June 10, 2011
Written By Chloe Lutts Jensen
“McCormick & Co., Inc. (MKC) has earned the right to be called an ‘annuity’ because it has consistently delivered 10% annual returns—through persistent price appreciation and annual dividend and EPS growth—to its owners over the past decade. This company owns some of the most impenetrable brand names in any market niche. … The brands—the eponymous McCormick, Lawry’s, Old Bay, and Zatarain—are so powerful that McCormick controls 60% of the consumer spice market.
“What McCormick doesn’t control directly with its own brands, it controls indirectly through private label partnerships. The company’s dominance extends beyond the consumer spice rack. Forty percent of the company’s sales are from large consumer-product companies including Kraft (KFT), Pepsico (PEP), General Mills (GIS) and Yum! Brands (YUM).
“The consumer business is the more profitable of the two segments, with operating margins on the consumer side of 19% compared to seven percent on the industrial side. Fortunately, the relationship between the two is symbiotic. McCormick has been able to leverage its corporate relationships to extend its own higher-margin brands. In China, for example, McCormick has been able to use its experience and logistics expertise to help Yum! Brands achieve extraordinary growth and increase market penetration with its own consumer brands.
“Innovation and invention would seem at odds with a product as basic as spices. After all, how much can you innovate with spices? The answer is, apparently, a lot. Nearly 10% of McCormick’s annual sales are derived from new products, such as Grill Mates (a seasoning line for grilling), Grinders (seasoning containers with grinders built in), Slow Cookers (a seasoning line for slow cooker devices like crock pots) and Perfect Pinch Seasoning Blends (a line of 18 blends of herbs and spices). All were introduced in just the past three years.
“McCormick is targeting new growth opportunities in the Latino market. According to the Census, over the past ten years the Hispanic population has surged 43% to 50.5 million in 2010 from 35.3 million in 2000. McCormick recently rolled out a new multimillion-dollar marketing campaign, featuring its El Bravo brand, aimed at Latino customers.
“Acquisitions have been another key growth driver. Twenty percent of 2011 sales are derived from acquisitions made in the past 10 years. Lawry’s, acquired from Unilever (UL) in 2008, was one of McCormick’s more savvy purchases. Lawry’s products are higher-margin than most of McCormick’s product line. What’s more, the actual production lines producing Lawry’s products can produce at lower costs than the bulk of McCormick’s production lines. This suggests that McCormick’s margins have room to expand as management applies Lawry’s production efficiencies to other McCormick lines.
“Higher margins, in turn, should translate to higher earnings and higher dividend payments. Neither has been a problem for McCormick over the years. Both EPS and dividends have grown at a 10% annual rate over the past decade. Even more impressive, free cash—money available to service dividends— has grown at an annual rate of 12%. I attribute McCormick’s exceptional bottom-line growth to management’s focus on operating efficiency and a greater percentage of sales being generated from higher-margin consumer products.
“As dividends and EPS go, so too goes McCormick’s share price. Indeed, the share price has more than doubled over the past decade, which means shares have been appreciating at an eight percent average annual rate. When the average appreciation rate is combined with an average yield of around 2.3%, investors would have realized just over 10% in average annual return over the past decade. … Management reaffirmed fiscal 2011 guidance and expects EPS of $2.80 to $2.85, with sales growing in a range of five to seven percent to around $3.5 billion. While the company hasn’t made any forecasts for 2012, the consensus analyst estimate is for EPS of $3.10.
“McCormick shares are trading at 17.5-times 2011 EPS, compared to the historically normal valuation of 19.3-times earnings. … Based on historical trends, McCormick’s dividend should rise another 100% in the next decade if sales grow at just a four percent annualized rate, which I don’t believe is a problem given McCormick’s success with recent spice innovations, and what I expect to be a successful surge into the fast-growing Latino market. … Buy McCormick below $50 a share.”
Ian Wyatt, High Yield Wealth, 6/6/11