The demand for spices and flavorings has never been higher, both among consumers and restaurant chains. McCormickit is (MKC 1.75%) Dominant position in the market helps it to take advantage of this positive trend.
But growth has become harder to come by, and less predictable, in this phase of the pandemic. And McCormick is struggling to raise prices fast enough to offset the spike in costs.
These factors helped convince the management team to drastically cut its 2022 earnings outlook, even as it expected strong sales growth to continue.
Sales trends were a slight disappointment. Rather than rising about 6% as expected, McCormick’s sales fell 1% overall. This decline reflects uneven results in its two main sales categories. While the restaurant supply segment increased by 10%, the consumer division decreased by approximately the same amount.
Increased demand is pushing up sales in cafeterias and restaurants. However, McCormick’s core retail unit is suffering from lower storage demand compared to a year ago.
Management attempted to dampen the noise of this pandemic-related volatility by noting that sales have increased 6% on a compounded annual basis since 2019, reflecting a 4% increase in the consumer segment and an 8% increase in his catering unit. “We continue to capitalize on long-term consumer trends that have accelerated during the pandemic,” CEO Lawrence Kurzius said in a press release.
The picture for short-term earnings has deteriorated considerably. McCormick reported a 5.5 percentage point decline in gross profit margin, which management attributed primarily to cost increases well above expectations.
Cost reductions in other areas of the business were also not enough to protect profitability. Adjusted pretax profit was $173 million, down 33% from $258 million a year ago. This drop was due in part to rising costs, but also to supply chain bottlenecks, pandemic shutdowns in China and the war in Ukraine.
Price increases across the portfolio only partially offset these factors. It could take more than a few quarters before McCormick returns to what shareholders might consider a more normal profit margin.
Kurzius and his team still expect solid sales growth this year. Revenue is expected to grow between 5% and 7% after adjusting for currency fluctuations, which is a slight improvement on this basic growth measure.
Still, the faster growth will likely be fueled by rising prices rather than increased sales volumes. The company generally prefers to target a balance between the two key growth metrics. McCormick also tells investors to prepare for significantly lower profitability this year, with adjusted earnings rising just 1% to 3%.
Longer term, McCormick is aiming to increase its profits by about 8% each year. Combined with a steadily increasing dividend payout, shareholders expect to see annual returns of around 10% from holding shares.
It’s clear that cost and supply chain issues will knock McCormick off that path back in 2022. It may take a few more quarters of earnings before we know whether the spice and flavors giant will rebound over the course of 2022. the 2023 financial year.