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

Good afternoon, everyone. I'd like to welcome McCormick & Company back to our Global Consumer Staples Conference today. With us this afternoon for our virtual fireside chat are Chairman, President and CEO, Lawrence Kurzius; and Executive Vice President and CFO, Mike Smith. Thanks very much to you both for spending some time with us here today. We appreciate it very much.

Thank you, Andrew. It's our pleasure to be here with you.

Outstanding. Perhaps maybe we kick it off with an interesting sort of dynamic, right, that we've been seeing play out across the food industry. At a time when sales have remained elevated, margins are being compressed. Many companies are certainly acknowledging inflation is running higher than sort of previously expected. Pricing plans are being modified, and additional cost pressure is being experienced, such as the impact of labor shortages. Perhaps maybe you both can comment on what McCormick is experiencing, sort of the actions you're currently taking and what you may be expecting in 2022.

Sure, Andrew. Thanks. Let me take that first, and I'll turn it over to Lawrence. As you said, it's definitely a dynamic environment, and we're not unique in experiencing these cost pressures. If you remember in our July earnings call, we raised our 2021 outlook for cost inflation to mid-single digits, and that was from the low single-digit range earlier in the year as a result of these broad-based inflation across commodities, packaging materials and our transportation costs. And from a pricing perspective, just as a reminder, in our Flavor Solutions segment, many of our contracts have automatic price adjusters for these commodities. We operate as a pass-through model. In Consumer, as well as our Flavor Solutions business that is not passed through, we are raising prices to offset these rising costs. And there's usually a time lag associated with pricing due to how quickly these costs are escalating. Most of our actions won't go into effect until late 2021. In the last few months, inflation has continued to ratchet up. We're entering a period that has the highest inflation of the last decade or even 2. But as we experience inflation, we mitigate that cost, for example, through our CCI program. And when we cannot, we have to price to market. And, Andrew, you mentioned margin compression, which is not only caused by any lag between pricing and cost escalation. But as you know, we only price to offset cost increases as well. Our long-term philosophy is to not margin up as we are more focused on the absolute dollar growth in operating profit. Lawrence?

Thanks, Mike. Andrew, also outside of inflation, we've incurred significant COVID-related costs, primarily for co-packing, co-manufacturing to meet the sustained elevated level of demand. And these costs are substantially behind us now that we brought internal capacity online, that we've progressed on replenishing inventories. We've stabilized our manufacturing environment. And we've gotten our use of co-packers down to fairly normal levels. So currently, we, along with our peers and our customers, are experiencing additional pressures in supply chain due to strained transportation capacity, as well as labor shortages and absenteeism from the COVID resurgences, especially in the distribution area. And some of those elevated costs that we've been incurring across our supply chain, labor cost being just one example, really long-lasting enough that we really have to pass them along and recognize they're not going to go away soon. And the disruption from Hurricane Ida has also created additional challenges that further complicates an already complicated environment. So these pressures not only impact our cost, but they also impact sales with the addition of further supply chain complexity, making it harder to get orders shipped to and received by customers. And all of that pressure is against the background of continued elevated demand. And I know on our third quarter earnings call, which is in about 3 weeks, I expect we'll talk about this more during that call. And frankly, looking out to 2022, right now, it's a little too early to speculate about cost pressure. But right now, it looks to be with us for some time. We are prepared to navigate through whatever the environment may be. Throughout our history, we've demonstrated we can manage through inflationary periods through a combination of pricing and cost savings.

Great. Over -- switching gears a little bit, maybe to share performance. Over the past couple of years, one of the main investor concerns was really around McCormick's U.S. market share performance in its key spices and seasonings Consumer segment. McCormick has been through cycles of differing share performance and a couple of years ago was not keeping pace with the core category. That changed in the year or 2 prior to the pandemic when the company was absolutely keeping pace with a very strong category growth. So at the start of the pandemic, McCormick realized significant share gains. Recently, though, you've not been keeping pace with the category. Can you talk about the current pressure, where you stand with trade inventory replenishment and if any of the specific actions that you're taking to again pace with the category maybe are different than those taken to drive share performance a few years ago?

Sure, Andrew. So overall, the scale of the sustained increase in demand and the duration of that increase has really been a challenge, not just for us, but for market leaders in other categories as well. In categories and regions where we've had strong supply on the shelf, we've been maintaining or gaining share. For instance, since the beginning of COVID, our EMEA supply chain is very well positioned to meet elevated demand, and this has contributed to our ability to grow share across that region. The share pressure we're experiencing stems only from where we've had supply constraints, really the U.S. spice and seasonings and the dry recipe mixes have been most notable. And as you know, we've expanded our capacity. We've now restored over 90% of the items which have been suspended to protect capacity for our best-selling items. There is a high correlation between share performance and shelf conditions that result from suspensions and allocations. Products where we've had strong supply and remaining on shelf have performed well. And with the shelf conditions improving, we're seeing sequential improvement in our share performance. So as our U.S. manufacturing situation is much improved, there are still some areas that are stretched by the high demand. And the current issues that I just mentioned related to logistics pressures continue to make it challenging for market leaders like us to keep high-demand products in stock and have slowed our progress in replenishing both retailer and consumer inventories. Our category vision has not been an issue, though, as we progressed through to the pandemic and our ability to keep up with the sustained high level of demand, and we know our share performance is correlated to these supply chain challenges. Flavor still is an advantaged category. Spices and seasonings benefited from the shift to more at-home cooking and consumption. The underlying trends driving our growth have not changed. And in fact, cooking at home, scratch cooking, particularly, and consumers' demand for clean, flavorful leading and trusted brands accelerated during the pandemic. And as we work through the increased demand, as well as the supply chain challenges in this new environment, we're continuing to fuel our growth through strong brand marketing, new product launches and our category management initiatives. We are making brand marketing investments across our portfolio to continue to connect with our consumers. We've got a robust pipeline of new product launches that differentiates our brands and strengthens our relevance with consumers, and we've also continued to advance on our sustainable packaging commitment, for instance, with sachet packaging in the U.K. that's 100% recyclable and in France with a redesign of our Ducros grinder which reduces our carbon footprint. In terms of category management, our initiatives are designed to strengthen our category leadership by driving growth for both McCormick and the retailer. Our category management initiatives, such as spice aisle reinvention that's underway, are even more exciting than our actions before the pandemic. And where our customers are taking our recommendations, they're outperforming the market, and McCormick is driving the category growth. So overall, we know share stabilization will take longer than just the restoration of suspended items due to various factors, such as discontinued items, customer-driven shelf resets and recovering the displaced distribution. We're confident, though, that through the successful execution of these strategies and actions that we're taking to drive growth, we're going to regain share, just as we've demonstrated in the past.

Great. And on your spice aisle reinvention, perhaps you can update us a bit on your progress and maybe provide any initial measurable benefits that you've seen?

Yes. Our initiative to reinvent the in-store experiences for spices and seasonings consumers is a great example of how we're driving our category leadership. So just as a reminder, we're changing the organization of the category based on our deep consumer insights on how consumers shop the spice section, and in many instances, introducing new merchandising elements, including a suite of navigational and inspirational element and transforming what is an often-confusing shelf to 3 shoppable sections. We're also moving faster with our product renovation and innovation, seeing particular success with upsizing key high-usage products that gives consumers a value offering for their beloved favorites. The retail reaction has been really positive, and early results have been strong. We've executed on the initiative across stores in the U.S., and it's driven both category growth for the retailers and for McCormick. We implemented thousands of stores in 2020 despite the pandemic and continue to implement stores in 2021. We're anticipating a cumulative implementation of about 10,000 stores by the end of this year. Now comparing to 2019, just to take some of the year-over-year noise out, the sales through the beginning of August, which is pretty current, indicate that retailers who have adopted the spice aisle changes are growing the category faster than those who have not. And our branded -- McCormick-branded spice and seasoning portfolio is growing a solid mid-single digits faster in the implemented stores versus those that have not made the changes. And this is just the beginning. We have a multiyear plan that extends beyond this initiative. We'll be investing in further initiatives that bring in new benefits to the category centered around freshness, sustainability and consumer pantry organization. Now your question was about the spice aisle program in the U.S. But outside the U.S., I'll just note that we've got initiatives that are driving our spice and seasoning leadership. We're driving strong category consumption and share gains across our EMEA markets with the innovation we're bringing to the category, and we're continuing the global rollout of our first choice bottle into the Eastern European markets. Whether it's consumer-preferred design, reinforcement of fresh flavor, the bottle packaging is really perceived as a premium offering from the sachets that are widely available in that market. And it's elevating the category and driving significant share gains in those markets. So if I could just pull together these comments and the comments from the prior question, we've got strong fundamentals and operating momentum. We're aligned with the long-term consumer trends, and we're successfully executing on our strategies. This foundation, combined with the improvement in shelf conditions and recovering from the supply chain challenges I just mentioned and our initiatives to reframe the spice aisle, bolsters our confidence in continuing on our growth trajectory and driving undisputed leadership in spices and seasonings.

Great. And maybe shifting gears for a moment, 2 of your last 3 acquisitions have been sizable condiment ones, both featuring hot sauce. What can you tell us about your Cholula early performance and any learnings you have since you've owned the brand?

Yes. This is a great brand. Our momentum with Cholula is really strong. In the Consumer segment, we're driving really just impressive results across all of the metrics. Cholula continues to outpace the category growth. It's gaining share in the U.S. We've grown consumption 12% since the beginning of the year, and this is on top of Cholula's strong growth last year. We've also increased Cholula's points of distribution by 13%, and we've grown household penetration by double digits. Our initiatives in brand marketing and leveraging promotional scale in innovation and renovation, which includes the launch of Cholula wing sauces and relaunching 2 of the existing flavors with cleaner formulas, and in category management, such as introducing new bottle sizes and expanding the channel penetration, are all yielding really strong results. And in Flavor Solutions, we've had equally great success driving growth with Cholula and foodservice. Since we acquired Cholula, everything is pretty well aligned with our findings in due diligence, and the integration was really straightforward. We've completed integration in about 90 days, as expected. We've got a proven playbook for hot sauce, which we're rolling out effectively to unlock Cholula's significant growth potential. And if anything, our biggest takeaway over the last few quarters is that we're more enthusiastic and confident about Cholula than before we bought it. And as the #1 Mexican hot sauce in the world, we will deliver on our plans and significantly contribute to accelerating our global condiments platform.

Great. And really the follow-on to that question, how big of a growth opportunity more broadly speaking do you think condiments is and can be for McCormick?

Well, condiments and sauces are our second-biggest consumer category right now, hot sauce, mustard, mayonnaise, ketchup and barbecue sauce comprising the biggest part of that category. We've been intentional on growing our condiments portfolio, both through acquisitions and through organic growth. And with our acquisitions of Frank's RedHot, French's and Cholula, we put ourselves in a leading position. We're the top -- we're the #3 brand globally in condiments -- global condiments category. And since then, our organic consumption growth has been outpacing the other leaders driven by our strong brand marketing investments, new product innovation and category management that we brought to the condiment aisle, and we're winning these categories in foodservice as well. So there is significant top line growth opportunity for McCormick, and they've got a higher margin profile that helps drive greater profit realization. We also believe that we're in advantaged parts of the category within high-growth areas like hot sauce. Hot sauce has a $4.6 billion category globally by itself, and Euromonitor projects it to grow at a 6% CAGR over the next 3 years. And Euromonitor has us as the #1 hot sauce company in the world. We see hot sauces a condiment for the next generation. Over 50% of global consumers choose spicy flavors today. Younger consumers like spicy even more than the previous generations, and most consumers are looking for more flavorful and approachable hot sauce, not just burn. We believe that's what our brands deliver. Our second quarter consumer consumption growth compared to 2019 shows very robust momentum in hot sauce. And in addition to the Cholula metrics I just mentioned, in the U.S., Frank's RedHot grew 33%. That's like 5 or 6 years of growth compressed into 2, and we're experiencing growth through other aspects of Frank's with the recent launches of Frank's and other formats, like frozen, to leverage the Frank's RedHot equity. In the U.K., Frank's RedHot grew 46%, and Frank's and Cholula are the 2 fastest-growing brands in the category in that market. And in Australia, Frank's RedHot consumption grew 52% versus 2019, also outpacing the category significantly by 3 times. And then there's mustard, $1.9 billion global category where we're the #2 in global market share, and it's a very close second, very close between us and the #1 manufacturer. And we're #1 across North America, U.S., Canada and Mexico. Euromonitor projects the category to grow 3% over the next 3 years. We expect to grow faster, and that's an acceleration from 2% pre-pandemic. And we're just creating a whole new era of mustard, bringing news and innovation to mustard. And in the new hybrid work environment, more lunches are going to be consumed at home. And in the U.S. where the #1 food eaten by Americans is sandwiches, believe it or not, we're in pursuit of adding mustard to the billions of sandwiches annually that are missing condiments. So our -- just to wrap it up, our condiment portfolio includes iconic global brands, as well as strong regional leaders. We've grown with purpose in the category organically, as well as with acquisitions of great brands. And we're confident our strategies and initiatives are going to continue to drive growth on this that will contribute to our attractive growth as a company.

Great. If we turn to Flavor Solutions segment now, a little over half of that portfolio relates to at-home consumption with your packaged food and beverage customers, and a little less than half of the portfolio relates to away-from-home consumption with your restaurant and other foodservice customers. Can you give us an update on what you're seeing in terms of the recovery in the away-from-home part of the portfolio, as well as the momentum you're experiencing in the at-home part, including the performance of recent acquisition, FONA, from earlier this year?

I'll start with the last and then go to the -- take it kind of in reverse order. So beginning with FONA. FONA's performance this year has also been great with very robust momentum across that business. We were excited by the second quarter year-to-date growth. We've had double-digit growth compared to last year. and beverages have been a particular strength. And within beverages, the fast-growing performance nutrition category, has continued to drive significant growth for FONA and deepen our penetration in that area. We're also getting growth by expanding and deepening our global footprint. In EMEA, we were able to leverage our existing flavor industry infrastructure from Giotti to expand flavors for a top FONA customer within that region. And in China, we're deepening our footprint as we approach the completion of both the FONA integration. And at the same time, we're bringing on additional flavor encapsulation and liquid flavor capabilities due to our earlier investments in that region. We've had some great new product wins with FONA, and its pipeline potential has hit record highs, which fuels -- which will fuel further growth going forward. And we're also leveraging McCormick's sustainability leadership to create new opportunities with FONA customers. So similar to my comments on our Cholula acquisition, our enthusiasm and confidence in delivering our plans and accelerating growth in global flavors platform only been strengthened in recent months. Now if I look at that Flavor Solutions portfolio, overall, we're very pleased with our -- with the performance of our Flavor Solutions segment. Through the second quarter, on a 2-year basis versus 2019, we delivered 11% constant currency growth, which, of course, includes contributions from both FONA and the foodservice aspects of Cholula, and 5% constant currency growth organically versus 2019. And we expect growth for the balance of the year on top of the second half growth that we had last year. Now from a food-at-home perspective, we continue to see strong growth with our customers package -- our consumer packaged goods customers driven by the strength of their iconic products, core products have done very well, as well as their new products. The innovation pipeline continues to be robust across our customer base, and we're continuing to execute on our portfolio migration with significant strength in our flavors product category. In away from home, that's also been strong. As we lap the impacts that we had in 2020, we are seeing robust recovery from our restaurant and other foodservice customers. Quick service restaurant demand momentum continues to be strong, and our customers have resumed limited time offers and promotional activities. Other restaurant business has been rebounding where pandemic restrictions are lifted and consumers return to dining outside the home. Additionally, those customers are benefiting from the shift to takeaway and delivery that was amplified by the pandemic. And of course, that gives us a knock-on effect on our Consumer segment where our condiments are used on those products. And recovery of foodservice customers, like institutional ones, is pacing slower, but it's coming along as we expected. So we know with resurgences and new variants, there's uncertainty on the continuing impact and duration of the pandemic. Over the last 18 months, we've demonstrated agility to navigate through the demand fluctuations. And this segment, like total McCormick, has a broad portfolio that drives consistency in our performance.

Great. Thinking about supply chain investments for a minute, many food companies, including McCormick, continue to reiterate their belief that a portion of the shift in consumer behavior towards eating at home should remain sticky, even as things settle into the new normal. You've shared that variables, such as an entirely new generation learning to cook or lunch at home being the new eating occasion, have only accelerated what has been a longer-term trend. And there seems to be a wide gulf between what companies are saying and where investor expectations lie. And McCormick is interesting, isn't just really talking about what it believes though. The company is actually investing behind it as well. So can you provide a little perspective on your supply chain performance and the investments that you have underway?

Sure, Andrew. Last year, we discussed the pressure on our U.S. manufacturing operations due to the sustained high level of consumer demand, and we talked about the investments we're making to add the equivalent of another U.S. manufacturing facility. We ended 2020 with significant U.S. manufacturing capacity, enabling us to meet that continued high demand, which averaged twice that of the total food industry, as well as progress towards replenishing those customer and consumer inventories. Our supply chain outside of the Americas, as a reminder, also experienced elevated demand in 2020 and currently. However, it didn't have the same level of manufacturing pressure given the capacity and capabilities we have built outside the U.S. in the past couple of years. Currently, our manufacturing operations are able to meet that continued elevated supply or demand for our product. However, as Lawrence said before, we're having some intermittent challenges, mainly with some packaging and ingredient suppliers, as they are also facing the same elevated demand and logistics pressures that we've mentioned before. Now from a consumer demand perspective, as we've talked about today and as we've talked about in the last 2 years, we do believe that the consumer behavior and sentiment are driving an accelerated and sustained preference for cooking or eating at home, which will continue globally and persist beyond the pandemic. So as you've heard us say also at previous investor events prior to the pandemic, our investments already are underway, both to expand capacity and our capabilities, as well as increase our resiliency. These are tangible proof of that conviction. First, in the Americas, we're increasing our capacity to support the fast-growing hot sauce category Lawrence just talked about and align our are condiment capacity toward higher-margin products by expanding our Frank's RedHot capacity in our Springfield, Missouri plant, adding Frank's RedHot capabilities in our South Bend, Indiana plant and for the first time outside the U.S. and Mexico. We're also optimizing and scaling up our new distribution center in the U.S. next year. And our largest -- it will be our largest distribution center in the world and will accommodate this expected future growth. In EMEA, our new U.K. condiment manufacturing facility will be operational in the first half of 2022, and we are proud that it will be our first net zero carbon building. And in Asia, our recent investments in flavor encapsulation and liquid flavor capabilities have come online in China and will drive more substantial growth in the region. These investments in our global infrastructure will allow us to remain agile and scalable and deliver the growth, in line with our aspirations, and importantly, demonstrate our belief that demand for our products will remain elevated.

Great. And, Mike, regarding capital allocation, in the past year, you've strengthened your balance sheet, reached a record cash flow from operations and made 2 high-quality acquisitions with Cholula and FONA. Have there been any changes to your capital allocation strategy? And can you comment on any near-term potential for M&A activity?

Sure. Andrew, I love a longer-term question, so thank you. We continue to have that disciplined and balanced use of cash, which McCormick has historically demonstrated. Our capital allocation and priorities really have remained unchanged. First, at a high level, we reinvested in the business to drive that long-term sustainable growth through internal capital investments or M&A; second, by returning cash to shareholders in the form of dividends or stock buybacks, and we are proud to be a dividend aristocrat; and finally, by paying down our debt. We continue to use economic value-added approaches on everything we do, and we've increased our focus on profit realization and robust cash generation from our top line growth, increasing the amount of cash we generate and meeting the commitments we have made on paying down our debt. Now in the past 18 months, we have taken advantage of those opportunities to emerge stronger. First, you mentioned there's 2 great strategic acquisitions that we had within the past year, and we're confident they will add to our proven track record of creating value through these acquisitions. And from a financing perspective, issuing the debt at historically low interest rates, we did bolster our liquidity and strengthen our balance sheet. Now as a reminder, acquisitions are a key part of our long-term growth algorithm, but we're also committed to remaining investment grade, and that's shown we can aggressively delever. Now while we're focused on paying down our debt now, we remain open to these acquisition opportunities in either segment to support our global growth strategies. As always, with our disciplined approach, we filter all of our opportunities against these growth strategies to ensure they will fit our vision of being the leading flavor company, to deliver exceptional shareholder value and meet our financial thresholds through the EVA lens I discussed before.

Great. And I think we've got time for sort of one more here. Thinking ahead to 2022, I know you're a few months away from providing guidance. Last year on your earnings call in late September, you provided some comments on organic sales growth expectations for the upcoming year. Following another dynamic year in 2021, I was hoping you could comment on any 2022 expectations at this point?

Sure, Andrew. Last year, we did make a comment in September because there was a big disconnect between our expectation and many of the estimates included in our consensus. That disconnect was specifically with our Consumer segment growth, so we just let the market know we expected to grow both segments in 2021. And so far, we're on track to do just that. The midpoint of our constant currency sales guidance range for this year is 9%, which we updated in July. And that would indicate approximately 5% organic growth, as well as strong contributions from our Cholula and FONA acquisitions. And that's on top of our 5% organic growth in 2020, and I think that's actually pretty impressive. I know there's a lot of focus on 2022. So while we're not providing 2022 guidance, we can make some general comments. First of all, McCormick is a growth company, and we expect to grow next year in both of our segments. We've focused on great categories that are growing and are a long-term tailwind for us. Our growth has continued to outpace our peers and center-of-store growth rates. Global demand for flavor remains at the foundation of our sales growth, and we're capitalizing on long-term trends that, if anything, have only accelerated during the pandemic and the younger generations that are fueling the demand for flavor growth at a greater rate. As for costs, yes, there's a debate on whether inflation is ongoing or transitory. But right now, it looks like cost pressures are going to be with us in 2022. And we're going to manage through them, just as we've done in the past, through a combination of cost savings and pricing actions. It also appears Andrew, that COVID is going to remain with us for a while, so there's going to be continued broad-based supply chain challenges and adjustments that are not going to be unique to us as the world continues to adjust to this new -- in this new environment. We've also got our ongoing ERP program. And as we shared earlier, these investments continued into '22 and '23. And while those could be a cost headwind in '22, we also expect a tailwind from the reduction in COVID expenses related to co-manufacturing that we expected this year, and that's a pretty good offset. So right now, while we're focused on finishing 2021, what remains a volatile environment, I want to just say we should -- I just want to encourage everyone to elevate above the noise in the environment right now. McCormick has grown and compounded that growth successfully over years, regardless of the noise of the moment. We're confident in the growth momentum, and our business is sustainable. And our focus on growth is relentless as we continue to drive McCormick forward and further build value for our shareholders.

Great. Well, I think that's a great place to leave it. I want to thank you, Lawrence and Mike, very much for spending some time with us today. And I'm looking forward to tracking the progress as we go forward and into 2022. Thanks so much again.

Thank you for having us, Andrew.