Reverses outside its realm trip McCormick

October 09, 2005|By JAY HANCOCK

There's nothing wrong with flavor-monger McCormick & Co. that Bob Lawless shouldn't be able to fix.

McCormick's stock plopped from a high of $39 last year to less than $30 last month after the company in Sparks disclosed problems with higher costs and disappointing sales to restaurant chains and food makers, knocking 8 cents a share off its anticipated 2005 profits.

But the problems seem caused largely by temporary factors that aren't McCormick's fault. (Hurricane Katrina, which hit McCormick's market for its Zatarain's Cajun-style products, is one.)

Free cash flow, the shareholder's best friend, should continue to improve at the century-old merchant now that costly investments in software for shipping, inventory and marketing have wound down.

And those investments should breed continuing profit-margin gains even if restaurant and food-maker sales don't start smartly rising again, and even if petroleum costs, for example, don't substantially abate.

At 20 times earnings McCormick stock still isn't cheap. But its punishment last month was too harsh, and investors apparently agree, as evidenced by the stock's partial recovery.

(McCormick closed Friday at $31.90, up from its $29.24 nadir in September.)

It shouldn't surprise anyone that what McCormick calls its "industrial" business is somewhat volatile. Each year the company sells industrial clients $1 billion in spices, herbs, mixes and coatings. But only 15 companies buy three-fourths of the flavorings, leaving McCormick vulnerable to stumbles and hesitations by key clients.

Industrial customers are restaurant chains such as Appelbee's, food manufacturers such as General Mills and distributors such as Sysco. The industrial trade is slightly smaller for McCormick than its sales to consumers who add seasonings to their own dishes.

This year several industrial customers suspended product rollouts that contained McCormick spices and were supposed to drive industrial sales even higher after a 7 percent increase in 2004. But for one reason or another - McCormick won't say because of confidentiality agreements - the products were delayed and industrial sales dropped slightly below last year's level for the third quarter.

In chats with analysts, however, CEO Lawless promises the rollouts are only delayed, not canceled. He expects them to occur next year, which would help put McCormick back on a decent sales-growth track.

And even if he's wrong, the company seems poised to keep reaping profit-margin improvements from expensive software that links factories with distribution operations and customers and allows sophisticated unit-cost and inventory management.

Even with this year's high shipping prices (blame gasoline costs), lackluster sales and a hangover from past overpayment on a batch of vanilla beans, McCormick is making profit-margin progress by reducing inventories and making administrative operations work more efficiently.

It's cutting costs at the rate of more than $25 million a year. A forthcoming company review of just how much McCormick earns on which consumer products and in what size container should reap even more efficiencies.

And the computer system used to achieve those gains is largely paid for; McCormick's capital investment fell from $100 million in 2002 to $70 million last year and looks to be even lower this year.

The stock market keeps forgetting this, but corporate profits do not arrive in tidy, predictable packets like, say, Treasury-bill interest. Would investors have preferred that McCormick and Lawless "manage" earnings to meet Wall Street's expectation, a technique that helped reintroduce the word "bubble" into the financial lexicon after the 1990s?

In my book, a willingness to report choppy earnings and brave the consequences is a hallmark of honest management.

Which is not to say that the recent bumps have been a joyride for shareholders. But Lawless' long-term record is good. The company seems to be executing on the factors it can control - internal costs.

And the factors outside its control don't seem that threatening. If sales recover next year, so should the stock.

jay.hancock@baltsun.com

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