McCormick & Company, Incorporated (MKC) Earnings Call Transcript & Summary

Thank you for joining us, everyone. This is Kasey Jenkins, Vice President of Investor Relations. We are pleased to discuss today McCormick's agreement to acquire the parent company of Cholula Hot Sauce. To accompany this call, we've posted a set of slides at ir.mccormick.com. We'll begin with remarks from Lawrence Kurzius, Chairman, President and CEO; and Mike Smith, Executive Vice President and CFO, followed by a question-and-answer session. During our remarks, we will refer to certain non-GAAP financial measures. These include adjusted EBITDA, adjusted margins, adjusted EPS accretion and our leverage ratio. Please refer to Slide 14 for a more detailed discussion of these non-GAAP financial measures. As a reminder, today's presentation contains projections and other forward-looking statements. Actual results could differ materially from those projected. The company undertakes no obligation to update or revise publicly any forward-looking statement, whether because of new information, future events or other factors. As seen on Slide 2, our forward-looking statements also provide information on risk factors, including the impact of COVID-19 that could affect our financial results. It is now my pleasure to turn the discussion over to Lawrence.

Thank you, Kasey, and thank you, everyone, for joining us. I'm pleased to announce that McCormick is reinforcing our position as a global flavor leader through the acquisition of Cholula. As you know, we are building the McCormick of the future through an overarching focus on growth, and this acquisition accelerates McCormick's condiment growth opportunities with a complementary authentic Mexican flavor hot sauce. Starting on Slide 3. As we continue to capitalize on the growing consumer interest in healthy and flavorful eating, Cholula, a brand known for authentic, bold and spicy flavors, is a strong complement to our portfolio, providing consumers and our foodservice operators with an even more diverse product offering that will only strengthen our growth opportunities. Cholula's calendar 2020 sales are expected to be $96 million with adjusted EBITDA expected to be $32 million. Cholula has an attractive margin profile, which is expected to be accretive to both the Consumer and Flavor Solutions segments in fiscal 2021 and excluding transaction and integration costs. I'm excited to share with you how the acquisition of the iconic Cholula brand fits with our vision of being a leading flavor company, meets our financial thresholds and will drive shareholder value. Now on Slide 4, hot sauce is an attractive high-growth category, and Cholula as a beloved premium brand is outpacing overall category growth in the U.S. and is a leading Mexican hot sauce brand. Cholula's products are proudly made in Mexico using high-quality ingredients and based on a 100-year-old recipe, comprised of a unique blend of fresh peppers and regional spices. The portfolio of 6 distinctive and authentic flavors is manufactured by strategic third-party manufacturing partners and reaches consumers through both retail and foodservice channels. Turning to Slide 5. We expect to continue to deliver differentiated results through the effective execution of our strategies. As we execute our strategy to accelerate our global condiments platform, the acquisition of Cholula is a meaningful addition to our portfolio and creates further growth opportunities. Cholula is highly complementary to our existing hot sauce portfolio and will broaden our flavor offerings to consumers and foodservice operators. Cholula builds on McCormick's strong condiment portfolio with significant brand equity and a differentiated traditional Mexican hot sauce taste profile. McCormick has the operational expertise and infrastructure to drive further growth of this iconic brand. Branded foodservice is a fundamental growth opportunity for Cholula, which McCormick is well positioned to capitalize on. We plan to both expand Cholula's distribution in its existing foodservice channels and increase new restaurant penetration. And importantly, we've demonstrated success in integrating brands. We expect this to be a straightforward integration, as Cholula has only 6 flavors and less than 40 SKUs produced by 2 third-party manufacturers. Given Cholula's attractive margin profile, we expect immediate accretion in the adjusted margins of both the Consumer and Flavor Solutions segments. As seen on Slide 6, Cholula is distinguished by its iconic wooden caps packaging and by its unique blend of piquin and arbol fresh peppers that bring a great balance between heat and flavor. The brand's value proposition is based on authentic differentiated flavors makes Cholula the leading Mexican hot sauce brand and adds a distinct new taste profile to McCormick. The hot sauce category is fueled by younger, multicultural consumers' growing desire for international and spicy foods as well as healthy and flavorful eating. Cholula and Frank's complement each other, reaching a broader consumer demographic across a variety of dishes and meal occasions. Cholula's passionate fan base with a particular affinity among younger and more diverse populations adds an attractive demographic to McCormick's already devoted consumer base and is incremental to our Frank's loyal consumer base. Cholula's usage over-indexes to Mexican dishes. And Cholula is complementary to Frank's even from a U.S. regional perspective. Frank's is more concentrated in the East and Cholula in the West, which represents an opportunity in other parts of the country. Both Cholula and Frank's are among the fastest-growing brands in the condiment aisle, and the acquisition of Cholula enables us to provide an even more wide-ranging offering across the hot sauce category that addresses complementary cuisine types, consumers and usage occasions. Moving on to Slide 7. We have a proven playbook and unmatched expertise to effectively and efficiently unlock Cholula's significant growth potential. Our operational expertise and infrastructure will allow us to elevate Cholula's brand awareness, increase availability of its products and extend its product offering into new flavors, formats and eating occasions to drive trial and household penetration. With only 4% household penetration today, there is considerable opportunity to welcome new consumers to the Cholula brand in addition to increasing our penetration with Cholula's existing consumers. Using our category management expertise, which we recently brought to the condiment aisle through the Frank's and French's acquisition, we will continue to collaborate with retailers on initiatives to optimize shelf assortment and placement in a fragmented hot sauce category. We also plan to accelerate Cholula's underpenetrated e-commerce business by leveraging the investments we've made in this channel, improving placement on the digital shelf and bundling online promotions with other leading McCormick brands. Our marketing excellence organization with a history of achieving industry-leading ROI will optimize Cholula's brand marketing spend and drive greater speed, agility and effectiveness. We will activate more opportunities to connect with consumers through differentiated investments, particularly capitalizing on our digital leadership. We expect our category management, e-commerce and marketing excellence in addition to our insight-driven innovation capabilities to accelerate momentum, expand distribution and drive growth. We're confident in our capabilities, as this is a very similar playbook to the one we successfully executed with the addition of Frank's and French's to our portfolio in 2017. Next on Slide 8. McCormick's broad presence across all foodservice channels is expected to strengthen Cholula's go-to-market model with tabletops and portion control packets, Cholula has a strong front-of-house presence, which is where approximately 40% of consumers have said they discovered Cholula. There are further growth opportunities in the front of the house and opportunities to grow penetration in the back of the house as well, and we're uniquely positioned to realize this benefit. McCormick's reach across customers, combined with our culinary foundation and deep insights on menu trends, expands the recipe inspiration and flavor solutions that we'll be able to offer operators. We plan to leverage Cholula's authentic Mexican flavor to provide a hot sauce brand that is complementary to Frank's and can be used in different meal types and occasions. For example, in menu offerings, Cholula will be applicable to more Mexican dishes and for Cinco de Mayo promotions, while Frank's is the staple for chicken, especially wings, and will continue to create opportunities for Super Bowl or March Madness promotions. Now turning to Slide 9. Before Mike provides more detail on the financial impact of this transaction to McCormick, I would like to comment on our acquisition strategy and track record. Acquisitions are a key part of our long-term growth strategy, and we have a strong history of success in driving value through acquisitions because of our disciplined approach. We have a process of filtering opportunities against our acquisition pipeline strategy, strengthening our leadership position, expanding our capabilities and categories, and driving scale and globalization as well as evaluating them against financial criteria. Our commitment to this discipline is evidenced in the acquisition of Cholula. It fits within our vision of being a leading flavor company, meets our financial thresholds and, we believe, will deliver shareholder value. Turning to Slide 10. In 2017, we acquired Frank's and French's and have continued to leverage our capabilities to drive growth. We've accelerated Frank's growth every year by increasing brand support, expanding into different categories through new products and extending points of distribution. We're also pleased to have returned the French's mustard brand to growth. In foodservice, we continue to increase restaurant penetration with significant new menu participation, and we're also gaining momentum in both French's and Frank's in many international markets. In addition, we realized the acquisition synergies ahead of pace and generated strong free cash flow to pay down debt. We have fully repaid the $1.5 billion in acquisition term notes and are on track to achieving our leverage objective of 3x net debt to adjusted EBITDA by the end of fiscal 2020. As seen by many of our brands on Slide 11, we have a proven track record of value-enhancing acquisitions, and we expect Cholula will only add to that history. Cholula clearly aligns with our acquisition pipeline strategy and strengthens our position as a global leader of flavor. Based on our financial discipline and rigorous process of identifying and vetting potential targets, we're confident that Cholula will create value for our shareholders similar to past deals. We will continue to pursue acquisitions that are consistent with our pipeline strategy and that will drive further shareholder value. And now it's my pleasure to turn it over to Mike.

Thanks, Lawrence. I will now provide some additional comments on the key financial highlights of the transaction, which you can find on Slide 12. Overall, we are very excited about this asset as it supports our focus on growth and will create long-term shareholder value. McCormick is paying $800 million in cash for Cholula, which represents an approximate multiple of 25x Cholula's estimated 2020 adjusted EBITDA pre-synergies. The transaction includes tax benefits, which will provide future cash tax savings that we estimate at a net present value of approximately $43 million. In addition, we expect to achieve run-rate cost synergies of approximately $10 million, which will be fully realized by fiscal 2022. We're factoring in the tax attributes acquired as part of the transaction and anticipated run-rate cost synergies. The multiple is approximately 18x. We expect sales from the strategic acquisition to be accretive to our long-term organic sales objective as we build upon Cholula's successful track record. Similar to McCormick, Cholula's consumer demand accelerated during the COVID-19 pandemic, with momentum continuing at an elevated level, more than offsetting the negative impact of COVID-19 on foodservice demand. In fiscal 2021, we will be lapping the strong 2020 growth driven by the COVID-19 volatility. Beyond the COVID-19 pandemic, we expect mid- to high single-digit sales growth. This asset also has a very attractive adjusted EBITDA margin profile, which we expect will be accretive to the margins in both of our Consumer and Flavor Solutions segments. We expect transaction and integration costs will dilute McCormick's earnings per share on a split adjusted basis in fiscal 2021. Excluding transaction and integration costs, we expect the transaction to be approximately 2% accretive to our fiscal 2021 adjusted earnings per share. We also anticipate approximately 2% accretion once the synergies are fully realized and excluding ongoing amortization expense. We expect to achieve cost synergies of approximately $10 million, which will be fully realized by fiscal 2022, with anticipated synergy opportunities in distribution, selling and marketing costs as well as general and administrative expenses. We will leverage the proven processes from our Comprehensive Continuous Improvement program, or CCI, to ensure we achieve these cost synergies. We expect to incur approximately $35 million of transaction and integration costs. Upon closing, certain transaction costs will impact earnings per share in the applicable fiscal year. We also expect to incur increased annual amortization expense of approximately $5 million. In terms of our capital structure, we expect near-term financing of the transaction to consist of a combination of cash on hand and commercial paper to be optimized next year as we evaluate our 2021 bond maturity. As Lawrence mentioned, we are on track to achieve our leverage objective of 3x net debt to adjusted EBITDA by the end of fiscal 2020, absent the closing of this transaction. Based on our demonstrated track record of debt pay-down from the Frank's and French's acquisition and our anticipated strong cash flow generation, we're confident that we will deliver on our acquisition plan. We are committed to a strong investment-grade rating to paying down debt and to continuing to grow our dividend as we have for the last 35 consecutive years. We will continue to focus on our ratings target and expect to continue exploring future acquisition opportunities, which are a key part of our long-term growth strategy. The transaction is expected to be completed within this calendar year, as the Hart-Scott-Rodino waiting period has expired. During our January earnings call, we will update you further on the financial impact to fiscal 2021. Finally, we are confident Cholula is a great strategic addition to the McCormick portfolio, which will help us drive faster growth while being accretive to margins as well as generating increased cash and creating additional long-term shareholder value. I'd like to now turn it back to Lawrence for some closing remarks before we move to your questions.

Thank you, Mike. To conclude, I'd like to recap the key takeaways as seen on Slide 13. We have a proven track record of creating value through acquisitions and accelerating performance of acquired brands. We believe this combination with Cholula will reinforce McCormick's position as a global leader in flavor by broadening our portfolio in the attractive, high-growth hot sauce category and thus accelerate our condiment growth. Additionally, it will also generate meaningful margin and earnings accretion. Finally, as we've continued to highlight, we're building the McCormick of the future with an overarching focus on growth. The acquisition of Cholula will continue to support differentiated growth and performance, positioning McCormick for success in 2021 and beyond. And now I'd like to turn to your questions.

[Operator Instructions] Our first question is from the line of Ken Goldman with JPMorgan.

I have 2 questions, if I may. First, you mentioned that the Hart-Scott-Rodino period had expired. I'm not an antitrust expert, but it's certainly a good sign. What does that indicate about where you are in the process with the government? I just want to make sure there's no additional meaningful regulatory or similar hurdles down this path.

Ken, this is Mike. I'll answer that one. And as you, I'm not a lawyer, but we did file early on the basis of a nonbinding offer because we wanted to be in a position to complete this transaction on a timely basis. So the waiting period has expired. And as we said in the script that we're ready to close this calendar year. So really nothing significant in our way at this point.

And then unless I missed it, I didn't hear a comment on how the quarter is going so far. You have less than a week to go, if my timing is right. Is there anything you can tell us along those lines or are willing to today? I know it's not the subject of the call, but sometimes companies volunteer to do that just when they do report major news like this.

No, Ken...

Mike, why don't you take that?

Yes. This is Mike, again. At this point, we wanted to focus on this acquisition. We do -- as you said, we're at the end of the quarter, but it's -- Thanksgiving is a big holiday for us, a lot of things happening. Fourth quarter is our biggest quarter. So we'll, in the January call, report our earnings and our guidance for next year as we traditionally have done. We did say, however, though, depending on when the transaction actually closes, we could have some transaction costs hit in 2020.

The next question comes from the line of Robert Moskow with Crédit Suisse.

Congratulations.

Thanks, Rob.

Cholula is a great brand. Some questions about how you're integrating this. Is -- do they have a sales operation? And will you fold that into your foodservice selling operation? I know that you restructured foodservice selling when you bought RB. I would imagine there's some pretty big synergies there. Is that where the synergies are? And then I have a follow-up.

Mike, do you want to take the synergy question?

Yes, I'll start off and then you can fill in. The synergies we feel similar to RB Foods, where we had $50 million of synergies, which we were able to achieve really. We have about $10 million of synergies here. And they come across the P&L, manufacturing, supply chain, SG&A, things like A&P, which I know previous owner has invested in, and we have a marketing excellence program, so we can get CCI out of that. So we have a pretty good program across all lines of the P&L. As far as structure, maybe, Lawrence, you could take that as to how that will kind of fold into our both Consumer and our Flavor Solutions business.

Yes. We expect through the integration period that we will retain the group, but the management team at Cholula is a group that was brought in specifically by L Catterton to run that business. And so we don't expect that they're going to stay with the business long term. And we largely expect that non-A&P portion of SG&A will not be incremental to our P&L beyond much more than a year. We have normal -- we have a very robust organization in terms of scale, and there are plenty of opportunities for people at Cholula that fit into that organization without incurring incremental cost just to the normal kind of turnover that we experienced in a typical year.

Okay. So maybe I'll...

Much like the acquisition of Lawry's, we would just expect minimal, very low level of incremental SG&A. So there is a good bit of synergy there.

Got it. And also, I noticed that there was no mention of international opportunities for Cholula. I think with RB, you did mention that as one of the selling points of the deal. Can you give us an update on how the RB brands did internationally and whether or not they met your expectations? And is there an opportunity here for Cholula?

Well, if I could speak to both, I'll say that the RB brands have certainly met our expectation for international. We've had some -- we continued to expand Frank's. And I'd say that the pleasant surprise in RB was on French's, where there seems to be more, I'd say, late brand equity internationally than we had anticipated. And so maybe a bit more upside there, more driven by that. But for this particular brand, 95% or maybe even more than that of the sales are in the U.S. There's a little bit of distribution in Canada, surprisingly, virtually nothing in Mexico, even though it's a Mexican style or Mexican-made hot sauce. In our modeling, we did not build in any meaningful international sales. I think that that's one of the potential upsides in our model. I mean what we expect is to drive continued strong growth in retail, building household penetration and capitalizing on a growing interest in hot and spicy foods, especially by younger consumers. In restaurant, there's -- Cholula is a tremendous front-of-house brand, and we expect to continue building that. And they are curiously under penetrated in e-commerce. And of course, this is something we're quite good at. We see that as a third significant growth opportunity.

Rob, we think the model is based primarily on the U.S., as Lawrence said, because we think there's a large amount of opportunity there. But we will use the RB infrastructure we've put in place with that acquisition to help us drive Cholula in our markets, such as Australia, U.K. and Mexico.

The next question is from the line of Alexia Howard with Bernstein.

So can I ask about the top line momentum at Cholula? I mean is this a brand that could be twice the size that it is? I mean what's the magnitude of the distribution gains and revenue opportunity that you see? I'm just -- I mean you've talked about e-commerce and opportunities to move regionally in the U.S. and different channels. But is this something that really could be meaningfully larger than it is today? And how fast is it growing historically?

Well, Cholula has had single-digit growth leading up to the COVID crisis and went through the pandemic as many brands did, including many of ours. They had a strong surge with the -- on the consumer side of the business that accelerated their penetration. And so 2020 is a little bit of an abnormal year if you look at the Nielsen, but we expect to grow in the mid- to high single digits for the Cholula brand and see quite a long runway of growth. I'm not sure how high up is. I mean hot sauce as an entire category is growing in mid-single digits. And Frank's is one of the fastest growers, so is Cholula. I think that there's a large opportunity. I hesitate to quantify just how high up is, but it's a lot bigger than it is today.

But I think we'll follow the same playbook we have with Frank's and French's, and we can go into other categories, platforms that allows us a lot of flexibility. And it's -- Mexican cuisine is on trend with younger consumers and then Hispanic, obviously.

Next question is from the line of Andrew Lazar with Barclays.

My sense is this brand, under the owners prior to L Catterton, it really wasn't much of a core business for them. And obviously, when Catterton purchased this and brought in the management team to run it, there were some, in my assumption, some pretty interesting early learnings, right, on what this brand was sort of capable of. So I'm curious if you have just maybe a couple of those learnings maybe that the current management team kind of saw pretty early on with this business and maybe where they had some of their initial success and to tell us kind of where the opportunity that remains -- which it seems like is sizable, where the opportunity that remains for you to take it to the next level?

Yes. I think that -- so I don't want to get to specific for competitive reasons in part, but certainly, the owner before Catterton, this was really a sidelined, noncore business and a little bit of a hobby. Catterton brought a lot of professionalism to the business, some really brilliant marketing thinking and some rigor around market research and consumer insights that they benefited from and that we will benefit from as well. They did some interesting thing with price-pack architecture that I think we will leverage back into our brands as great case studies. And they did a few interesting things with large restaurant operators that we'll leverage. But I don't want to get to specific more than that.

Understood. It's also not that often you see a brand like this, to your point, that has so few sort of current flavor variants and so few SKUs on the shelf. So it seems like that's where some of the maybe closer-in opportunity could be sort of akin to what you've done with the Frank's brand in terms of package sizes, flavor variants, maybe some different formats and such. But I know you've gone into a little bit about that, but maybe a bit more about what you're able to do -- or what you saw in the Frank's business along those lines that maybe have some similarities to where you can go with Cholula?

Right. So one of the things that we've been able to do with Frank's is extended beyond hot sauce. And so we have actually done Frank's frozen buffalo wings, which just seems like natural. We are -- we have launched, as part of our innovation program, some Frank's frozen appetizers that have done really well. We've leveraged the Frank's flavors into the seasoning category and recipe mix category, which are core categories for us. And we've leveraged Frank's with our Flavor Solutions customers, where we've done some -- even some co-branded products using the Frank's underlying flavor in a way that's really proprietary. The branding really adds value to our Flavor Solutions customers' product. And we can do the same with Cholula. If you just think about authentic Mexican food positioning here in the U.S., there are a lot of opportunities, I think, that extend this brand.

Next question is from the line of Faiza Alwy with Deutsche Bank.

So 2 questions for me. One, on the top line. I guess I'm more interested in the overlap between Frank's and Cholula and how you intend to maybe run those 2 brands. What maybe the niches might be? I know you touched on this a little bit. But I would love to hear more sort of, in your diligence, sort of what were some of the differences you saw. And then secondly, just on margins, how sustainable are the high margins at Cholula? Because I think you mentioned that there's third party manufacturing. And I wonder if there's a plan to bring that in-house over time. But then you also mentioned potentially increased marketing. So I'm curious on how you think about the margin opportunity sort of beyond the initial synergies.

I'll take the first part of that question, and I'll let Mike talk about the margins. But in terms of the consumer overlap between Frank's and Cholula, these 2 brands are highly complementary to each other. The usage occasions and the consumer mindset around consumption are quite different. And the 2 complement each other more than other brands in the category do. And so I think that they'll work together very well. We've got a track record of working with multiple brands in the same category to address different consumer occasions and need states. And I think that we're going to be able to do that. And we'll find that these 2 -- it's possible for us to grow both of these at a high rate in a complementary way. Mike, do you want to take the margin question?

Yes. On the margins, Faiza, I mean, obviously, Frank's and French's was also a very high-margin business, and we got the same questions back then, and we've been able, through our synergies and CCI programs, to keep the margins high. I mean as far as third-party manufacturing, they have strategic suppliers. That's something we would look at. However, it's a low capital model right now, which drives ROIC, obviously. So we have to balance that out and take a look at that over time as we learn more. I just want to make sure you've heard us right on A&P. I mean the previous owner has made significant investments in A&P to raise the brand. We didn't say we're going to increase that necessarily. We said we would probably use our marketing excellence teams to really focus on areas that make better sense for us and drive synergies that way also from our CCI program.

Our next question comes from the line of Adam Samuelson with Goldman Sachs.

I was hoping to just clarify the 2020 performance a little bit. I mean you can see kind of pretty sharp acceleration in the sales data at retail in Nielsen, but just in aggregate, I mean how -- help us understand kind of what the business has actually done this year from both top line and EBITDA perspective?

Yes. Adam, this is Mike. I mean just to put it in perspective, about 2/3 is consumer, about 1/3 foodservice. So obviously, foodservice, just like our foodservice piece of the business, which is 20% globally for us, has been hurt due to this pandemic. But their consumer side has done very well, obviously, as our consumer side has done. We normalized their EBITDA to make sure we took out any plus or minuses from this when we did our modeling, and we were modeling this going forward based on recovery, keeping that mid-single digits to high single digits on both flavor -- excuse me, foodservice and consumer. So I think just as you model, think about it that way.

Okay. All right. That's helpful. And then just on the plans going forward, just -- when I pull up the ACV, it's already fairly high in the high 60s based -- per Nielsen. So is the opportunity less about just doors itself and more just optimizing the footprint on shelf and number of SKUs and the different sizes and flavor SKUs than just more doors.

Well, Adam, I think that some of it's more doors. I mean there is -- there is still -- I mean 60% for a brand like Cholula is still low. And so there's a great opportunity to build distribution. But more than that, it's the household penetration gains and consumption rate that we expect to continue to build as well as innovation beyond the existing product.

Our next question comes from the line of Chris Growe with Stifel.

I just had a question to follow on, on Adam's question there. So do you expect then fiscal '21 sales to grow off of that $96 million base? Just -- I'm not looking for a number, just to understand is there a unique COVID benefit this year? [ I realize you have ] some offset in foodservice. Or is there a kind of adjustment that we need to make to fiscal '21?

I think...