McCormick's Bland Outlook

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Spice purveyor McCormick (NYSE: MKC) is looking to improve its efficiency with a series of moves that should save the company a minimum of $30 million a year. But even though the changes might bode well for the company in the long term, the short-term impact was enough to send the company's shares plunging by 12% around midday Wednesday to a new 52-week low.

McCormick announced that it is lowering fiscal 2005 earnings guidance by $0.08 to a range of $1.58 to $1.62 a share. Although that is a 4% to 7% gain over fiscal 2004, it is below the 10% average annual return that analysts expect from the company over the next five years.

The earnings shortfall is a result of early loss estimates from Hurricane Katrina and soft demand in the industrial segment -- think industrial food processors and restaurants -- which accounts for 48.5% of sales but only 33.9% of operating income (between its consumer and industrial businesses).

But what hurt McCormick the most, at least for now, is its announcement of a number of actions that will take place over the next three years to improve its operating performance. These changes are expected to result in an annual pre-tax savings of $30 million to $45 million after the third year. But the cumulative pre-tax impact will consist of charges to the tune of $100 million to $130 million. Even though it's not enough to plunge earnings into the abyss, it does represent roughly 10% of current trailing earnings before interest, taxes, depreciation, and amortization (EBITDA). And that's what Wall Street didn't like today.

Investors would be wise to review fellow contributor Rich Smith's skepticism over the company's valuation in January 2004 and then Tim Beyers' questioning of its being maxed out two months later.

This past March, I noted that McCormick's was a commodity company, exposed to crop risks and other macroeconomic factors. Back then, the company was announcing quarterly results. Net income was flat because vanilla bean hedges had gone south. And to be fair, the risks have not changed, since the company is still widely exposed to the aforementioned factors.

Competitor International Flavors and Fragrances (NYSE: IFF) has seen its flavors business grow slowly even as it implemented systems to improve its operating performance. But based on its own results to date, McCormick has an outlook for savings that can fairly be judged as too optimistic.

For now, investors seeking relative safety in a food-industry investment might look at Motley Fool Income Investor recommendations Heinz (NYSE: HNZ) and Unilever (NYSE: UL) (NYSE: UN) instead.

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Fool contributor W.D. Crotty does not own shares in any of the companies mentioned. Click here to see The Motley Fool's disclosure policy.