Spice maker provides a lesson

July 30, 2008|By JAY HANCOCK

To understand the intense economic pressures sweeping the globe, you could earn a master's in business administration or convene a focus group of economists and Fortune 500 CEOs.

Or you could look at McCormick & Co.

The spice purveyor illustrates just about every kind of contemporary economic trauma: soaring crop prices, expensive energy, depressed consumers, inflation, tighter profit margins, layoffs, gyrating currency values and nutty credit markets.

The Sparks-based company has coped very well, partly by raising prices and contributing to the nation's 4 percent-plus inflation rate. But the challenges are severe enough that nobody should expect McCormick shares - or those of corporate America generally - to soar any time soon.

McCormick's main problem is one faced by almost any manufacturer - spiking costs for raw materials. Agricultural commodities and packaging constitute all but 20 percent of the company's total expenses.

It doesn't disclose what it pays for soybean oil, vanilla and raw herbs and spices. But crop prices have surged by more than a fifth since last year, according to the Labor Department. Last month CEO Alan D. Wilson said McCormick is dealing with "unprecedented periods of escalating costs."

Blame droughts, storms, growing demand for food in developing nations and farmland diverted to grow corn for Washington's inexcusable ethanol program.

McCormick has been able to raise its own prices by much less than the general spike in raw-material costs - only about 5 percent. This is the classic squeeze of the middleman seen in times of rising inflation and weak consumer demand.

McCormick has also been dinged by high energy prices, although again it won't say by how much.

It is a testament to the company's management that, so far, these pinches have hurt profit margins very little.

One reason may have been smart hedging on commodities - locking up future supplies at good prices. Another is that foodstuffs subject to the worst inflation - flour, soybeans and dairy items - go disproportionately into McCormick products sold to food manufacturers, which have been more amenable to price increases.

But a big reason for McCormick's margin maintenance was cost-cutting, including the kind of layoffs that have contributed to the country's rising unemployment rate and miserable consumer confidence levels. The company has shed more than a thousand jobs since 2005 in a process that included closing manufacturing plants in Maryland and California.

With the national unemployment rate pushing 6 percent, home prices plunging and gas around $4, McCormick customers are shopping for the best deals they can find and are understandably reluctant to pay more at the store.

The company credits its ability to raise prices in part to the fact that cooks see spices and herbs as an affordable luxury.

You might not be able to afford diamonds or a BMW, but you can still fancy up your backyard cooking with the Grill Mates Grinder.

"We are seeing consumers not completely walking away from some indulgence, and we are providing - helping provide - a fairly inexpensive indulgence," Wilson told stock analysts last month.

"People are trading down from restaurant meals and they are not necessarily giving up the idea that they want to have a nice meal," Wilson siad.

Maybe not, but McCormick also sells tons of spices to restaurants, which are having a very tough year. Thus the company gains business in the home kitchen only to lose it at Bennigan's.

In any event, said Wilson, cost pressures will prohibit any improvement in McCormick's profit margins for the rest of the year.

This economy's hallmark is the seesawing debt market, hit by billions in real estate losses.

Even McCormick, with little exposure to real estate, hasn't been immune. Last year it lost $10.5 million on an interest-rate bet related to future borrowings, although the loss will be recorded a bit at a time over 10 years.

The weak dollar, another characteristic of what is sure to be proclaimed the recession of 2008, has also helped drive up McCormick's costs. Many of its spices are bought overseas. But a falling dollar isn't an unalloyed curse; it also boosts the value of McCormick's foreign sales and profits.

The company booked an 11 percent increase in dollar-denominated sales for the most recent quarter, but nearly 4 percentage points of that came from currency gains.

Throw everything in a bucket and McCormick earned $53 million in the quarter ended May 31, a 29 percent increase from the corresponding period last year. Much of the gain came from the fact that last year's profits were depressed by millions in severance payments and other restructuring costs.

Still, the profits beat analysts' estimates, and yesterday McCormick stock neared $40, surpassing its previous high point, reached two years ago. Several analysts have "buy" recommendations on the shares.

Then again, the real estate meltdown continues unabated. Oil is still over $120. Crop prices are sky-high. Friday's unemployment report is expected to be dismal.

In this economy, even McCormick's inexpensive indulgences are no sure thing.

jay.hancock@baltsun.com

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