Spice Up Your Portfolio

01/07/2009 9:46 am EST

Focus: STOCKS

Josh Peters

Editor, Morningstar DividendInvestor

Josh Peters and analyst Ann Gilpin of Morningstar DividendInvestor, say spice maker McCormick offers tasty valuations and a hearty dividend.

McCormick (NYSE: MKC) controls at least half of the market for spices and seasonings in North America and is more than twice the size of its next-largest branded competitor.

With leading brands such as McCormick, Lawry’s, and Old Bay, the company has sustained solid sales growth and profitability in its category. Over time, the company has introduced new products on top of its trademark brands while maintaining its focus on flavor.

At the end of 2007, about 10% of sales were from products introduced in the past three years, and the bulk of consumer sales came from value-added products, such as grinders and unique ethnic seasonings.

McCormick is able to dominate the spice and seasoning market because of one of the biggest problems facing food companies: Many consumers choose the less expensive private-label offerings. However, McCormick is also the largest producer of private-label spices and seasonings in North America.

This allows it to limit the threat posed by private labels, ensuring that no other company gains enough scale in this segment to significantly affect the pricing of McCormick’s branded offerings. McCormick also dominates in the industrial business and is a leading supplier to the largest multinational packaged food, beverage, and restaurant companies.

To spur sales growth, McCormick has looked to product innovation and acquisitions. It is revitalizing its US spice business with contemporary labels, new flip-top caps, and gravity-fed merchandising systems, which have improved product awareness and sales. McCormick also acquired Thai Kitchen and Simply Asia in 2006, both of which are in the fast-growing Asian packaged food category.

The company recently purchased Lawry’s, its only real remaining competitor in the spice and seasoning aisle. We wouldn’t be surprised to see more acquisitions, especially as Kraft Foods (NYSE: KFT) is rumored to be shopping some of its smaller brands that may interest McCormick, such as A1 steak sauce and Grey Poupon mustard.

A dividend payout ratio of 42% provides solid coverage for cash dividends, especially in the context of resilient earning power. The firm’s leverage is a bit higher than normal after funding the Lawry’s purchase with debt, but a pause in share buybacks will allow cash flow to reduce this additional debt quickly. McCormick’s dividend has risen each year since 1986, posting a 13% compound growth rate since.

Revenue growth typically runs in the mid-single digits, but a combination of modest profit margin expansion (owing to a very strong competitive position) and share buybacks make at least the low end of management’s 9% to 11% annual growth target for per-share earnings and dividends look reasonable.

At a 9% growth rate for McCormick’s dividend, we would anticipate average annual total returns in the 12%–13% range over the long run. (The stock closed under $32 Tuesday, below Morningstar’s fair value estimate of $37—Editor.)

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