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McCormick Pinned At Neutral

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We are reiterating our Neutral recommendation on McCormick & Company, Inc. (MKC - Free Report) following its third quarter results, where earnings of 78 cents per share beat the Zacks Consensus Estimate by 2 cents. The results topped the prior-year quarter’s earnings of 69 cents by 13% on the back of robust sales, favorable operating income and tax rate, offset by lower income from unconsolidated operations.

Total revenue grew 6% year over year to $978 million while it lagged the Zacks Consensus Estimate of $991 million. On a constant currency basis, revenue increased 9%. Half of the increase was credited to the acquisitions completed in 2011 (acquisition of Poland-based Kamis S.A. and Kitchen Basics, a leading brand of liquid stock; and a joint venture with India-based Kohinoor Foods Ltd.). Price increases, in response to high input costs, also contributed to the overall revenue growth.

We are encouraged by the company’s strong brand portfolio that includes McCormick, Lawry’s, Zatarain’s, Thai Kitchen, Simply Asia and Club House in the US; as well as Ducros, Vahine, Schwartz and Kamis in Europe and the Middle East and Africa (EMEA). Moreover, McCormick has been focusing on enhancing its products to remain competitive. New products like Hispanic rice mixes, frozen Simply Asia entrées and a holiday multi-pack of small-size Extracts are expected to be launched in the fourth quarter of 2012 to improve its portfolio of spices. The company expects these new products to contribute 10% to annual sales by 2015.

Also, McCormick is strategically increasing its presence both in the developed as well as emerging markets through acquisitions and joint ventures. In 2011, the company completed the acquisitions of US-based Kitchen Basics, Inc. and Poland-based Kamis S.A. The company also completed the joint venture with India-based Kohinoor Foods Ltd. All the three deals are driving sales growth.

However, McCormick has been suffering from high material costs since the last few years. The increase in price of raw materials such as dairy products, pepper, wheat, onion, capsicums, soybean oil and garlic adversely impact the company’s gross margins.

To combat the above mentioned difficulty, McCormick has undertaken a program, namely, Comprehensive Continuous Improvement (‘CCI’) program to increase its investments, thereby leading to increased sales, operating income and profit. The company expects to generate cost savings of at least $45 million under the CCI program in fiscal 2012.

McCormick experienced a difficult macroeconomic environment in fiscal 2012 and still expects this to continue in 2013. The company remains exposed to unfavorable foreign currency translations as it has a considerable international presence. The company also faces interest rate risk due to fluctuation in these rates. With increased investments in emerging markets, McCormick is exposed to the economic and political risks of these countries.

Currently McCormick holds a Zacks #2 Rank (short term ‘Buy’ rating), just like its peer General Mills, Inc (GIS - Free Report) which also holds a Zacks #2 Rank (short term ‘Buy’ rating).

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