McCormick & Company

Moat: 3/5

Understandability: 1/5

Balance Sheet Health: 3/5

McCormick & Company is a global leader in the flavor industry, manufacturing, marketing, and distributing a variety of spices, seasonings, condiments, and other flavor products.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

McCormick & Company, a global leader in flavor, demonstrates a moderate moat, securing its market position with a blend of brand strength, distribution networks, and consistent quality that have created a loyal customer base. However, this moat is not impenetrable, especially against competitive pricing or private labels, which can weaken its ability to sustain high returns in perpetuity.

Business Overview:

  • Revenues Distribution: MKC operates through two main segments: Consumer and Flavor Solutions. The consumer segment involves the sale of spices, seasonings, and other flavor products directly to consumers, accounting for roughly 68% of 2022 net sales. The Flavor Solutions segment is a diversified set of businesses, selling to food manufacturers and food service companies, accounting for 32% of revenues. This segment includes large customers like Pepsi, Nestle, and McDonald’s.
    • Geographically, the Americas is their largest region, accounting for roughly 60% of revenues in 2022. Asia Pacific accounted for 18%, and EMEA for 21%.
  • Industry Trends: The flavorings industry is competitive and has shown consistent growth, driven by consumer demand for authentic and diverse culinary experiences. As consumers seek healthier and more personalized meal options, it has led to an increased demand for a variety of different spices and seasonings, including organic and natural ingredients. In addition, the food service industry continues to consolidate, creating new customers and new forms of demand. In terms of pricing, it is getting more and more competitive and that could have consequences on margins.
  • Margins: Profitability is mostly maintained by selling premium products under a well-recognized brand and also a large scale in buying raw materials. The company’s gross profit margins have historically been around 40%, though recent inflation in the supply chain has led to pressures and slightly decreased profitability. However, selling products under the McCormick brand helps in holding margins.
  • Competitive Landscape: The industry is competitive with a diverse range of players, ranging from large, established firms to smaller, regional players. Key competitors for MKC include Kerry Group, ADM, and Givaudan, each having different specializations. In the consumer segment, the competition comes primarily from private-label and generic brands.
  • What Makes McCormick Different? McCormick is different because of its focus and experience in the flavor industry, which dates back more than 100 years. It’s the biggest spices brand in the world, and therefore a household name, something that gives its a major advantage. Moreover, it has focused on getting better and more efficient at supply chain, marketing and research and development.

They are also very focused in sustainability by partnering up with farmers and using more recyclable plastic, which should also resonate well with consumers that are more focused on that.

  • Recent concerns:
    • Global supply chain constraints, which have led to increased expenses, are a primary concern.
    • Increased inflation on inputs, leading to higher operating costs, is another challenge.

Management expects a moderate increase in operating expenses for fiscal year 2023. * The company is also seeing increased price competition. The cost of ingredients is also increasing.

Financial Analysis:

  • Revenue: In 2022, net sales increased by around 3.6% driven mainly by price increases, with volume declining slightly. Revenue growth has been a mix of acquisitions and organic growth.
  • Profitability: As mentioned before, margins have decreased slightly because of the inflation in costs. However, management claims that the long-term strategy should improve margins.
  • Cash Flows: Historically, McCormick has been able to generate strong and consistent cash flows. As mentioned, capex is mainly focused on investing for improving efficiency and productivity. Free cash flow has been a good portion of net income, but there is a clear intention from the management to increase this in the coming years by targeting cost savings and improve the supply chain.
    • Net Cash from Operating Activities totaled $894.5 million for FY 2022.
  • Debt: In the short term, the company is taking on more debt to finance acquisitions. Debt has to be kept in check so that it will not impact the business long-term.
    • Total debt amounted to roughly $5.5 billion in November 2022, which is a large portion of total assets.
    • The total debt to book equity ratio is above 1, which could be concerning.

Moat Rating: 3/5

  • Justification:
    • Brand Recognition: McCormick has strong brands with widespread recognition and loyalty, giving it pricing power.
    • Distribution Network: The extensive distribution network gives the company access to wide range of customers that they otherwise would not be able to.
    • Switching Costs: The switching costs are somewhat high for food manufacturers and food service companies, because these companies are usually seeking consistency in their supply chain, and switching providers would involve testing and time investments. However, the switching costs in the consumer segment is low because the customer can buy any brand without friction.
  • Economies of Scale: Because of its size, it has economies of scale, specially in the production process.
  • Competitive Pressures: While McCormick possesses a moat, it is not immune to competitive threats. * Private Labels: Private labels are competing on price. The price competition, combined with lower brand recognition, often puts a ceiling on the premiums that McCormick can charge, which limits the amount of pricing power that the company has.
    • This is especially true in the consumer segment, as people care more about price than they do brands. * Competition in Food Service: Food service companies also are able to push back on price, because they are large customers and they want lower costs from the suppliers.

Risks to the Moat:

  • Shifting Consumer Preferences: Changes in consumer tastes and preferences may affect the company, if they are not able to adapt to these changes quick enough.
  • Raw Materials Price: The price of the raw materials, including spices and other ingredients, is volatile and the cost could severely increase in the future, if the company does not manage to make long term deals at favorable prices.
  • Supply Chain disruptions: The company is dependent on its global supply chains, so disruptions might severely impact the revenue in future.
  • Intense Competition: The global flavor industry is highly competitive and can pose a challenge for MKC, that could result in the loss of market share or pricing power.
  • Private Labels: The competition from private labels and generics are putting a pressure in pricing and thus the margins.

Business Resilience:

  • McCormick has been in the industry for more than 100 years and has shown a good ability to adapt to changing market conditions.

Understandability: 1/5

  • It is extremely easy to understand what MKC does: spices and seasonings business with an integrated business model.

Balance Sheet Health: 3/5

  • Justification: The balance sheet is not as healthy as some other strong companies. While the current assets/liabilities ratio is OK, the increasing debt levels are concerning. A good portion of assets are now made up of intangibles, which might be problematic if the company has to refinance or look for additional funding. But its cash flow remains good, and should be able to pay down debt.
  • Current assets / Current liabilities: 1.27. * Net debt/equity: 1.2 * Debt to EBITDA: 3.3x

Final Notes:

McCormick & Company is the biggest player in the spice and seasonings industry and has a good brand that can help it maintain its earnings and create a moat. However, it is important to be aware that it still has some competition from competitors and a lot of competition from private labels, both of which might affect margins and ROIC. In recent times, it has been facing a lot of headwinds in terms of inflation, that can also affect their profitability and cash flow. Management is focused on improving cost cutting, while maintaining and improving supply chain to lower risks associated with that. Overall, it is a solid business, but with few challenges and therefore has a moderately sustainable moat.