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Kellogg margins hurt by cuts to snack prices, higher costs

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Kellogg's Corn Flakes cereal is pictured at a Ralphs grocery store in Pasadena, California August 3, 2015. REUTERS/Mario Anzuoni/File Photo
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By Richa Naidu and Nivedita Balu

(Reuters) - Kellogg Co (K.N) reported lower-than-expected quarterly profit margins on Thursday as the cereal maker spent more on marketing and transportation and had to cut prices on snack foods after it stopped distributing directly to U.S. retailers.

The Battle Creek, Michigan-based company switched to its more widely used warehouse model last year to reduce expenses at its U.S. snacks business. Previously, delivering its Pringles and Special K cereal bars directly to stores meant it could charge retailers higher prices.

Second-quarter adjusted gross margin fell to 35.7 percent, below the 37.6 percent analysts expected, according to Thomson Reuters I/B/E/S. Margins were also hurt by higher transportation costs that have been plaguing Kellogg and other packaged goods companies.

"We see transportation costs up strong double digits, and we see that continuing for the foreseeable future, driven by the driver shortage," Chief Executive Steve Cahillane told Reuters.

Kellogg shares were flat on Thursday, having fallen as much as 3.8 percent in morning trading, weighed by margin concerns even after the Corn Flakes maker topped Wall Street's net sales estimates for the fifth straight quarter and raised its full-year sales and profit outlook.

"Kellogg's profit margins are below peers, which leads us to believe there is significant room for improvement," Edward Jones analyst Brittany Weissman said, adding the market had expected more from Kellogg going into the quarter.

First-half organic sales growth was pulled down by about 2 percentage points because of last year's direct store delivery exit, Chief Financial Officer Fareed Khan told analysts on a post-earnings call. That drag should lessen through the third quarter because the warehouse model will have been in place for a full year, he said.

Kellogg, struggling with shifting trends as more people opt for low-sugar options, protein bars and yogurt for breakfast over cereals, has been buying smaller snack brands aimed at health-conscious consumers and expanding in emerging economies.

The company, which bought protein bar RXBAR for $600 million last year, raised its full-year outlook, betting on the acquisition and its investment in Nigeria's Multipro.

Kellogg said it expects net sales to rise 4 percent to 5 percent in fiscal 2018, and earnings per share to rise 11 percent to 13 percent, both on a currency-neutral basis. The company had previously forecast a sales rise of 3 percent to 4 percent and earnings per share growth of 9 percent to 11 percent.

(Reporting by Richa Naidu in Chicago and Nivedita Balu in Bengaluru; Editing by Meredith Mazzilli and Chris Reese)