McCormick Earnings: Prudent Productivity and Portfolio Management Initiatives Prop Up Margins

The tide appears to be turning at wide-moat McCormick MKC if second-quarter marks are a guide; the firm chalked up 10% organic sales growth (resulting from 11% higher prices and a 1% drawdown from lower volumes and unfavorable mix) while expanding adjusted gross margin by 310 basis points to 37.1%—a byproduct of efforts to raise prices, extracts costs, and prune lower-margins brands from its operations. This marks a shift for a business that has been struggling at the hand of supply chain disruptions and competitive angst. Although we perceived some of these pressures as transitory, we view its staunch commitment to investing in consumer-valued innovation and marketing as the impetus that should ensure its dominant competitive edge holds longer term. We forecast McCormick will expend around 5% of sales, $400 million annually, on research, development, and marketing to support its brand standing with consumers, retailers, restaurateurs, and packaged-food behemoths.

But beyond the results, McCormick also announced that after seven years at the helm, CEO Lawrence Kurzius will be assuming the role of executive chairman and handing the CEO reins to COO and president Brendan Foley on Sept. 1. Foley (a nine-year veteran of the firm) struck us as the heir apparent, given his grasp of McCormick’s category and geographic footprint. And because Foley has been integral in scripting the firm’s strategic playbook (centered on stringently extracting costs while directing resources toward product innovations and marketing), we don’t expect it will veer from its current course. As such, we’re maintaining our Standard capital allocation rating.

When taken together, we intend to edge up our $63 fair value estimate by $1-$2 per share on account of a slightly higher gross margin outlook and time value. However, we don’t think investors should stock up on the firm’s shares at current levels, which trade at a 45% premium (more than 30 times adjusted earnings) to our intrinsic valuation.