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McCormick & Company (NYSE:MKC) is scheduled to report its third fiscal quarter earnings in the pre-market session on Tuesday. Here’s what investors need to know.
McCormick Stock Key Metrics
Through the first half of fiscal 2023, MKC has grown sales by 5.4% to +$3.2B, driven primarily by pricing actions taken in response to the inflationary cost environment. These actions have been enough to preserve gross margins in the mid-30% range.
MKC Q2FY23 Form 10-Q – Summary Of Current Year Operating Performance
Operating cash flows are just under +$400M through the first half of the year, aided in a large part by a more favorable working capital position as it relates to inventory balances. The strength in cash generation is offset to a degree by their rising interest burden on their floating rate exposure.
MKC Q2FY23 Form 10-Q – Partial Summary Of Cash Flow Statement
Over the past two years, results have been mixed, with a better track record on EPS as opposed to revenues. In the most recent quarter, MKC beat by $0.03/share on EPS and came in-line on revenues.
Seeking Alpha – Earnings History Of MKC
MKC Guidance and Estimates
MKC projects full-year sales growth to be 6% at the midpoint. This would be down from the 8% YOY growth achieved in the second quarter, or 10% in constant currency terms. The modest outlook is despite the upcoming holiday season, which historically translates to a stronger second half performance.
While the sales outlook was reaffirmed, forecasts for adjusted operating income and EPS were both revised upwards. Adjusted operating income is now seen growing 10% to 12% compared to the previous forecast of 9% to 11% growth.
The favorable target is a product of several factors, the first of which is savings from MKC’s global operating effectiveness (“GOE”) program. This program, which includes supply chain optimization among other objectives, is expected to provide a 800 basis point (“bps”) favorable impact.
A more accommodative comparable environment relating to COVID-related disruptions in China is expected to provide another 300bps tailwind. While positive, incentive compensation is expected to result in an 800bps offset, effectively negating the benefits achieved in the GOE program.
The expected 200bps improvement in adjusted operating income contributed to a bump in overall full-year adjusted EPS to a midpoint of $2.625/share, up from a prior midpoint of $2.585/share. This new range reflects a YOY increase of 3-5%.
What To Watch In McCormick’s Q3 Earnings
Flavor Solutions: In Q2, the segment logged its ninth consecutive quarter of double-digit sales growth, at 11.4% and 12.7% in constant currency terms. The growth was broad-based, with strength reported in all three operating regions. Granted, the strength was largely driven by pricing actions and a more favorable comparable environment in the case of MKC’s Asia/Pacific region. But the continuing sales momentum is positive heading into the back half of the year.
Headwinds in volume led to some concerns regarding customer destocking, but I don’t expect this to materially impact sales in this unit. In Q3, I expect a 10th consecutive quarter of double-digit sales growth, with outperformance in the Americas region, led by a strong summer barbeque season.
Volume Performance: MKC’s sales gains thus far have been driven primarily by pricing actions. In Q2, constant currency sales grew 10%, with an 11% contribution from pricing and a 1% decline in volume and product mix.
With previous pricing actions in place, the attention will likely increasingly turn to volume improvement. While further improvement is necessary in their Flavor segment, the sequential improvement from Q1 to Q2 in the Consumer segment was promising.
Seasonings growth related to new products within flavors also bodes well for the second half of the year, though the strength here may continue to be offset by the past pruning of low margin products.
Though MKC hasn’t been impacted as heavily by consumer trade down, I do expect volume to remain a headwind when Q3 results are released due to a softer outlook in the Asia-Pacific region, specifically in China.
Asia/Pacific Region: MKC’s business in China is on a continuing path to recovery. But the sales trend remains below expectations due to regional economic pressures, which are straining consumer spending and hindering the pace of reopening. The overall region’s strength also has been a product of a more favorable comparable environment to last year, where sales were negatively impacted by restrictions surrounding COVID-19 resurgences in China.
In other markets outside of China, the Asia/Pacific region is on solid footing, with strength in branded spices and seasonings. Heading into earnings, I expect continued weakness in China with a modest offset from the other operating markets.
Is MKC Stock A Buy, Sell, Or Hold?
I view MKC as a hold ahead of the company’s Q3 earnings release. While the outlook was raised last quarter, much of the revision was because of the more favorable comparable environment in China. For example, the lapping of the impact of the COVID-related disruptions in China are contributing to a 3% impact in adjusted operating income. This accounts for nearly all the guidance revisions. Sure, the management team pointed to savings from their GOE program. But the benefits here are expected to be fully offset by the build back of incentive competition.
Analysts at Bank of America also viewed the revision with little enthusiasm. Their reasoning centered around the conservative adjustment in relation to their performance through the first half of the year. This may suggest that the second half, a period that is historically stronger than the first, could be weaker than expected. Elevated inflation with rising gasoline prices could also negatively impact the holiday baking season and could lead to greater trade down from consumers in terms of flavors and seasonings.
Though the stock is trading at the bottom-end of its 52-week range, I don’t believe shares have enough value potential for new or further initiation. Consensus estimates guide for 12% upside. And Bank of America had gone even further with a $100/share price target. But I don’t believe this is attainable in the current rate environment, especially given MKC’s holdings of floating rate debt. In 2023, for example, interest-related headwinds are expected to be an 8% headwind to EPS. While EPS growth is still expected to be positive, the interest burden is a heavy anchor.
At just under 30x forward earnings, MKC’s trading multiple appears too spicy for the current market environment. A strong beat on Q3 results with a better-than-expected showing in sales volume, however, may warrant reconsideration. For now, at least, I prefer to remain on hold.
