How Safe Is McCormick's Dividend?

Spice and flavorings giant McCormick (NYSE: MCK) has a long-running dividend that's kept growing through industry recessions and expansions alike. But is that payout still safe now that the company is splurging on a $4.2 billion acquisition of a group of Reckitt Benckiser brands?

Let's look at prospects for McCormick's dividend to expand at a market-beating rate over the next few years.

Dividend history

McCormick has boosted its dividend in each of the past 31 years, which is a testament to management's desire -- and ability -- to prioritize direct cash returns to shareholders. The Dividend Aristocrat's raises have been strong recently, too. The payout increased 9.3% this year and by 7.5% in fiscal 2016. The two previous years saw increases of 8.1% and 8.8%, respectively.

McCormick's annual payout is now $1.88 per share, equating to a 2% yield. That's just slightly less than an investor could get from buying a diversified U.S. stock market index fund.

Operating trends

Improving operating trends form the basis for McCormick's dividend raises. The good news for income investors is that these figures describe a steady business with strong pricing power. That's the key benefit of owning a diverse portfolio of leading branded spice and flavoring products.

McCormick's net sales have risen in each of the past five years. Gross profit margin just hit a five-year high of over 41% of revenue, thanks to increased selling prices. Operating margin similarly touched a recent high in 2016, as management enacted aggressive cost-cutting plans.

There's no concern on cash flow or profit, either. Operating cash was over $650 million last year -- or three times its annual dividend payout. McCormick's payout ratio is below half of its profit, which means it's nowhere near the point where management might have to consider pausing raises or cutting the dividend.

Outlook and leverage 

McCormick's latest business update kept the spice giant on track for 5% sales growth in 2017 as profits rise by approximately 8%. That's consistent with management's long-term plan that calls for boosting annual sales by between 4% and 6% and raising earnings by between 9% and 11%.

Following that update, management announced its $4.2 billion purchase of Reckitt Benckiser food franchises, including French's mustard and Frank's RedHot hot sauce. That price tag equates to over one-third of McCormick's market capitalization, but it still isn't likely to threaten McCormick's dividend.

After all, management sees the purchase boosting profit margin and driving faster earnings growth beginning next year. The acquisition will be funded mostly through debt that will need to be paid off quickly to keep borrowing costs in check. McCormick plans to make no changes to its dividend policy, though, and instead aims to save cash by scaling back spending on share repurchases.

The company has allocated about $650 million toward stock buybacks over the past three years, or a bit more than its $200 million annual dividend commitment. Investors can expect most of that spending to go toward debt repayment instead. The dividend should continue growing, though, as long as McCormick's operating cash flow stays healthy as it works to integrate the new brands into its global business.

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Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool recommends McKesson. The Motley Fool has a disclosure policy.