With the sell-off in stocks continuing to close last week, the S&P 500 Index briefly entered into bear market territory.
Talk of recession is increasing as inflation continues to reach high levels. This in combination with fears that the Federal Reserve will be too hawkish in fiscal tightening has investors jittery. This doesn’t even take into account Russia’s ongoing invasion of Ukraine, supply chain issues in multiple sectors and Chinese lockdowns due to Covid-19.
In short, investors have plenty to worry about, which has led to risk assets falling sharply.
That said, investors with long-term horizons should consider buying quality companies at now reduced prices. Personally, I prefer stocks of companies with decades of dividend growth, as these names have provided increased shareholder payments even in times of recessions.
I am also focusing on those names in industries that tend to perform better during economic downturns as their products and services remain in demand.
One name that is becoming more attractive to me is McCormick & Co. Inc. (MKC, Financial).
Company background and results history
McCormick operates in the highly fragmented spice and seasoning industry, with the company estimated to have 20% market share. Proving just how dominate the company is, this is four times the size of the closest competitor. McCormick has a market capitalization of $24 billion and generates annual revenue of more than $6 billion.
McCormick is probably best known for its red cap spice and seasoning containers, but the company is much more than that. The $4.2 billion purchase of Reckitt Benckiser Group’s (RBGPF, Financial) food division in 2017 added condiments such as Frank’s Red Hot and French’s Mustard to the portfolio. This expanded McCormick’s reach in these respective categories.
In 2020, the company then added Cholula for $800 million from a private equity firm. This transaction, combined with the previous addition of Frank’s Red Hot, gave McCormick the two top brands in the hot sauce category. This category is estimated at $5 billion annually, with both product lines growing at a faster rate than the competition.
The moves to augment its core portfolio has paid off for McCormick. Revenue has a compound annual growth rate of 5.2% over the last decade. Since 2017, revenue has improved at a faster rate of 6.9% per year. This directly correlates to the addition of Reckitt Benckiser’s food division.
Adjusted earnings per share growth have run ahead of revenue growth, as the CAGR since 2012 is 8%. The five-year growth rate is 9.4%. Net profit has improved 8.1% and 10.8% over the past 10- and five-year periods of time, respectively. An increase of nearly 300 basis points for the net profit margin is a direct reason why McCormick has enjoyed an acceleration in both profit and adjusted earnings per share gains.
There are very few consumer packaged goods companies showing growth of this magnitude, especially when comparing the medium-term improvement to the long term. McCormick has accomplished this because of its market leadership and its willingness to bet big on acquisitions to further expanded its size and scale.
Recession performance and dividend growth history
McCormick’s leadership position in its industry has given the company a wide moat that has prevented severe declines in business during recessions. In fact, the company has seen its business improve even in downturns.
Listed below are the company’s earnings per share totals before, during and after the Great Recession:
- 2006 adjusted earnings per share: 86 cents
- 2007 adjusted earnings per share: 96 cents (11.6% increase)
- 2008 adjusted earnings per share: $1.07 (11.5% increase)
- 2009 adjusted earnings per share: $1.17 (9.3% increase)
- 2010 adjusted earnings per share: $1.33 (13.7% increase)
- 2011 adjusted earnings per share: $1.40 (5.3% increase)
- 2012 adjusted earnings per share: $1.52 (8.6% increase)
McCormick’s adjusted earnings per share grew nearly 22% from 2007 to 2009 as the company successfully navigated one of the harsher economic periods in recent memory. This feat was accomplished without the aid of buybacks as the share count increased by 8 million shares over this period.
This is just a small sample of the company’s consistency. McCormick hasn’t seen a year-over-year decline for adjusted earnings per share in more than 15 years. Net profit has improved every year for the last decade. Outside of 2019, revenue has increased every year since 2012.
Yearly growth in all metrics has led to strong dividend growth rates. Most recently, McCormick raised its dividend 8.8% for the Jan. 10 payment. This is within the vicinity of the 10-year compound annual growth rate of 9.1%.
The dividend yield is on the low side at 1.6%, but matches the average yield of the S&P 500 Index.
What McCormick lacks in yield, it more than makes up for with consistent dividend growth. The company’s dividend grew 20% during the 2007 to 2009 time frame. The company has increased its dividend for 35 consecutive years, earning McCormick the title of Dividend Aristocrat.
Dividend payout ratios and the impact of debt on future dividend growth
McCormick’s dividend is also well protected from both an earnings and free cash flow perspective.
Shareholders saw $1.36 of dividends per share in 2021. With the company earning $3.05 per share, the payout ratio was 45%. McCormick should distribute $1.48 of dividends per share in 2022, implying an expected payout ratio of 46%. Both payout ratios are very close to the average payout ratio of 44% since 2012.
Followers of the company shouldn’t be surprised at how close the 2021 and 2022 payout ratios are to the average. The last decade has seen the payout ratio range from 41% to 46%.
McCormick has paid out dividends of $371.5 million over the last four quarters while generating free cash flow of $605.3 million, for a payout ratio of 61.%. This is above the average free cash flow payout ratio of 45% since 2018, but still in a safe area.
Turning to debt obligations, McCormick’s interest expense over the last year was $135.9 million. The company’s total debt at the end of the most recent quarter was $5.37 billion, resulting in a weighted average interest rate of 2.5%.
The attached Excel sheet image illustrates where McCormick’s weighted average interested rate would need to reach before dividend payments were not covered by free cash flow.
Source: Author’s calculations.
McCormick’s weighted average interest rate would need to reach above 6.8% before free cash flow failed to cover dividend payments. Admittedly, this is lower than I typically would like to see from an investment, but a solid cushion exists nonethless. Therefore, I don’t believe that debt obligations will impact future dividend growth.
Valuation analysis
McCormick closed Friday at $90.32. Using company guidance for the year, shares trade with a forward price-earnings ratio of 28.2. This is a premium to the 10-year average multiple of slightly more than 24 times earnings. However, this is below the annual average price-earnings ratios for the stock since 2019.
On an intrinsic value basis, shares look to have upside potential.
McCormick has a GF Value of $97.83, giving the stock a price-to-GF Value of 0.92. GuruFocus rates the stock as fairly valued, but reaching the GF Value would result in an 8.3% increase in share price. Add in the dividend and McCormick could provide a nearly 10% total return from current levels.
Final thoughts
McCormick has a commanding market share position in its industry, allowing it to enjoy a breadth of business that competitors cannot replicate. The company has a history of using strategic acquisitions to improve its standing in other areas outside of its core business that end up meaningfully adding to results.
The business model strength has led to more than three decades of dividend growth. Given the reasonable payout ratios, dividend growth is likely to continue even if a recession were to occur.
The market-wide declines have now sent shares of the company lower, providing an opportunistic entry point for investors looking to purchase the stock
A massive market position, long history of raising dividends and a reasonable valuation suggests that McCormick could be a good long-term investment at the current price.
