McCormick Purchase Worth the Price?

Wide-moat McCormick (MKC) has confirmed its intent to pay $4.2 billion for Reckitt Benckiser’s food brands--Frank’s RedHot sauce, French’s mustard, and Cattlemen’s barbecue sauce--in a deal expected to close by year-end. We think the strategic rationale of the tie-up, the possibility of which we'd written about in April, is clear: It affords McCormick the opportunity to leverage its leading presence in the spices, seasoning, and food flavoring aisle with high-growth, high-margin condiment brands, complementing its 2015 purchase of U.S. barbecue sauce maker Stubb’s. Although this beefs up McCormick's position in the center of the store, which has been plagued by languishing growth prospects in the aggregate, the growth profile these newly acquired brands boast is quite impressive, especially in light of the intensely competitive landscape, with management citing mid-single-digit annual top-line gains each of the past 20 years.

However, McCormick paid a full price--7.2 times estimated fiscal 2017 sales and 19.5 times EBITDA--which we think points to the likelihood that a bidding war emerged for these attractive assets; a slew of packaged food firms were rumored to be interested after RB placed these brands on the block this spring. While this is above the 14-19 times EBITDA we anticipated RB’s food fare would fetch, we recognize that the assets' high 20s operating margins far exceed the mid- to high teens levels that characterize the packaged food landscape (and McCormick), which we think supports an above-average valuation.

We intend to review our discounted cash flow assumptions but don’t foresee a material change to our $96 fair value estimate, with the benefit from the addition of this fast-growing, highly profitable mix offsetting the rich price tag. With the shares trending lower, we believe long-term investors may have an opportunity to build a presence in a high-quality packaged food operator with relatively attractive growth prospects at a discount.

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