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Kellogg's Turn-Around Efforts to Lift Sales Defying Weakness

Zacks Equity Research

On Jul 12, 2017, we issued an updated research report on the cereal and snacks company, Kellogg Company K.

The company’s shares have been trading below the Zacks categorized Food-Miscellaneous/Diversified industry for the last one year. The stock has lost 21.4% during this period compared with the industry’s decline of 13.9%. Yet, earnings estimates have remained stable for the current year and the next in the last 60 days.

Restructuring Efforts to Drive Earnings

The primary reason behind this lackluster share price performance is probably its weak sales trajectory. Much like other food companies, General Mills Inc. GIS, Mondelez International, Inc. MDLZ, The Kraft Heinz Company KHC and others, Kellogg too has been struggling to increase sales for the last few years, primarily due to lower demand. Kellogg reported revenues of $3.25 billion in the first quarter of 2017, reflecting a decline of 4.1% year over year and marking the ninth straight quarter of a revenue decline.

More precisely, the company’s cereal category has declined in recent years due to consumer’s shifting preference to more protein, less artificial ingredients, and more on-the-go options.

That said, Kellogg has already made efforts through increased investment and better innovation behind its brands. The company is also in the middle of multiyear restructuring and cost-savings programs that are expected to drive improvements in profit margins.

Most importantly, aggressive cost cutting has been a key strategy for Kellogg to boost growth in the face of tepid sales. For that, Kellogg has taken its cost-cutting plans a notch higher with the retrenchment of more than 1,000 employees across several of its facilities in the U.S. Also, the company announced plans of closing down several of its distribution centers as part of its efforts toward shifting to a warehouse distribution model. Kellogg already uses this system for its Pringles brand and in parts of its U.S. Snacks segment.

The company will no longer be shipping products directly to retail stores. Instead, it will ship to retailers' warehouses. This move is an extension to its previously-announced efficiency and effectiveness program, Project K, and is expected to result in cost savings of approximately $125–$175 million. Kellogg now expects $600–$700 million in Project K cost savings through 2019 compared with the previous expectation of $425–$475 million through 2018. Management is of the view that the new model will simplify the cost structure, while driving growth and profits for the company and its retail partners (read more: Kellogg Chalks Out Cost-Cutting Plans, Lays Off 1000).

Apart from Project K, another cost-saving program involves a new budgeting technique, zero-based budgeting (ZBB), which will allow the company to scrutinize overhead costs more effectively. This is anticipated to result in significant savings over the next few years.

Meanwhile, Kellogg is channeling funds toward product and packaging innovation as well as reformulation of many existing products to keep up with the rapidly changing views of consumers regarding health and wellness. Recently, Kellogg’s venture-capital fund (eighteen94 capital) invested $2 million in Bright Greens, a maker of plant-based frozen smoothies. This marks the second investment by eighteen94 capital, after putting in money into food startup Kuli Kuli in Jan 2017 to tap the growing demand of herbal teas and moringa-based products (read more: Kellogg Company Invests $2 Million in Bright Greens).

We believe systematic cost savings, while reinvesting a major portion of it to support volume growth should support sales and earnings growth for Kellogg.

The company is expected to post reasonable earnings growth with the current growth estimate being 5% for 2017. Additionally, the stock’s long-term earnings growth rate of 5.96% and a trailing 12-month Return on Equity (ROE) of 67.99% (against 20.02% for the industry) reflect its inherent strength.

The company holds a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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