Tuesday, April 9, 2013

McCormick is Still in Fashion

If you share my opinion that the market is getting a little too much in love with food stocks right now, then the recent results from McCormick $MKC will have done little to allay any concerns. While they were perfectly okay, they didn’t offer much upside potential to a stock already trading at a lofty evaluation. On a more positive note, I think there are one or two things in here that read across better for other parts of the food industry.

McCormick reports mixed results

For a while now, I have been of the opinion that McCormick was a good company, but the market was overestimating its performance. For example, in a previous article I pointed out that the underlying growth (i.e. excluding acquisitions) in its consumer segment (which contributes nearly 80% of income) for the previous two quarters was only 4%. In addition, growth in the industrial segment has been noticeably slowing this year. Yet, the stock has soared.

Fast forward to the latest set of results, and the good news is that the consumer segment has seen stronger growth, thanks to a mix of brand marketing support and an increased desire among consumers to dine at home. Meanwhile, the industrial segment has suffered a decline.




The negative growth within industrial was due to a combination of tough previous year’s comparisons as well some regionally specific issues. Oddly enough, European performance was described as ‘robust’, while the Americas saw steady sales to food manufacturers but significant declines in food service sales. Meanwhile the Asia Pacific region saw sales decline, mainly due to the problems that Yum! Brands $YUM is having in China.

Putting these things together, I think it is important to appreciate that there is an element of a zero sum game here. If hard pressed consumers are buying more spices because they want to eat at home, then it is reasonable to expect them dining out less in the kind of quick service restaurants that McCormick sells into. In other words you can’t look at these issues in isolation.

Reading across from McCormick’s industrial sales

Any analysis of the U.S. quick service restaurant sector must begin by looking at McDonald’s $MCD, and I wasn’t particularly impressed by its recent results. Its Chinese sales have been weakening for some time, and its anemic looking U.S. growth was achieved partly due to revamping the Dollar menu and making promotions. Meanwhile, McDonald’s is talking about the Informal Eating Out (IEO) category being flat to negative for 2013.

As for Yum!, it has got back on track in the U.S., but that too is a result of promotions and recovering from having dropped the ball previously while focusing on China. The good news in all of this is that fast food companies like Yum! and McDonald’s are recovering volumes by taking action, and ultimately that will work out positively for McCormick. Indeed, the company is forecasting a stronger second half within industrial as these effects take place. Furthermore, Yum! is surely set to recover from the chicken debacle in China.

As for demand from food manufacturers, McCormick suggested that it was seeing them more inclined to invest for growth (rather than last year’s cost cutting efforts), but that there were fewer major launches planned than in previous years.

Companies like Campbell Soup $CPB have been forced to innovate with flavorings in order to generate category growth or hold market share against private label competition. The essence of the problem (pun intended) is that consumers continue to trade down and shop in discount and dollar stores.

This has caused significant disruption for many food companies' traditional distribution channels. As a consequence, over the last few years, Campbell and others have had to differentiate their offerings via offering new flavorful products, while trying to cut costs elsewhere.The shift in emphasis towards growth is a good thing.

In summary, the difficulties for the fast food companies look set to continue. In addition, there is not let up in pressure for food manufacturers.

Where next for McCormick?

The forecast of 2013 growth of 3-5% was reaffirmed with a stronger second half forecast, thanks to the actions taken by its industrial customers to drive volumes in food service. Meanwhile, the higher margin consumer segment continues to do well and long-term trends (more flavorful food plus demographic changes ) look favorable for growth.

The question boils down whether you really want to pay 20 times current earnings for a stock set to grow earnings in single digits for the next couple of years. Frankly, I’m not, but the market might not agree with me. Food stocks are in certainly the fashion right now but, for how much longer?