Here's a classic market puzzle: a company reports quarterly earnings that are better than expected, and its stock price... falls off a cliff. That's what happened to McCormick & Company (MKC) on Tuesday. Shares dropped nearly 6% to a fresh 52-week low. The culprit wasn't the numbers from the past three months; it was the company's enormous bet on the next few decades.
McCormick announced a deal to merge with the food business of Unilever PLC (UL) in a transaction valued at a whopping $44.8 billion. The market's immediate reaction suggests investors are doing some heavy math on the future debt load and what this means for their slice of the pie.
The Good Quarter That Got Ignored
First, let's look at the results everyone seemed to overlook. For the first quarter, McCormick posted adjusted earnings per share of 66 cents, beating the consensus estimate of 60 cents. Sales came in at $1.874 billion, also ahead of the expected $1.787 billion. That's a 17% increase in net sales from a year ago.
"First quarter total volumes were in line with our expectations, and we anticipate sequential improvement with growth building throughout the year, as we benefit from brand investments, increased innovation in both segments, and distribution gains," said CEO Brendan M. Foley.
Breaking it down, the Consumer segment (think the spices and extracts you buy at the store) saw sales jump 25% year-over-year to $1.145 billion, though that was heavily aided by acquisitions and currency exchange rates. The organic growth there was a more modest 2%. The Flavor Solutions segment (which sells to other food companies) grew sales by 6% to $729 million.
Profitability improved, too. Adjusted gross margin expanded to 38.6% from 37.6%, and adjusted operating margin ticked up to 14.3% from 14.0%. By most measures, it was a solid report.
The $44.8 Billion Elephant in the Room
So why the sell-off? Enter the merger. McCormick and Unilever plan to combine McCormick with most of Unilever's global food business. The idea is to create a flavor powerhouse with about $20 billion in combined revenue.
The deal structure is where investors started reaching for their calculators. Unilever and its shareholders will get equity representing 65% of the new, combined company. Based on McCormick's recent stock price, that stake is valued at $29.1 billion. On top of that, Unilever gets a $15.7 billion cash payout.
When the dust settles, the ownership of the new company will look like this: Unilever's shareholders will own 55.1%, current McCormick shareholders will see their stake diluted down to 35.0%, and Unilever the corporation will hold onto another 9.9%. For a McCormick shareholder, your company is effectively buying a huge business, taking on a lot of debt to pay for part of it ($15.7 billion in cash doesn't grow on trees), and you're ending up with a smaller percentage of the whole. It's a lot to digest in one morning.
The companies valued both Unilever Foods and McCormick at roughly 13.8 times their projected 2025 earnings before interest, taxes, depreciation, and amortization (EBITDA).
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