CAG ConAgra Brands Inc

McCormick & Co. Inc. (MKC) posted results for the third quarter of 2011 with operating earnings of 69 cents a share, surpassing the Zacks Consensus Estimate of 64 cents. The quarterly earnings benefited from higher operating income, as well as cost savings.

Further, new product innovation, distribution gains and increased investment in brand marketing also led to the growth. However, earnings lagged the prior-year quarter's 76 cents.

The prior-year quarter experienced a reversal of $14 million on account of a significant tax accrual, which added 10 cents to earnings per share. Excluding this impact from the year-ago period, earnings per share increased 3 cents in the third quarter of 2011.

For fiscal year 2011, management reaffirmed its earnings per share guidance in the range of $2.74 to $2.79, including the impact of the acquisitions and the joint venture. Sales are expected to grow 6 to 8% in local currency, with the sales impact from favorable currency exchange rates at 2%.

Quarterly Sales Details

Total revenue in the third quarter grew 16% year-over-year to $920.4 million from the year-ago quarter, benefiting from McCormick’s favorable volume, product mix and pricing actions taken to curtail increased raw and packaging material costs. Revenue also exceeded the Zacks Consensus Estimate of $870 million.

Segments and Margins

Consumer business

Segment revenue for the consumer business surged by 15% year-over-year to $522.0 million in the reported quarter, owing to favorable currency exchange rates. Revenue for McCormick‘s segment also increased due to increased pricing, favorable volume and product mix.

Operating income for the segment also increased 5% to $100.5 million largely resulting from higher sales and Comprehensive Continuous Improvement (CCI) cost savings. However, these were partly offset by increased material costs and increased marketing for Zatarain’s brands in the U.S.

Industrial business

Segment revenue for the industrial business rose by 17% year-over-year to $398.4 million in the third quarter of 2011 attributable to increased pricing, favorable volume and product mix.

However, operating income for the McCormick’s segment declined 8% to $28 million mainly from increased material costs, which more than offset the impact of higher sales and CCI cost savings.

During the quarter, McCormick has offset the dollar impact of higher costs with pricing actions and CCI cost savings. However, the net effect of these factors led to a decline in gross margin in the third quarter of 2011 to 39.6% from 42.1% in the third quarter of 2010.

Moreover, McCormick’s pricing actions and cost savings from CCI are expected to offset increased material costs in the remainder of 2011. Although, material costs have increased beyond the initial projection of McCormick, the company currently expects to achieve at least $50 million of cost savings from CCI in 2011, up from the prior projection of at least $45 million.

Capital Structure

McCormick posted cash flows from continuing operations of $85.7 million till the third quarter of 2011, down by $60 million from the prior-year period, largely as a result of increases in inventory. Inventory levels increased due to higher cost of materials, the impact of currency exchange rates, and raw material possession to ensure constant supplies. McCormick remains on track to implement a new inventory management process in order to improve inventory levels.

McCormick's Board also declared a dividend of 28 cents per share for the quarter, which is payable on October 24, 2011 to shareholders of record as on October 10, 2011.

Acquisition

Acquisitions and joint ventures have remained a top priority for McCormick. Recently in September, McCormick consummated its joint venture with Kohinoor Foods Ltd., India to market and sell basmati rice and food products in India.

The venture, which was announced in June 2011, will now be named as Kohinoor Specialty Foods India Private Ltd. McCormick had invested INR 5.2 billion ($113 million) in the deal for an 85% interest in Kohinoor Specialty Foods India Private Ltd.

Recently, McCormick also sealed the deal to acquire Kamis S.A., which is a leader of spices, seasonings and mustard in Poland.

McCormick recorded $1 million of transaction costs in the quarter related to the acquisition of Kamis and the Kohinoor joint venture. Further, the company expects to record total transaction costs of $11 million related to Kamis and Kohinoor, which will lower 2011 earnings per share by 7 cents per share.

Through the end of the third quarter, $4 million of these costs had been recorded, which lowered earnings per share by 2 cents. In addition, $7 million of these costs will be recorded in the fourth quarter based on the September 2011 closing dates of the Kamis and Kohinoor transactions, which will lower earnings per share during this period by 5 cents per share.

Besides, McCormick continued to invest in its brands in the third quarter of 2011, while increasing marketing support by 27% which includes an emphasis on brand value, a U.S. campaign for Hispanic products and advertising for Zatarain's brand.

Though the company has completed multiple acquisitions that have expanded its product portfolio, we believe that such a strategy has inherent risks. Additionally, the competitive nature of McCormick’s market is a matter of concern.

McCormick which competes with ConAgra Foods, Inc. (CAG) and Kraft Foods Inc. (KFT) currently holds a Zacks #3 Rank translating into a short term ‘Neutral’ rating. Over the long term, we provide a Neutral recommendation on the stock.

 
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