Wide-Moat McCormick Getting Back on Track After Mustering Up a Solid Q1, but Shares Heated

In recent quarters, we’ve opined that the rash of challenges plaguing McCormick MKC would prove transitory (supply chain hiccups and COVID-19 restrictions in China), and first-quarter marks (6% organic sales growth, an 80-basis-point downdraft in adjusted gross margins to 36%, and a 40-basis-point shortfall in adjusted operating margins to 14.5%) give credence to our sentiment. This also struck the right note with the market, with shares up 10% on the print, though our fervor is more tempered; we expect to edge up our $62 fair value estimate by a low-single-digit percentage to account for time value. With shares trading 30% above our intrinsic valuation, implying a lofty low-30s times our fiscal 2023 earnings estimate, we think investors should await a more favorable risk/reward opportunity.

Although recent price hikes (a nearly 11% benefit to top-line growth in the quarter) are offsetting a portion of the inflationary headwinds McCormick continues to battle, much consternation remains on the health of the consumer. But we see McCormick as well positioned to navigate these pressures. Encouragingly, management seems wedded to plowing additional resources behind consumer-valued innovation and marketing support, which we forecast will approximate 5% of sales, or $400 million annually, the next 10 years. From our vantage point, innovation (in both packaging and flavors) should make consumers more amendable to higher prices at the shelf while also serving to quench the hunger for new fare that continues within its packaged food and beverage client cohort (encompassed within its flavor solutions arm, 40% of sales). When taken together, we think this buttresses the brand intangible assets that underpin its wide economic moat.

Despite recent performance and our go-forward outlook, though, we plan to raise our Uncertainty Rating for McCormick to Medium from Low, consistent with our quantitative methodology.