A bit of background: the business was established in 1889, and has brands sold in more than 100 countries around the world. On the quantitative side, the company has some enticing offerings as well: They have achieved double digit EPS growth rate (11% per annum) since the turn of the century, and have increased their dividend for 25 consecutive years. On Thursday morning, the company gave some prepared remarks and spoke with analysts during the Q&A session; here are some of the highlights from the conference call and the press release:
In the third quarter, the Company increased sales 16% to $920 million (up 11% in constant currency). Volume drove 6% of the increase, while higher prices, which were to cover increased raw material and packaging costs, accounted for the remainder.
Gross profit rose 9% to $365 million due to higher sales, but rose at a slower rate than the sales increase due to the net effect of higher costs (the company originally expected 7-8% cost inflation; they now expect it to be in the double digits. and to persist through 2012); as a result, gross profit margin fell 250 basis points to 39.6% from 42.1% in the same period of 2010. CEO Alan Wilson put it best: “To summarize this portion of my remarks, our business is being challenged by a difficult economy, a weaker consumer and escalating material costs.”
As I’ve noted previously in articles, companies are pumping up their advertising spend to differentiate their products from competitors and build brand equity, resulting in less elastic demand. McCormick is no different; in Q3, they increased marketing support by 27% when compared to the year ago period. An example of this is in the United Kingdom: “In the U.K., we are operating in a competitive retail environment where private label share has increased in many categories. We have redirected a portion of our brand marketing support to emphasize to consumers the value of our products, and we have also accelerated the development of several new products, which are differentiated from our competitors in the marketplace. While the U.K. continues to be a challenging market, our actions led to a modest increase in volume and product mix this period.”
Despite the increase in material costs and advertising spend, operating income increased marginally (2%) to $128 million.
The impact of discrete tax items added $5 million to net income in the third quarter of 2011. In comparison, discrete tax items added $16 million to net income in the third quarter of 2010. Of this amount, $14 million related to the reversal of a significant tax accrual for a past tax year (which added $0.10 to earnings per share in Q3 2010).
Excluding this impact from the year ago period, earnings per share in the third quarter of 2011 increased $0.03, from $0.66 to $0.69 per share. Here is management’s explanation on the call for why they think it is appropriate to adjust for $14 million in Q3 2010 but not the $5 million in Q3 2011:
“As you analyze third quarter results, keep in mind that we also had significant discrete tax items in our year-ago results. In the third quarter of 2010, discrete tax items added $16 million to net income. Of this prior year amount, $14 million related to the reversal of a significant tax accrual for a closed tax year. This tax accrual was recorded based on uncertainties about the tax aspects of transactions where the company reorganized its European operations and divested certain joint ventures. This reversal increased earnings per share by $0.10 in the third quarter of 2010 and was treated as a non-GAAP adjustment.”
For the full year, management reaffirmed their sales (6% to 8% increase in local currency, with an additional 2% from favorable foreign exchange) and EPS expectations ($2.74-2.79, essentially flat with the $2.75 earned in 2010). The stock was down more than 3% at the close, at a price of $46.24 per share.
About the author:I'm a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves. As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-10 names; from the perspective of a businessman rather than a market participant / stock trader, I believe this is more than sufficient diversification.
I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over a period of many years.