Investors are in a tough spot trying to short anything in consumer staples these days and MKC is an excellent example of why that is the case. The company guided down 2013 significantly when it reported Q4, to the point where Q1 is achievable based on where consensus has settled ($0.56). Since the guide down, the company’s multiple has expanded significantly (and significantly may be understating it, massively may be a better word). At some point, valuation is going to matter in this name, but as we are fond of saying, valuation isn’t a catalyst. Earnings are, however, a catalyst, so here is a quick look at where we shake out on the quarter:
MKC is up against its toughest revenue comp of the year (+15.8% reported, +9.5% constant currency organic).
The company’s 2013 outlook contemplates a 1% benefit from pricing, which seems reasonable to us - keep in mind that the company anticipated pricing of 5% across both of its segments in 2012, and was only able to achieve that target in 1H (Q3 pricing +4.5%, Q4 +3.2%).
The company’s 2-4% volume/mix forecast is likely 2H weighted given the progression of volume/mix in 2012 (+4.3% in Q1 moving to -0.3% in Q4).
We are at the lower end of the company’s range for our Q1 estimate. Acquisitions won’t be a factor in sales growth in Q1 and currency should remain a drag on top line – the net result is our revenue forecast of $924.8 million, slightly below consensus of $925.7 million.
However, the company’s gross margin comp (-274 bps) is the easiest year over year comparison of 2013 as the company is lapping a significant increase in input costs.
Material cost increases are forecasted to increase 3% in ’13 (high single digit cost inflation in 2012), and that should be a trend that improves throughout the course of the year. Consensus gross margin is 39.4%, only a slight improvement versus 2012 (39.19% reported). We think consensus may be too conservative on this metric – we are looking for a 50 bps increase, with a net result of a 3.3% increase in gross margin dollars versus 2012.
While SG&A as a % of sales declined 102 bps in Q1 2012 and the company is lapping a $9 million increase in brand marketing support, we are forecasting a modest increase in this metric - +15 bps.
Taken together, we forecast a modest gain in EBIT margin of 35 bps. In Q1 2012, the company’s EBIT margin declined 172 bps making this quarter the the easiest comparison of the year for MKC.
Finally, the tax rate will be lower year over year (29.5% forecasted full year annual tax rate).
Where does that leave us?
Our forecast is for EPS of $0.60 per share, $0.04 ahead of consensus, recognizing that Q1 2012 consensus declined versus the prior year (-2.9%). This is precisely why it has been so tough to be short anything in staples – the combination of money flows and the fact that there aren’t a heck of a lot of names where we have a clear path to an earnings miss. Having said that, we don’t see beating a sandbagged Q1 as a positive catalyst for MKC, particularly in light of the recent multiple expansion in the name. Quite frankly, it’s hard for us to see how you get hurt on the short side here, but in the spirit of full disclosure we have thought that for about $3, or 1 full P/E turn. Also, it seems that unless a staples company posts a clear EPS miss followed up by a conference call where management lights themselves on fire, staples names only go up on EPS, regardless of quality (GIS?). Finally, we should also point out that short interest has crept up in the name in recent weeks and, unfortunately, it seems that any short in consumer staples is a weak short, so we wouldn’t take in a full position and would be prepared to short higher – the multiple will matter at some point.
Call with questions,
HEDGEYE RISK MANAGEMENT, LLC