McCormick (MKC) delivered Q4 adjusted EPS of $1.54, a 21% increase y/y. Organic sales growth was driven by a good balance of volume and price increase, reflective in our eyes of the strength of McCormick’s portfolio. This led to a 220bps margin expansion, which is respectable in the food sector. We see 2018 guidance as achievable and thus maintain our view of MKC as a core holding in the consumer staples sector. Price target revised up to $117.
Current Price: $104 Price Target: $117 (increased from $107)
Position Size: 2% YTD Performance: +9%
Thesis Intact. Key takeaways from the quarter:
1. 4Q 2017 sales results were up 20%, including a +15% impact from RB Foods and Giotti
a. Consumer segment up 18.3% ex-FX (2.2% volume/mix, 2.3% price)
b. Industrial segment: +23.5% ex-FX (4.9% volume/mix, 1.3% price)
c. Adjusted operating income grew 36%, expanding margins by 220bps (+140bps for the year)
d. Adjusted EPS growth of 21%
e. 4Q 2017 sales growth was balanced between volume & price, a testament to the quality of the company, in a food environment that has been deflationary in the past couple of years
f. Working capital improvement was the main driver for 2017 cash flow level, a good measure of the company’s and management’s strength
2. Initial 2018 guidance in line with its long-term targets
a. Organic sales growth target of +3-4% (in-line with long term objectives of 4-6% including M&A), +1% favorable impact from currency, and 8% impact from RB Foods recent acquisition
b. Integration of RB Foods going well, ahead of schedule
c. Adjusted gross margin to increase 150-200bps, even with low-single digit material cost inflation
d. Operating margins to increase 23-25%, helped by $100M in cost savings
e. Effective tax rate 24% (not all sales are US based, and fiscal year ends in November rather than December implying one month at the old rate), lower than 26-27% they experienced in the past 3-4 years
f. Adjusted EPS $4.80-4.90, growing 13-15%
3. Valuation: updating price target to $117 to reflect strong cash flow generation and sustainable top line growth.
a. MKC offers a current run-rate real cash yield of ~4%: 2% dividend yield + 2% buyback yield.
The Thesis on MKC:
• Industry Leader: McCormick & Company (MKC) is a leading manufacturer of spices and flavorings. MKC has been in business for 120 years and the founding family still has ownership interest
• Growth opportunity: Spice consumption is growing 3 times faster than population growth. With the leading branded and private label position, MKC stands to be the biggest beneficiary of this global trend
• Offense/Defense: MKC supplies spices to major food companies including PepsiCo and YUM! Brands giving it a blend of cyclical and counter-cyclical exposure
• Balance sheet and cash flow strength offer opportunities for continued consolidation through M&A in the sector