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Kellogg (K) Gains From Buyouts, Costs and Soft View Hurt

Zacks Equity Research

Kellogg Company K has been benefiting from the consolidation of Multipro, improved consumption trends, gains from price/mix and growth across revitalized brands. Further, the company is on track with brand growth initiatives and is boosting presence in emerging markets.

However, the company is reeling under pressure due to rising input costs and sluggishness in North American business unit. This, along with adverse currency impacts, and higher interests and tax rate is weighing on the company’s bottom line. Let’s take a closer look at both sides of the story.

Factors Driving Kellogg’s Performance

Kellogg boasts solid product portfolio and brand identity in both cereals and snacks. Its portfolio consists of strong brands such as Pringles, RXBAR, Bear Naked, Cheez-It, Rice Krispies Treats among many others. Kellogg is also dedicated toward augmenting its portfolio through adding more products under existing brands, innovation and marketing initiatives.

The company currently spends a high percentage of profits on brand building. In this respect, it invests in efforts such as digital media, consumer promotions, traditional advertising and augmenting in-store capabilities.

Along with these, the company is gaining from buyouts, investments in core consumer divisions and building its business in emerging markets of Asia, the Middle East and the African (AMEA) regions. Markedly, the Pringles acquisition has opened up growth opportunities in these fast-growing nations. The company is undertaking efforts to expand business in the emerging markets of Russia and Central Europe. Further, it has been benefiting from the consolidation of Multipro. We note that during the second, third and fourth quarter of 2018, Kellogg’s revenue growth was primarily driven by the takeover of RXBAR and consolidation of Multipro.

The company is also on track with productivity saving initiatives. It is particularly striving toward reducing overhead costs pertaining to Direct-Store Delivery in U.S. Snacks. We note that the company successfully completed the Project K program. Savings from this program are being invested in brand-building initiatives, improving logistics, sales capabilities and innovation. Further, it is on track with deployment of growth strategy, and is accordingly undertaking efforts to restructure portfolio.

Hurdles in Kellogg’s Path

Kellogg’s is struggling with rising input costs. During the first quarter of 2019, high input costs weighed on the company’s gross margins. Adjusted operating profit also fell almost 7% year over year due to increased distribution and input costs. The company is likely to continue witnessing pressure stemming from high costs.

Additionally, Kellogg’s North American business unit has been sluggish for a while now. During the first quarter, the region reported declines across categories like snacks, cereals and frozen foods. The cereal category was mainly hurt by shipment timing and transition in packing across certain brands. Lower demand for cereals due to competitive pressure from other breakfast alternatives has also been hurting category growth. The snacking unit during the first quarter faced pressure from write-offs related to product recalls under the RXBAR banner.

The company trimmed the guidance for 2019 after taking into consideration the impact of divestiture of certain snacks, cookies, crusts and ice cream businesses. For 2019, sales are expected to grow 1-2% at cc compared with the earlier view of nearly 3-4% growth. Further, adjusted operating profit (at cc), which was earlier anticipated to remain roughly flat year over year, is now expected to decline 4-5%. Kellogg envisions adjusted earnings to drop 10-11% (at cc).

In the past one year, shares of this Battle Creek, MI-based company have decreased 17.7%, underperforming the industry’s decline of 5.6%.

Nevertheless, we expect aforementioned tailwinds to offset these hurdles and help this Zacks Rank #3 (Hold) company to win back investors’ confidence.

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