices, herbs, and extracts in the U.S. are or will soon be non-GMO, for example. About 80% of its premium gourmet lines are organic as well, and the company continuously invests in its own proprietary flavor modulation technologies to meet "low" and "no" challenges without sacrificing flavor.

Another risk to consider is acquisitions. While McCormick has historically been very good at executing on acquisitions, the Reckitt Benckiser deal is by far the company’s largest, and only time will tell if the deal’s hefty 19.6 times 2017 projected Adjusted EBITDA multiple means that McCormick overpaid.

Furthermore, the deal significantly increased McCormick’s leverage ratio (Debt/EBITDA) to 4.9, though management expects this to come down to 3.0 by the end of 2020.

However, management's deleveraging plan is predicated on achieving the firm's targeted synergistic cost savings (which would lower the price paid to a far more reasonable 15.9 times 2017 Adjusted EBITDA), which aren't guaranteed.

While the company digests this big deal and focuses on restoring its balance sheet over the next couple of years, income investors may be in for a slower pace of dividend growth.

Finally, be aware that because the company operates in over 150 countries, McCormick faces a lot of currency risk; a strong dollar can result in sales, earnings, and cash flow growth headwinds.

While currency fluctuations generally zero out over time, short to medium-term swings can result in the company falling short of its growth expectations.

For example, management’s impressive long-term growth guidance figures (9% to 11% EPS and FCF per share growth) are based on constant currency, meaning that in any given year McCormick could fall short, resulting in dividend growth disappointing.

Closing Thoughts on McCormick

Few companies have demonstrated the consistency that McCormick has over the last 100 years. The company’s dividend safety and long-term growth prospects are excellent, and the business should benefit over time from competing in slow-changing, steadily-growing markets. 

While consumer tastes are changing, McCormick's well-managed brands and science-based focus on keeping up with the latest dietary and health trends help ensure that the business stays relevant. 

Investors can’t be faulted for questioning the price McCormick paid for Reckitt Benckiser’s foods business, but management has earned the benefit of doubt with their capital allocation track record. The integration process has gone well so far, and 2018 synergy targets are actually pacing ahead of expectations.

McCormick's relatively low yield may knock it out of consideration for current income-focused portfolios, but the company's double-digit dividend growth potential makes it a solid candidate for investors looking to benefit from decades of steady income growth and healthy total returns.

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