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Kellogg May Not Be Healthy for Investors

July 31, 2014 | About:

Kellogg Company (NYSE:K) is a producer of ready-to-eat cereal, and also sells snack and convenience foods such as cookies, crackers, potato chips, cereal bars, fruit snacks and frozen waffles. Its brands include Froot Loops, Corn Flakes, Frosted Flakes, Rice Krispies, Special K, Cocoa Krispies, Keebler, Pringles, Pop-Tarts, Kashi, Cheez-It, Eggo, Nutri-Grain and Morningstar Farms.

Being one of the world’s largest producers of cookies and crackers, and whose products include Special K, Pringles and Corn Flakes, among others, has been pressured by increased competition in the breakfast and snack industries and soft demand from consumers.

Weak Performance

The maker of Frosted Flakes, Special K and Mini-Wheats has a market cap and dividend yield are $24 billion and 2.7%, respectively. Kellogg’s mainstay U.S. cereal business, accounting for 40–45% of sales, has been performing poorly since 2012 due to sluggish category growth. Lower demand for cereals due to competitive pressures from alternatives including yogurt, eggs, bread and peanut butter is hurting category growth. More recently, the company witnessed cereal category weakness in other developed countries like the U.K., Canada and Australia. Moreover, though snacks improved slightly in the first quarter, it did not do too well in 2013.

In addition to the general movement away from cereal, some of Kellogg's troubles have to do with its brands in particular. Its Kashi line, for instance, has fallen out of favor with the health set because it failed to keep pace with trends, such as offering options without genetically modified ingredients.

Shares of Kellogg, which also sells Pringles chips and Keebler cookies, fell as much as 3 percent in early trading to their lowest in more than a year. While volumes declined 3.5%, price/mix added 1.1% to sales. Currency had a negative impact of 0.7%.

Kellogg pays a quarterly dividend of $0.46, which at the current price per share, yields 2.71%, slightly below its largest competitor General Mills (NYSE:GIS), which pays 3.02% in dividends.

Kellogg’s adjusted operating profit declined 5.5% to $559 million due to lower sales and timing of cost of goods sold. Profits were weak in the U.S. as well as in Europe and Asia-Pacific.

What to Expect

Kellogg has strong commercial programs in place and plans to increase investments in core categories, with key programs scheduled to start in the second quarter. Moreover, price mix is expected to remain positive throughout the year.

However, in the second quarter, management expects the top line to return to growth after witnessing sales decline in the previous two quarters. Kellogg expects volume trends to improve over the remainder of the year driven by significant increase in brand building investments, mainly behind the core categories. Moreover, price mix is expected to remain positive throughout the year. However, adjusted operating profit is expected to decline slightly in the second quarter due to higher brand building investment.

In a phone interview, Kellogg CEO John Bryant said the company had a variety of strategies to improve cereal sales in the months ahead. The primary tactic will be a marketing campaign that reminds people of how much protein is in a bowl of milk and cereal. However, adjusted operating profit is expected to decline slightly in the second quarter due to higher brand building investment.

The Company will Shut Bakery Operation in Columbus, US

Kellogg plans to shut its bakery operations in Columbus, Georgia, US. This move could result in the loss of 325 jobs at the facility. The company intends to close the entire bakery by the end of 2015, while layoffs will start in next spring.

Project K May Save the Company

Last year, Kellogg announced a cost-saving four year program, coined as Project K. This program may save the company an estimated $425-475mby 2018. This cash may be pumped into the business in order to revive the business. The project has been doing so far and should be able to derive more strength in 2014.

Expenses related to the project are expected to hurt full-year earnings by 60-65 cents per share in 2014, while adjusted gross margins are expected to increase by about 40-50 basis points.

To End

Kellogg has given investors outsized returns over multiple kinds of economic environments. Kellogg might be a great company, but its products are quickly falling out of favor. The company has a declining cereal business. Cereal sales in the U.S. have been sluggish as Americans increasingly reach for alternatives such as Greek yogurt or breakfast sandwiches from fast-food chains. Even within the cereal aisle, Kellogg is facing more competition from smaller players that position themselves as healthier alternatives. Investors should stay away from this company for a while till the conditions improve.

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