McCormick &, Incorporated Management Discusses Q2 2013 Results – Earnings … – Seeking Alpha

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Alexia Howard with Sanford Bernstein.

Alexia Howard – Sanford C. Bernstein & Co., LLC., Research Division

I’m sure others will ask about the quick service situation, but I’d like to ask about India. You’ve built up your sales in China through acquisitions and organic growth pretty rapidly over the last few years, so I’d like to hear a little bit more about the strategy and the priority level for India. Could you give us a little bit of information about what percentage of sales are currently in India? How important this new restaurant chain customer might be and might there be other opportunities like that? Might we see further acquisitions in India? And just a little sense of the priority level of India versus China at this point.

Alan D. Wilson

Sure. India is much more of a developing market for us than China is. We’ve been in China for more than 20 years. And we’re in China with both our Consumer and our Industrial business, and so we’ve had time to build that out. India, right now, we have mainly a Consumer business, along with a couple of joint ventures that are more ingredient-based. Our strategy is really similar because the Industrial business helps provide the scale for us to continue to grow and expand our Consumer business. Although in this case, we have an established Consumer business that will allow us the scale to start to build out an Industrial business. India is still pretty small percentage of sales, less than 5%. And we are very bullish on the market, although we recognize that it’s going to be a long run, long-term growth strategy for us. Remember, as we stated when we made the Kohinoor acquisition, our strategy there is to evolve to a much more value-added portfolio, and we’ve started to do that by introducing the Rice n Spice mixes and some of the 2-minute meals. So what we want to do is put our value-added products through the distribution channel that we acquired when we bought Kohinoor.

Operator

Our next question comes from the line of Thilo Wrede of Jefferies & Company.

Thilo Wrede – Jefferies & Company, Inc., Research Division

I would have thought that the organic growth rate in the Consumer business in EMEA might accelerate with the — now that you have integrated Kamis and you can roll out the products into new regions. And I think you alluded it to in the slides that Russia is actually a great growth driver for you right now, yet the organic growth rate doesn’t seem to budge too much. Was I too optimistic? Or are there really too many offsetting factors? What’s the outlook there that this can get better?

Alan D. Wilson

No, we have a multitude of markets here, and our business has performed pretty well. It’s off of a very strong growth in the quarter last year, and so we expect that we’ll continue to grow. We’re pretty bullish on our business in Poland. Our business in Russia is continuing to expand. Our business in the U.K. and France are a little more mature, but we’re still seeing volume growth in both those markets.

Thilo Wrede – Jefferies & Company, Inc., Research Division

So the organic growth rate of around 3%, we should expect that for the rest of the year as well?

Gordon M. Stetz

Well, obviously, it’s an environment that continues to feel economic pressure. So it’s an area that we’re actually very pleased with the performance in certain of those markets given the tough conditions that they’re operating and where you see volume declines in other categories, and in fact, our growth is outpacing those other categories. So we’re looking for positive volume growth because they continue to execute well. We’re leaning into those businesses in the back half of the year with new products and part of our advertising increases targeted in Europe. So we’re looking for strong growth, but we haven’t been so far as to give a specific number. But we’re still expecting good growth out of that region.

Thilo Wrede – Jefferies & Company, Inc., Research Division

Okay. And then just one housekeeping question. Does your — does the new guidance include any kind of currency headwind assumptions?

Gordon M. Stetz

It reflects whatever currency rates are — we are at right now.

Thilo Wrede – Jefferies & Company, Inc., Research Division

Then let me ask differently. Does the — is the guidance reduction driven at least partially by currency as well?

Gordon M. Stetz

No. It’s primarily the 2 items we mentioned, which is the impact of the transaction cost from Wuhan and the delayed recovery in the Industrial side of our business.

Operator

Our next question comes from the line of Ken Goldman of JP Morgan.

Kenneth Goldman – JP Morgan Chase & Co, Research Division

And forgive me if you mentioned this, but other than rice, could you update us on some of your more important inputs and maybe what you’re seeing for the next couple of quarters in terms of total COGS Inflation?

Gordon M. Stetz

Yes, Ken, this is a Gordon. We don’t see any news to the update that we provided at the beginning in the year, and that included a 3% adverse impact or increase on material costs during this year, with a lot of that occurring in the front part of the year and then moderating as we progress through the year. That continues to be the same outlook that’s baked into the guidance we’ve just provided you, and that’s also one of the factors we are including as we think about our gross profit margins and how they are improving quarter-to-quarter and stabilizing and recovering as we progress through the year.

Kenneth Goldman – JP Morgan Chase & Co, Research Division

And then second question, we are seeing — we’ve heard companies like Kroger and Safeway, over the years, talk about growing more in terms of natural and organic products. But really, they seem to be kind of putting their money where their mouth is for the first time and accelerating the growth of shelf space for those items right around now, at least especially Kroger. So first, I’m curious if you’re seeing that as well. And second, is there an opportunity for McCormick to benefit from that? Not that people necessarily in spices are looking for more natural and organic than they are in other shelf-stable categories. But I’m just curious how you’re thinking about kind of growing where the growth is, so to speak, in packaged food.

Alan D. Wilson

Sure. And we have had organic spice items for more than 12 years and have continued to update that. In spices, it hasn’t been as big a factor. Consumers already assume, and rightly so, that spices are naturally grown, that they’re relatively safe and have some positive property. So there is certainly a segment of the market that likes it, but it hasn’t taken the kind of rapid growth that other packaged foods categories have had. But certainly, we respond pretty quickly to trends, and as we see those develop, our teams are pretty agile to make sure that we’re hitting whatever the consumer is looking for.

Operator

Our next question is from the line of David Driscoll of Citigroup.

David Driscoll – Citigroup Inc, Research Division

We get the Knapp Track data, and it seems to reflect pretty significant improvements in same-store trends — same-store sales trends for the restaurant U.S. sector — the U.S. restaurant sector. So kind of question is kind of why doesn’t this translate into a better expectation for industrial volume trends for your U.S. quick serve business? Kind of why not a better outlook starting in the third quarter?

Alan D. Wilson

It depends on what they’re selling and what they’re driving growth in. And if there is a large amount of new product innovation, typically that serves our business pretty well. If they’re focusing on things like value menus, it — we’ll have some sales, but it’s not the high-velocity, higher-margin products that really drives our business. And if they’re focused on out-of-main-time type products like breakfast, we have less participation. So there’s certainly trends there that we see as positive. We just don’t see it recovering as much in our third quarter.

David Driscoll – Citigroup Inc, Research Division

So if I maybe restate, what you’re saying is that while maybe the macro for QSR is good, it just didn’t turn out to be good in the places that you needed to be good in?

Alan D. Wilson

That’s correct. That’s a pretty good way to state it.

David Driscoll – Citigroup Inc, Research Division

And then maybe just one follow-on on to this whole point. So because the idea was that maybe if you see a slowdown in your QSR, maybe there would be a commensurate pickup in your much higher-profit margin business in Consumer such that you would see kind of neutral changes to your guidance. Obviously, that’s not what happened. Maybe can you explain that a little bit? When you gave this new guidance, is there any pickup within the Consumer business? Because you guys just gave the net numbers, you gave the amalgamated numbers. When you look at the mix between Consumer and Industrial, do you have a better profit outlook within Consumer itself?

Gordon M. Stetz

David, this is Gordon. I would say it’s in line with our original expectations. I’d say that given the opportunities that we see behind the growth in those businesses, you’ve seen us increase some of our outlook as it relates to our A&P spend, and that’s given the opportunities we see on a global scale behind innovation and brand marketing support. So whatever improvement that we’re seeing to CCI or the incremental volume that we’re seeing in Consumer, we’re — I’d say we’re leaning into with some of the increase in the marketing spend. So net-net, we’re about where we thought we would be on the Consumer side of things. So hence, we are adjusting down to reflect, as I said earlier, primarily the Wuhan and that delayed recovery in Industrial.

Operator

The next question comes from the line of Akshay Jagdale of KeyBanc.

Akshay S. Jagdale – KeyBanc Capital Markets Inc., Research Division

First is just overall sort of long-term question. You have a lot of puts and takes, which is also unusual for McCormick. I mean, do you really think judging your company’s performance on underlying operating income growth is the right way to look at it? I mean a lot of good companies, and I consider your company to be a very good company, tend to offset headwinds, whether they are pension related or QSR or things like that. So I mean, can you just help me understand, from your perspective, if you’re really happy with sort of double-digit underlying earning — operating income growth, excluding all these puts and takes or whether you are somewhat disappointed that there are all these headwinds in your business that you weren’t able to manage, I guess, over the last few months or year?

Alan D. Wilson

We’ve got pieces of our business that we’re pretty happy with the underlying performance, and as we stated, our Consumer business has pretty good momentum. Our Industrial business is a little more challenged, and we’d certainly like to be a little better there, but the underlying profit growth is pretty good. Obviously, we’d like to be offsetting these things, but we think about our business for the long term. We’re not necessarily managing year-to-year or quarter-to-quarter, and so part of the reason that we’re continuing to make investments in our marketing spending is to make sure we maintain that healthy business. We view the challenges in Industrial to be temporary. And so what we don’t want to do is overreact to something that we think is going to turn around, so that’s philosophically how we think about it. And what we’re trying to do with the updated guidance is just be transparent with the best look that we have at this point.

Akshay S. Jagdale – KeyBanc Capital Markets Inc., Research Division

Okay, great. And just on the India business, we do cover a company that competes directly with you there. And I was — it was interesting that your view of the market is that, I guess, supply or the crop is short, which is why prices are up. And interestingly, your demand seems to be affected negatively by higher prices, which is not what we’re hearing from the other company that we cover. They’re saying the crop is flat, prices are up slightly, but because they play across the value and the premium segment in basmati rice, their demand continues to be up despite higher prices to the consumer. So I’m just trying to bridge the gap there. If you could provide any perspective on that, that would be helpful.

Alan D. Wilson

I can’t help you much with that particular competitor. I think they’re in the mode of building their distribution inside the country and are more focused as an export company. But we’ve shared the dynamics that are impacting our business. And again, just to reiterate, our objective in that business is to drive value-added products through that supply chain. Certainly, basmati rice is a big part of the scale there and important to us, but our objective, long term, is to really move up the value chain.

Operator

The next question comes from the line of Ann Gurkin of Davenport & Company.

Ann H. Gurkin – Davenport & Company, LLC, Research Division

The first one, just start with your comments in your release about distribution gains in the Consumer business. Can you give me some examples?

Alan D. Wilson

Predominantly, Russia is what we were talking about with that.

Ann H. Gurkin – Davenport & Company, LLC, Research Division

Okay. And then are we still expected to hear news about a new flavor platform launch at the end of this year, calendar ’13?

Alan D. Wilson

We certainly expect so.

Ann H. Gurkin – Davenport & Company, LLC, Research Division

Okay, great. And then finally, I was just curious about competitive landscape for snack flavoring, offerings in the Industrial business. Are you seeing the competition increase, more people trying to get into that space? Can you just comment on that?

Alan D. Wilson

Well, certainly, a lot of consumer companies are focused pretty heavily on driving snacks. And as you probably know, we focus on a couple of strategic customers. We’re continuing to grow and win business with our strategic customers, and we don’t necessarily participate heavily outside those strategic customers. So certainly, I don’t know that the competitive landscape has changed. There is certainly more focus by a lot of companies on driving their snack business.

Operator

The next question is from the line of Eric Katzman of Deutsche Bank.

Eric R. Katzman – Deutsche Bank AG, Research Division

A couple of questions. I got on a little late, so I apologize. But Gordon, was the $0.02 hit from Wuhan, is that all you expect from that transaction this year?

Gordon M. Stetz

From a transaction cost standpoint, that’s correct. There’ll be integration costs in the remainder of year that offset the incremental profitability, but from a transaction cost, that would be it.

Eric R. Katzman – Deutsche Bank AG, Research Division

And are those integration costs like inventory hits or…

Gordon M. Stetz

It’s really a number of things as we incorporate them into all of our McCormick system, so it’s everything from incorporating them into our IT systems to QA systems to financial systems. It’s broad-based as we go in and start to integrate them more closely to our operations.

Alan D. Wilson

U.S. resources on the ground help with the integration, those kinds of things.

Gordon M. Stetz

Right.

Eric R. Katzman – Deutsche Bank AG, Research Division

Okay. Then, switching over to Industrial. I guess there have been 2 problems with McCormick from the — I guess, from Wall Street’s perspective. One is we have no visibility on your raw material basket, which, I think, Ken asked about. And then Industrial, you don’t really have, at the end of the day, a lot of control over the business. And I recall there have been other times where you’ve said these new products are going to be introduced, these new products are coming from your Industrial customers and they’ve either been delayed or canceled or what have you. So why should we have confidence that the fiscal fourth quarter is going to rebound in Industrial where, again, there have been times where that just hasn’t been the case?

Alan D. Wilson

You’re right. We don’t necessarily control the timing of new product introductions, but we can see, through planning, what our customers are planning or expecting to do. So — and based on the visibility that we have right now, we would expect a recovery. Remember, we had a fairly weak fourth quarter in 2012, so we do expect some recovery there.

Eric R. Katzman – Deutsche Bank AG, Research Division

Okay. And then last question, I guess, Alan, just more broadly on the Consumer side. Again, maybe I missed it with your intro comments, but are you seeing the middle-income consumer get a bit stronger? It seems as if private label has been a bit weaker of late, and so you have a pretty decent view into that given your private label operations. Maybe you could just kind of touch on that.

Alan D. Wilson

What we’re actually seeing, which is an interesting dynamic in the data, is some customers moving away from opening price point, really deep discount products, at least in our category, and there’s a bit of a trade-up happening from that opening price point to private label and then up to brand. So we’re seeing a little bit of an interesting dynamic. It’s been led by a couple of more value retailers that are — have been able to trade up the consumer. I can’t speak as to how that’s happening across other categories, but we’re certainly seeing the dynamic in our category, which, by the way, we see as positive.

Operator

Our next question comes from the line of Robert Moskow of Crédit Suisse Group.

Robert Moskow – Crédit Suisse AG, Research Division

I guess I continue to be impressed by the performance of the Consumer division. You have sales growing at a mid-single digit rate in Consumer, and a lot of other packaged food companies are struggling to do 1% to 2%. Obviously, Industrial is going the other way. But when you look at how the business is performing, Alan, is — this kind of pace of growth, do you think it’s sustainable? And you have, like, a good pipeline all the way into 2014 so that when we get past the headwinds this year from pension expense and maybe Industrial kind of normalizes again, I know it’s a long way to look out, but do you look at ’14 as being another year where you can deliver that 9% to 11% EPS kind of algorithm?

Alan D. Wilson

We certainly expect — we expect that we’re going to do that long term. It’s early to be giving guidance for ’14, but we’ve got good momentum in our Consumer businesses around the world, we’re executing pretty well with really focused and targeted programs around big events and pulling in all parts of our portfolio from Zatarain’s to Lawry’s to Simply Asia to our core stuff, so we do feel pretty good about the momentum there. And certainly, we would expect that ’14 should see some relief from the pension expense.

Robert Moskow – Crédit Suisse AG, Research Division

Alan, a follow-up. Like the back half for Consumer, obviously, things have to get even better, I guess, in order for the guidance to be deliverable because it’s a double-digit operating income growth. And I know that there’s some very easy comparisons in the back half coming, but do you feel like that’s true, that consumer has to get even better in order to deliver the back half? Or do they just have to keep delivering the kind of results that they’re delivering right now?

Alan D. Wilson

They have to keep on pace with where they’re delivering now. And remember, we did have a few onetime issues in the fourth quarter last year. We don’t expect those to repeat. We’re pretty focused on execution in the fourth quarter.

Robert Moskow – Crédit Suisse AG, Research Division

Okay. So they just have to stay on plan?

Alan D. Wilson

They have to stay on plan.

Operator

Our next question is from the line of Tom Graves of S&P Capital.

Thomas Graves – S&P Equity Research

A couple of questions on China. With the recent acquisition, it sounds to me like there are a couple of benefits you’re looking for, not only the acquired business there, but the opportunity to increasingly leverage the distribution system with traditional McCormick products through the acquired distribution system. Is that a fair assumption?

Alan D. Wilson

Absolutely. The Wuhan business is stronger in the central parts of China. Our core business has been stronger in the coastal region. So what we plan to do is introduce more McCormick products through the central region, but also take some of the Wuhan products into the coast.

Thomas Graves – S&P Equity Research

Okay. And also, is it fair to assume that you’re looking for this acquisition to be at least modestly accretive to fiscal ’14 earnings per share?

Alan D. Wilson

Yes.

Operator

Our next question is from the line of Leigh Ferst of Wellington Shields.

Leigh Ferst – Wellington Shields & Co., LLC, Research Division

I also had a question about Wuhan. It has really high market share in the regions where it operates already. Can you comment on what the potential is long term for their market share?

Alan D. Wilson

Well, we expect that it will grow for a couple of reasons. One is as we expanded into other regions, there is certainly an attractive market opportunity. The products are core to how Chinese cook. The second piece of it is we do expect — even though there’s a lot of discussion around a little bit of a slowdown in the growth rates in China, there’s still pretty robust growth. So as the market grows, we’ll be able to take advantage of that, but we do see expanding the distribution and taking advantage of that.

Leigh Ferst – Wellington Shields & Co., LLC, Research Division

I guess the question will be, how much competition do they have in other regions in which they don’t operate already? I mean…

Alan D. Wilson

Well, there’s lots of competition in these products, and there are the usual suspects that we compete with around the world. So we feel pretty good about our prospects and being able to hold our own.

Leigh Ferst – Wellington Shields & Co., LLC, Research Division

Okay. And then moving to India, you had the steep price increase for the rice. Is there — how much time will you give it to make sure that, that was the right decision versus — how do you weigh that versus the risk of losing market share?

Alan D. Wilson

Well, we’re balancing market share and volume with cost. And so we want to make sure that we maintain a — we’re not willing to necessarily lose a lot of market share, so we’ll be pretty focused. The price gets reset every year based on what happens in the markets and how we acquire positions. And so I would expect it to get reset as we go into next year. I don’t have any outlook on what the clock looks like, but as we — but the timing of that is towards the end of the year, when we’ll be starting to make procurement decisions.

Leigh Ferst – Wellington Shields & Co., LLC, Research Division

Okay. And then closer to home, you sound pretty positive on grilling, but some other companies have been concerned about the weather affecting the various businesses on the grilling. Have you — what’s — can you comment on the weather? Do you — how much — how can you factor that into your outlook?

Alan D. Wilson

We do, and certainly, we would have hoped to have seen a better Memorial Day weekend, from a weather standpoint. It was raining in the Northeast. And I think what you’re seeing is the impact of some of that. But we have pretty good momentum already built off cycle, so we’re — we believe, based on growing household penetration and continuing to introduce new products in grilling, we see it as pretty robust.

Operator

Our final question this morning is from the line of Chris Growe of Stifel Financial.

Christopher R. Growe – Stifel, Nicolaus & Co., Inc., Research Division

I just had 2 quick questions. First was you had indicated that we would see a little pickup in QSR sales in Q3. So my question is just, are you seeing just a pushout of those product introductions or promotions you were expecting? Is that what’s negatively affecting the third quarter?

Alan D. Wilson

It’s a little bit of that, and it’s just a little bit of the products that we’re supplying not moving as quickly and recovering as fast as we would expect it. So it’s a little bit of product innovation and a little bit of where the customers are focused on driving growth.

Christopher R. Growe – Stifel, Nicolaus & Co., Inc., Research Division

Okay. And the other question I have was just in relation to, I think, it’s [indiscernible] in the fourth quarter. Is there any — I know you’ve got an easy comp in the Industrial division, is there anything unique to the Consumer business in the fourth quarter that should make its profits be that much stronger?

Alan D. Wilson

Well, last year, we had some supply chain issues largely related to Hurricane Sandy. So we feel like our business was somewhat suppressed in — our sales were suppressed. Our consumption actually was pretty good through the fourth quarter. That’s why we feel more confident that we should deliver.

Operator

I will turn the floor back over for closing comments.

Alan D. Wilson

Thanks for your questions and for participating on today’s call. Through our growth initiatives, CCI programs and the efforts of McCormick employees around the world, we’re overcoming a number of headwinds in 2013 and delivering solid sales and profit growth. Our passion for flavor, broad portfolio and expanding global presence have us well positioned to meet consumer demand for flavor on both developed and emerging markets.

Joyce L. Brooks

Thanks, Alan. I’d like to add my thanks to those who participated on the call. Through July 11, you can access a replay of the call by dialing (877) 660-6853, and the conference ID number for that is 414507. You can also listen to a replay on our website later today. If anyone has additional questions, regarding the information, I can be reached at (410) 771-7244. This concludes this morning’s call.