Published by Bob Ciura on November 11th, 2017
In order to become a Dividend Aristocrat, a company must have a strong brand and dominant industry position.
The Dividend Aristocrats are a group of 51 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
A perfect example of a Dividend Aristocrat with an industry-leading brand, is consumer products company McCormick & Company (MKC). McCormick has increased its dividend for 31 years in a row.
Its dividend growth streak is due to its high-quality business. McCormick is the global leader in food spices, seasonings, and flavors.
This has fueled McCormick’s dividend growth for many years. The stock has a 2% dividend yield, which is only about average. However, its business model and growth prospects are anything but average.
McCormick is an excellent choice for dividend growth.
Business Overview
McCormick was formed in 1889, when founder Willoughby M. McCormick started making flavors and extracts in his cellar, which he then sold door-to-door.
The business grew at a gradual pace. In 1896, McCormick entered spices by issuing its first McCormick’s Cookbook.
Over time, the company has steadily built itself into the leading spices and seasonings company in the world.
Today, McCormick sells its products in more than 150 countries and had annual sales of approximately $4.4 billion last year.
It manufactures and distributes a wide range of spices, seasoning mixes, and condiments.
Source: Barclays Global Consumer Staples Conference, page 6
Major brands include McCormick, Lawrys, Stubb’s, Club House, Ducros, Schwartz, Kamis, Kohinoor, Zatarains, Thai Kitchen, and Simply Asia.
McCormick operates in two segments:
- Consumer (60% of sales)
- Industrial (40% of sales)
The business environment for McCormick is very strong. It is benefiting from changing trends. Consumers are cooking more at home, due in part to falling grocery prices.
To do this, consumers are using more spices, seasonings, and flavorings. This has created a favorable fundamental backdrop for McCormick, and as the industry leader, it has taken full advantage.
McCormick’s constant-currency sales are up 6% over the first three quarters of 2017. Sales growth was due to a mix of volume growth and pricing increases. Adjusted operating profit is up 13% in that time.
Growth Prospects
Going forward, there is plenty of room for continued growth for McCormick, due to a growth in the emerging markets, and acquisitions.
First, international growth is a strong catalyst for McCormick, particularly in emerging markets like China.
Source: Barclays Global Consumer Staples Conference, page 19
McCormick’s sales in China rose at a 39% compound annual rate over the past five years, thanks to its popular brands like Daqiao and others.
Economic growth in the emerging markets is higher than in developed nations. And, China is a huge opportunity for consumer products manufacturers like McCormick. China has a population of 1 billion, high economic growth, and a rapidly-expanding middle class.
Separately, acquisitions are a major part of McCormick’s growth strategy. Recent acquisitions include Frank’s RedHot, French’s, and Cattlemen’s.
Source: Barclays Global Consumer Staples Conference, page 31
On July 18th, McCormick announced it had acquired Frank’s RedHot and French’s as part of a $4.2 billion purchase of RB Foods, the food division of consumer products giant Reckitt Benckiser (RGBLY). This was the largest deal in McCormick’s history, and will be a major growth driver going forward.
For example, Frank’s RedHot is the leading hot sauce brand in the U.S., with double the market share of the next-closest competing brand. Frank’s RedHot has posted 7.8% compound annual sales growth over the past three years, compared with the category average of 5.5%.
Meanwhile, French’s has four times the retail market share as the next closest mustard brand.
The common theme within McCormick’s M&A strategy is that it seeks out top brands that lead their respective categories, that can be easily scaled up.
For 2017, McCormick expects currency-neutral sales growth of 10%-11%. With margin expansion and share repurchases, adjusted earnings-per-share are expected to increase 11%-12% in 2017.
Competitive Advantages & Recession Performance
The two most important competitive advantage for McCormick are its brand strength and global scale.
McCormick is the top brand in the $11 billion global spices and seasonings industry, which is expected to grow at a 5% compound annual rate for the next five years.
McCormick has market share of 20%, which makes it nearly four times the size of its next-largest competitor.
As a result, this gives McCormick leverage over retailers, and pricing power. These qualities help the company generate consistent profits each year, even when the economy enters recession.
McCormick managed to grow earnings-per-share each year during the last recession. Earnings-per-share during the Great Recession are below:
- 2007 earnings-per-share of $1.92
- 2008 earnings-per-share of $2.14 (11% increase)
- 2009 earnings-per-share of $2.34 (9.3% increase)
- 2010 earnings-per-share of $2.65 (13% increase)
As you can see, McCormick & Company grew earnings-per-share every year through the Great Recession. Not only that, the company averaged double-digit annual growth each year, which was highly impressive.
Valuation & Expected Returns
At the midpoint of 2017 guidance, McCormick expects adjusted earnings-per-share of $4.22 this year. As a result, the stock trades for a price-to-earnings ratio of 22.8. This is slightly above its 10-year average price-to-earnings ratio of 19.1, according to ValueLine.
Source: Value Line
Based on ValueLine data, McCormick has increased its earnings-per-share by 7% per year, over the past 10 years. It is worth noting that the past decade includes the Great Recession.
If the economy stays out of recession, the company should easily manage at least 7% earnings growth going forward. Given the company’s strong brand and multiple catalysts for future growth, 8%-10% annualized earnings growth is not out of the question.
A potential breakdown of expected returns is below:
- 4%-6% revenue growth
- 1% margin expansion
- 1% share repurchases
- 2% dividend yield
Even with a fairly conservative revenue growth projection, McCormick could generate total returns of 8%-10% per year, including dividends. If the company achieves higher revenue growth, total returns would be even greater than the above forecast.
And, McCormick is a high-growth dividend stock. The company has increased its dividend by 9% per year over the past five years. Last year, it increased its dividend by 9.3%.
McCormick has not yet increased its dividend this year, as it typically does so in late November. Investors can look forward to another high-single digit dividend increase for 2017, thanks to the company’s strong growth prospects. McCormick has a healthy dividend payout ratio, of 45% based on expected 2017 adjusted earnings-per-share.
Final Thoughts
McCormick dominates the spices and seasonings category. Its strong brands provide the company with high profit margins and growth opportunities, both in the U.S. and the international markets.
The stock is not a screaming bargain right now, but premium companies rarely are. If anything, McCormick could see its valuation expand to the S&P 500 average, given the high quality of its business.
Income investors may be turned off by McCormick’s 2% dividend yield, which is only about average. However, McCormick is a very strong dividend growth stock.
