Risk-Reward Balanced at Kellogg - Analyst Blog


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We have maintained our Neutral rating on Kellogg Company ( K ) following appraisal of first quarter 2012 results.

As previously announced on April 24, Kellogg's first quarter 2012 earnings per share of 95 cents missed the Zacks Consensus Estimate of 98 cents.The first quarter earnings also lagged the prior-year figure of $1.00 per share. Weak revenues in Europe and in the U.S. cereal category, high commodity costs and investments in supply chain initiatives led to the earnings miss in the quarter.

The world's largest cereal maker reported revenue of $3.44 billion, down 1.3% in the quarter, mainly due to the sluggish European business and weakness in the U.S. cereal category.

Gross margins declined 90 bps to 39.9% in the quarter due to lower revenues, commodity cost increases and supply chain initiatives. Kellogg's adjusted operating profit dropped 6.1%. Kellogg also slashed its 2012 financial outlook following the weak start to the year.

Despite the first quarter miss and the related cut in guidance we are bullish on the long-term prospects of the company due to its solid brand positioning, its geographic diversity and cost saving initiatives. We like the company's continued focus on brand building and innovation. Management earmarked 2011 and 2012 as transition years for the company. In 2011, the company made significant investments in brand building which led to $800 million in incremental sales from innovation. In 2012, management plans to continue to invest at a rate equal to or greater than the rate of revenue growth in 2011. Management believes the revenue synergies from recent investment activities would have a positive long-term effect on the company's top line.

In June 2012, Kellogg completed the acquisition of  Procter & Gamble 's ( PG ) snack unit, which included the iconic Pringles brand, for $2.7 billion. With the deal, Kellogg becomes a strong player in the snacks business, second only to PepsiCo, Inc ( PEP ). Further, we believe the Pringles buyout is likely to reduce Kellogg's dependence on its mainstay cereal business which is currently struggling. The Pringles acquisition will also provide additional growth opportunities in the fast growing emerging nations. Management expects Pringles to fetch a market of another $2 billion. Besides, Pringles is expected to boost revenues by more than $500 million in North America. The combined company is expected to generate more than $15 billion in annual sales and over $6 billion in snacks sales globally.

Further, Kellogg's continued cost-reduction initiatives are aimed at providing greater visibility in achieving its long-term profit growth targets. In 2010, Kellogg began investing in its supply chain initiatives. These initiatives, though creating near-term earnings headwinds, would help build a stronger foundation for growth in 2012 and beyond.

The company's efforts to drive profitability and brand equity are however tempered by the more matured and somewhat sluggish cereals business and economic uncertainty in Europe. Kellogg's mainstay U.S. cereal business has grown in the low single digits in the past few quarters. Management expects this business to remain challenging in 2012 and grow no faster than its present rate.  Moreover, the European business has consistently recorded both sales and operating profit declines as the region continues to face difficult economic conditions and competitive activity. The company has also cut down on brand-building and overhead costs in Europe to counter revenue headwinds. The company still expects this region to remain challenging in 2012 with hope of some recovery in the second half. Margin headwinds from rising raw material prices and a high debt burden remain areas of concern.

KELLOGG CO (K): Free Stock Analysis Report
PEPSICO INC (PEP): Free Stock Analysis Report
PROCTER & GAMBL (PG): Free Stock Analysis Report
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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