Kellogg in Neutral Lane - Analyst Blog

We reiterated our Neutral recommendation on Kellogg Company (K).

Kellogg reported an EPS of 90 cents a share for the third quarter of fiscal 2010, which was in line with the Zacks Consensus Estimate. However, the EPS declined 4.3% year-over-year from 94 cents. Total net sales for the quarter dropped 4% to $3.2 billion, whereas operating profit plummeted 5% to $541 million.

Excluding the effect of foreign currency translation, net sales decreased 2% and operating profit declined 3%. Weak profits and revenues were primarily attributable to softness in the cereal category, competition and the impact of the voluntary recall of select packages of breakfast cereals.

Kellogg follows two operating principles Volume to Value and Manage for Cash). The Volume to Value strategy concentrates on profits (value) rather than market share (volume). Kellogg has focused on brand building through new product innovation and improving the product mix by concentrating on optimal price/mix combinations.

Marketing efforts are aimed towards the more profitable cereals and snacks business, in order to increase sales and expand margins. In the Manage for Cash initiative, working capital was reduced by effective inventory management and cost cutting.

Kellogg markets brands that generate higher margins. Management is intensifying the brand-building program with increased advertising and promotional expenditures in line with the goal of increasing brand-building spending at twice the rate of sales growth.

Further, product innovation has always been a key to growth at Kellogg's, providing customers with wider options. Management evaluates innovation as a percentage of sales on a three-year rolling basis. The company's strong track record of delivering results through innovations has led to introductions in two prime categories: Health and Wellness, and Convenient Solutions for both adults and children.

However, Kellogg has a highly leveraged balance sheet. The company is focused on continued reinvestment into its brands, as well as optimizing its business model and global organization.

Further, product recalls occasionally impact earnings. For example, on June 28, 2010, the company announced a voluntary recall of certain breakfast cereals such as Apple Jacks, Corn Pops, Froot Loops, and Honey Smacks on account of uncharacteristic off-flavor and smell coming from the liner in the package. This recall has impacted the company's earnings, sales and operating profits for two consecutive quarters.

Headquartered in Battle Creek, Michigan, Kellogg Company manufactures and markets ready-to-eat cereals and convenience foods (including cookies, crackers, toaster pastries, cereal bars, and frozen waffles).The company primarily competes with General Mills Inc. (GIS), Conagra Foods (CAG-Analyst Report) and Sara Lee Corp. (SLE) and currently has a Zacks Rank#3 which translates in to a short term Hold rating.