Kellogg Company (NYSE:K)
February 20, 2013 8:00 am ET
John A. Bryant - Chief Executive Officer, President, Director and Member of Executive Committee
Ronald L. Dissinger - Chief Financial Officer and Senior Vice President
Jonathan P. Feeney - Janney Montgomery Scott LLC, Research Division
Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division
Christopher R. Growe - Stifel, Nicolaus & Co., Inc., Research Division
Jonathan P. Feeney - Janney Montgomery Scott LLC, Research Division
To be with the CFO of IFF, International Flavors, and very much has taken the spot that was to be used by Heinz. Okay. With that, it's my pleasure to welcome the Kellogg Company to CAGNY. First off, please join me in thanking Kellogg for sponsoring another fantastic breakfast this morning.
CAGNY very much appreciates all the support that Kellogg has given to this organization over a long period of time. As you all know, it's been a very busy year for Kellogg. It's acquisition of the Pringles business has not only provided more scale in snacks in the U.S. but transformed its snacks business internationally with scale on both developed and developing markets. So too, have we seen its core U.S. cereal trend starts to perk up on the back of a renewed innovation platform. Here to tell us all about this is CEO, John Bryant. I turn it over to you, John. Thanks for being here.
John A. Bryant
Hello, everyone. Let me start by turning your attention to the forward-looking statement disclaimers. If you could take a chance to read that, that would be great. In terms of today's agenda, we had our Day at K just a few months ago so you had an opportunity to see the broader theme and to get a sense of what direction we're going in. And we had our fourth quarter earnings call just a few weeks ago where we highlighted our Frozen Foods business. So today, we'll do something a little bit different. I'm going to give an overview of where we are as a company, some of the changes that we've made, some of the organizational implications as well. And then we're very fortunate to have Andy join with us here today.
Andy was the -- is one of the executives who came over from Pringles. So he was running the Pringles business in Europe and was also the Global Equity Head. So in charge of the brand globally for Pringles under the P&G organization. And now he's joined us. He's running our Central and Eastern Europe, Middle East, Africa business, a big part of the European business. So Andy is uniquely positioned to talk about really 3 things: how the Pringles integration is going; as a key member of the European leadership team, what we're doing to turn around our European business; and then talk to specific regions in terms of CEEMEA.
And then Ron Dissinger, our CFO, is here to talk about our financial expectations.
So let me get started with the overview of the company. We have had some strategic changes, changes in directions, over the last couple of years. I'll highlight what's changed and what hasn't changed. To make that a reality, we had to reorganize ourselves internally and we have had the opportunity to bring some great new talents into the organization as well.
Let me start with the strategy of the company, 4 primary growth platforms. We want to be the leader in global cereal. No surprises there, but one thing that might surprise you is we constantly reframe and redefine what we mean by cereal and I'll talk more about that. The single biggest strategic change is moving from what was essentially a large U.S. Snacks business to a true global snacks player. And that's what Pringles really helps us achieve. Third, we have a very fast-growing Frozen Foods business in North America. We want to keep driving that growth going forward. And then finally, what we're doing to expand our emerging market's platform.
In terms of Cereal, we are absolutely, passionately committed to growing the Cereal Category around the world. And you can see around international, we still have relatively low per capita consumption. So there's a lot of opportunity for continued growth there. But even in a market like the U.S., we absolutely believe we can grow the Cereal business and with that, the Cereal category in the United States.
Why do we have this confidence? It is a low-calorie, nutrient-dense food form. It is very affordable, relatively inexpensive. A lot of underlying reasons that I believe that we can continue to grow. Plus, from a versatility perspective, it's much more versatile than a lot of people give it credit for. 10 years ago, 20% of all breakfast cereal was consumed outside the breakfast occasion. Today, 30% is consumed outside the breakfast occasion. So we can drive additional consumption in Cereal in other day parts, whether it be dinner replacement or snacks -- snacking throughout the day. In addition, if you look at per capita consumption for Cereal, it bimodal. High for kids, comes down to 20-, 30-, 40-year-olds and starts coming back up again and older adults have as high consumption per capita as kids. Over the aging population, we have another demographic trend that will help us there as well. So as we look at Cereal and our very traditional definition of cereal of a bowl, cereal, cold milk, spoon, first thing in the morning, we think we can keep growing that business. But the other opportunity for us is to challenge that definition of cereal. How can we provide the benefits of cereal to consumers in a different way. I got 3 examples on the slide here. One, is the Kellogg's to Go breakfast beverage that we launched in one major retailer last year that we're taking nationally in 2013. This product has 10 grams of protein, 5 grams of fiber, essentially all the benefits of cereal and a bowl of milk in a portable format. We're seeing a very good response for this, still early days. But we see this as an opportunity to bring consumers in who otherwise will be skipping breakfast or skipping cereal and eating something else. So the opportunity for us to participate more in dashboard dining. When it comes to a point, it's actually hard to do that with traditional cereal.
I don't know how big this could be, but there's one market out there, Australia, where there's been a breakfast beverage business for over a decade. That breakfast beverage business is equal to about 20% the size of the Australian Cereal category. If you got to be 20% of the size of the U.S. Cereal category, this will be a $2 billion sub-category. So a definite growth opportunity for us as we look to the future.
As we think about cereal, consumption of milk is often a barrier to consumption of cereal. And so we're looking at products like Nutri-Grain Breakfast Biscuits in the U.K. to provide the benefits of cereal first thing in the morning without having to force milk consumption with it. We've been doing this for many years around the world with cereal bars and granola bars, but in some parts of the world, particularly Continental Europe, a lot of cookies are actually consumed at the breakfast occasion. So here's an opportunity for us again to leverage a food form that doesn't require milk consumption and provide the benefits of cereal first thing in the morning.
And then there are other markets in the world where hot breakfast is more of a traditional habit. So if you're in South Africa, if you're in Soweto, the consumer there is they got 30 minutes to boil corn, make a product called mealie, which is essentially a porridge-type product. We've come out with Kellogg's Corn Flake Porridge in South Africa to provide a more convenient, great tasting alternative, and this business is doing very well. We're actually struggling to maintain supply to keep up with demand. So we believe we can grow the Cereal category and we can continue to challenge ourselves how can we provide the benefits of cereal in different food formats to better meet the needs of our consumers.
Before with the big strategic shift for the company, is to go from what was primarily a U.S. snacking company truly a global snacking company, and Pringles makes this a reality for us. In the U.S., Pringles is more of a bolt-on acquisition. We had a $4 billion Snacking business already following the Keebler acquisition. Pringles adds about $0.5 billion to that. We've been leaning into savory snacks for many years with Cheez-Its, Special K Cracker Chips and now we're stepping into savory snacks. And we're seeing an immediate, very positive response from the Pringles business once we cut it over onto our sales organization, and the business is growing very well as a result.
So we feel very excited of our ability to make this even a bigger business in the U.S. But what it really does is transform our international business. We now have a snacking platform, as well as a cereal platform. In the past, we had largely a Cereal business that, in its part time, would try to sell some snacks that were cereal-derived snacks. Now with this snacking platform, we have the ability to leverage the U.S. innovation pipeline. The Keebler transformed that business in the U.S. 10 years ago, but it did very little for international business. It's been a great source of growth over the last decade for us in the U.S., now we can start to drive more international growth by both having a cereal and snack platform and leveraging our global innovation pipeline.
As we think about Pringles, it does more than just provide this great platform for growth. It has some outstanding synergy opportunities and all we've done so far is quantify some of the obvious synergy opportunities. Most of our synergies are just turning off the P&G allocated costs and picking up the Pringles business and supporting it with the Kellogg infrastructure, and you'll see those synergies flow through 2013, 2014.
There are harder-to-quantify synergies that we also believe are out there. When we had our supply chain challenges a few years ago, we look at best-in-class food manufacturing. And the facility that most impressed us was a Pringles facility here in the United States. And by acquiring that facility, we now have access to the integrated work system that underlies that facility and enables us to work well. And we can now take that, make it Kellogg-specific and roll it across our facilities over the next several years. And of course, it also came along with the acquisition of some outstanding people. So we feel very, very good about the Pringles business and what's it going to do to help transform our snacking platform.
The third platform for growth is our North American Frozen Foods business. Now this business has grown 8.5% CAGR over the last 10 years. This is a tremendous growth business. It's about a $1 billion business. It's a fair-sized business as well. Three platforms within this business, one is Eggo. Eggo is the second strongest brand in the Kellogg portfolio, second only to the Kellogg main brand itself. We can keep growing the Eggo business. There is a bit of a trend towards hot breakfast and this is our opportunity to take advantage of that trend and strive in the growth of Eggo. There's also a trend out there towards avoiding meat or going to meat alternatives, and our Morningstar Farms business, as the clear leader in that category, is well positioned to take advantage of that growth.
And also, we see a trend towards frozen entrees, a desire within frozen entrees for people to have more natural better for you frozen entrees. And within that, we have the Kashi offering.
But here, again, is an example where we're redefining or reframing our business. We launched the Special K Flatbread biscuits -- flatbread sandwiches last year. Tremendous growth behind that. So much that we're already on our second production process and we're only just turning on the marketing program as we come into 2013. So this is a great source of growth. It's actually been growing double digits the last couple of years. As we go forward, we expect it to continue to grow strongly.
The fourth area is our emerging market platform. This is the defining event in the food industry. How do we position ourselves as a company to take advantage of the development of these markets? And we have tripled our emerging market business over the last decade, it's now a $2 billion business. And the beauty of Pringles is, again, it gives us 2 platforms of growth from these emerging markets, not just cereal but also snacks. And yet, there's even more we can do and need to do in these markets. But then we think about it in terms of 3 different groups. One, is businesses we've been in for a long period of time where we have wonderful infrastructure, very strong brands and we can keep growing organically. India, South Africa, Brazil, growth in this business is 10%, 20%, 30% a year. Now if we find an acquisition that accelerates our growth, we'll obviously do it in these markets, but these markets are not acquisition dependent. There are other markets out there where we have done acquisitions and joint ventures such as Russia and Turkey, which Andy will talk about later, and our recently announced joint venture in China with Wilmar. It's a very exciting joint venture. Wilmar is the third-largest consumer goods player in China. It has a tremendous manufacturing/distribution network. And that joint venture is both cereal and snacks. And we're excited about both the cereal opportunity and the Pringles opportunity within China. And then there's other parts of the emerging markets where in the next few years, you'll see us take actions, whether it be Eastern Europe, most of Africa and parts of Asia, which is still a relatively white space for the Kellogg Company.
There are 4 growth platforms. Now to make that strategy a reality, we had to look at how we organize ourselves as a company. So we changed our structure and we put some new talent into the company. In terms of the biggest change in our structure is our international snacking platform. With the Pringles acquisition comes an entire snacking team in Europe, Latin America and Asia-Pacific. So now we can drive our Snacks business and not distract ourselves from Cereal because we have different parts of our organization focused on both opportunities.
We've had an incredible influx of talent within the business from the Pringles acquisition, and we're very excited about having these distinct platforms. And then in other markets where we don't have the same organizational size and capability, we're leveraging other companies' capabilities such Wilmar in China and Ülker in Turkey. And not surprisingly, there's been a fair bit of change in the company as a result. Of our top 100 people, in the last 2 years, probably 60% are in new roles and roughly 20% are new to the company. And that's particularly true in our international business. Now some of the 20% that's new to the company has come from Pringles, but some have come from Colgate, from Cadbury/Kraft and a number of other companies as well. And so we have brought in a great new set of talent. And with 20% of the senior leadership coming from outside the company and a much greater proportion of that within our international business, it's challenging as to how we run our international business. And we're constantly looking to evolve so we can accelerate the growth of that international business. So what we've seen is a change in strategic direction, a change in structure, new people coming in to help us set ourselves up for the future. And we think that's helping us drive visibility as a company.
Now as you think about visibility, we have headwinds and tailwinds. Over the last few years, we've had some significant headwinds that are dissipating or going away, one has been our supply chain issues. We have made substantial investments backing our supply chain. We believe we've turned the corner in our supply chain. You'll still see the odd small recall and sign [ph] every now and again. That's the nature of the food industry. But the size and frequency should go down dramatically. And we feel that we've really made the right investments and are making great progress there. That's been a very significant headwind that's going away. In fact, it could become a slight tailwind as these plans step the line [ph] even more effectively and efficiently in the future.
The second is cost inflation. Now over the last few years cost inflation has far exceeded savings. As we go to 2013, we have 5% cost inflation and 4% savings, a 1 point delta. That's actually a headwind in the first quarter that turns into a tailwind in the back half of the year. So as you think about the phasing of that difference is -- what inflation we do have is much more front-end loaded and actually becomes a tailwind in the back part of the year. So 1% is probably the smallest gap we've seen for some period of time and is quite manageable, but also the sequencing in the year is important to understand.
Now in addition to that, there's the headwinds that all consumer goods companies have, U.S. consumers under pressure, macroeconomic environment in Europe and of course, we always compete in intensely competitive categories. But there are some tailwinds that are very exciting for our company as well. One is the Pringles synergies. The Pringles synergies gives us additional visibility in 2013, and the Pringles platform and the growth we're seeing as we cut the business over on the Kellogg sales organizations gives us increased confidence in top line from Pringles as well. So we've got some good visibility coming in there. And in 2013, we'll have even more innovation than we had in 2012 or 2011. So we have good growth, good visibility into our 2013 numbers despite some of the headwinds that we have out there.
What's different in Kellogg's? I think Pringles transforms our international business, gives us improving visibility. We have the right structure, we have the right people and right roles and the right strategy going forward. We're challenging the definition of our categories to drive even additional growth and we're building out our emerging market platform. What's the same? We are absolutely committed to our sustainable growth model, what we used to call volume to value. We'd love to see gross margin expansion over time. It hasn't been possible over the last few years with high cost inflation. Our gross margin in 2013 is relatively stable adjusting for Pringles and if we can go forward in a more modest cost inflation environment, we can continue to grow gross margin as we did through most of 2000. And now that we have some incredibly strong brands, we'll continue to invest in our brand building, at or above the rate of sales growth. We are an innovation powerhouse, and I think the Pringles integration, which is actually one of the most complicated things we've done because we're carving a business out of P&G and bolting it on to Kellogg's, it's actually going extremely well, which demonstrates our ability to execute.
So where does that leave us? We're heading in the right direction. We're organized to win. We've got great people, right people in the right roles. And we're absolutely committed to our sustainable growth model, and we're getting back on that model as Ron will show you in more detail.
Now it's my pleasure to have Andy Jones come up and talk about Pringles, Europe and CEEMEA. Thank you. Andy?
Thank you, John. Good morning. As John mentioned, I joined the Kellogg Company last year with the Pringles acquisition. And I'm delighted to be here today at CAGNY as a member of the Kellogg team. I would like to talk to you today about the status of our Pringles integration, the impact that our Pringles integration is having on our international business as John just referred to. And then I want to talk a little bit about the status of our great strategy in Europe, with particular emphasis against some of our European emerging markets.
But first on Pringles. As some of you will have heard, we described the Pringles integration as an integration of superlatives for the Kellogg Company. This is our biggest ever worldwide integration with Pringles sales in more than 150 countries worldwide, and this integrating of brands at $1.5 billion is the second biggest brand in the Kellogg portfolio worldwide. And the good news is that the integration is going very well.
In fact, Pringles is exceeding our expectations. Top line growth in 2012 was higher than the company had originally assumed. Our programs are delivering on the integration, synergies and expectations in every area of the business and we have maintained very good customer service levels throughout the integration and the transition period. And on top of that, we can now say that many of our biggest integration tasks are behind us. As John mentioned, we have exceeded our expectations in retaining Pringles -- the Pringles team members in the business, and I personally am delighted to say that so many of our team have found a wonderful new home in Kellogg and are making such an impact on the future of the Kellogg business. As we entered this integration, our mantra was not to leave a single can, and as we enter now the final phases, we're pleased to say that our transition is on track and we'll exit the transition services agreement with P&G on time.
Let me spend a couple of minutes talking about how Pringles is impacting our international business, which John referred to earlier. First of all, it is accelerating our growth in international markets and I'll talk a little bit more about that in a moment. Secondly, it is building our snacking capabilities. And this is a category that is much more impulse-driven than our core Cereal category, and the Pringles team are able to bring some fresh capabilities and mindset to our Snacking business. And Pringles is really helping the company deliver on its objective of being a balanced snack and cereals company. It is also accelerating our reorganization in Europe. I'll talk a little bit more about that in a moment, too, to focus a region on stronger and more consistent growth for the future. And we are delivering some good cost synergies across the business in areas like our go-to-market infrastructure, warehousing and distribution and our service centers. They really have been a catalyst for us to help improve the Pringles operations, particularly in our international businesses.
So in that context, let me talk a little bit about Pringles as a global and international brand. Pringles have a much more balanced international footprint than our core Kellogg's business. In fact, our single biggest region on Pringles is Europe. And in some markets, some key important markets like Germany, Pringles literally doubles the size of our existing business in those countries. And you can imagine, that provides a fantastic platform for changing our business going forward and for future growth.
Pringles is also growing in every region of the world. Over the last 2 years, Pringles has delivered mid-single-digit growth rates in Europe, in Asia and in North America and double-digit growth rates in Latin America and some key emerging markets like Russia. In fact, Latin America has just closed its third successive year of strong double-digit growth. And this is driven by a fantastic brand around the world. We have some excellent brand equities in countries, including in Asia and in Europe especially. And as you can see from this chart, we have some great share position in a number of key markets around the world. But the good news is that all of these markets still have fantastic opportunities for growth in a food company like Kellogg.
It's also a brand with truly global appeal. Pringles is one of the top 10 Facebook brands amongst the food and drink companies on Facebook. The fan base is a great demonstration of the strength of this brand amongst our core target audience. With nearly 20 million fans in our international markets around the world, from countries as diverse as Argentina, Turkey, Korea and Australia, it's a brand where we have also been able to scale global innovation and global programs. Our biggest product innovation last year, the renovation of our core chip shipped to 85% of our business around the world in a matter of only a few weeks from the first launch. And we were able to do that with marketing that was qualified across 3 regions of the world, and as you can see, executed in multiple languages all around the globe.
In fact, even our commercial activity traveled well across regions, our Merry Pringles! Christmas event last year shipped in over 100 countries in every region of the world. Personally, I always love to see the first displays go up in Aruba in the Caribbean. It's great to see the snow scenes in the Caribbean. So as you can see, this really has been, as John said, a transformational acquisition for our international business and for our Snacking business, and we are delighted to say that it is on track to date.
So let me turn to the European business and an update on our growth strategy. As you know, this has been a difficult region for Kellogg in the last few months as it has been for many consumer goods companies. The economic environment is still tough, especially in Southern Europe, in Greece, in Italy and in Spain for example. At the Investor Day in November, many of you have seen Paul Norman lay out our growth strategy for Europe, to get Europe back to sustainable growth. Sustainably growing Cereal in and out of the bowl, as John talked earlier, explosively growing Snacks, which have been under represented in our European portfolio and accelerating growth in our European emerging markets and to do this with bigger, better, large, scalable pan-European ideas and an organization that is designed for future growth. I will talk about each of these over the next few minutes.
But let's look first at our current results. We are making progress in Europe. As you can see, we made sequential improvement through each of the 4 quarters of 2012. And while this may not yet be exactly where we want to be longer term, we do believe this is a very good step in the right direction.
We are innovating more in Cereal. In the last few weeks, we have launched a number of new initiatives. On Special K, we have renovated the food. On Crunchy Nut, we have introduced granola into the U.K. and we have also launched Breakfast Biscuits. And across 2013, we do expect to see a pickup in our rate of innovation in Europe.
We have also been growing our Snacks footprint, not only on Pringles but also on the balance of our portfolio. We've been filling out the Special K portfolio. We've entered salty with Special K, with the launch of Cracker Chips. And we are entering new segments in the sweet and the wholesome sector with Breakfast Biscuits exceeding our expectations in all of the markets that we've launched so far.
And as I mentioned, we are also reorganizing for growth in Europe. We are moving from a country-by-country local operation to regional Cereal and Snacks category business units designed to drive pan-European scale in our innovation and our brand-building programs. And we are building focused and strengthened go-to-market capability in all of our markets across the region, including the emerging markets. And we're able to do this not only with more effectiveness, but also more efficiency because of the scale that the Pringles acquisition has brought to the business in Europe.
Let me turn now to the last of those pillars of our growth strategy, which is the emerging market. We have almost endless opportunities for growth in the Central and Eastern Europe, Middle East and Africa region, but I'm going to talk today about 3 of the key markets. The first is Turkey. Turkey is a country with a young, dynamic, well-educated, optimistic population. It is already the 17th biggest economy in the world and the Cereal category there has tripled in the last 7 years. As John mentioned earlier, we operate in Turkey through a joint venture with Yildiz Holding and the Ülker brand name. This joint venture was formed in 2005. Yildiz is one of the biggest food and beverage companies in Turkey and it provides us with access to deep distribution that we could not get on our own, the purchasing scale and the local production that allows us to tailor our food to the local consumer needs.
In the last few months, our focus there has been on accelerating growth through accelerated innovation. And already, in 2013, we have launched an improved Special K product. We have launched Tresor into the teen cereal markets in Turkey, a product that has been a great success in the balance of Europe. And we've also launched the new light, salty cracker with a product that is tailored to local flavorings, local consumer needs and the local price point to win in the marketplace.
The second market is Russia. Russia has the potential to be the #1 consumer market in Europe by 2020. As many of you know, Kellogg arrived late to the party in Russia in many respects with the acquisition of United Bakers in 2008. The Russian team, over the last few years, has been transforming that business from a traditional bulk business to a modern packaged food, modern trade-focused, totally national business today. And they have been streamlining the manufacturing network and building a core profitable range. We are already in Russia a true Snack and Cereal business with a #2 brand through our local brand, Lyubyatovo, in 3 categories in the country.
And Russia is also Pringles' fastest-growing market in the European region. So adding in Pringles to the business mix in Russia again provides a fantastic platform for us to capitalize on growth in this market in the years ahead.
And finally, I'd like to look at the Middle East. Middle East is a region with a population of 300 million people today. But that is forecast to double in just the next 40 years. Kellogg's are already well established in the region and well set for the future. But we are now moving our mindset from being an export market to a growth-focused market for the years ahead. And we're able to do that by building innovation on our big, regional power brands like Special K, we just relaunched in Saudi Arabia, for example, and also by tailoring our marketing to our consumer needs in the region. You'll see here, for example, our Ramadan initiative on Pringles and also our corn flakes marketing, which leverages a local consumer insight of consumers adding fruits and nuts and other fresh products to their morning bowl of cereal.
These are just 3 of the opportunities in our emerging markets. As John mentioned, we have many more. We have white space opportunities in Central and Eastern Europe in many countries, and we have some great developing opportunities in Africa in some of the fastest-growing big market of the African continent, and we look forward to working against those in the years ahead.
So just to recap. From a European perspective, we are on track versus our growth strategy. We are making progress and results are improving, but we have fantastic opportunities for more growth in the future and this is a very, very exciting opportunity.
And with that, I'm going to hand over to Ron Dissinger.
Ronald L. Dissinger
Good morning, everyone, and thanks very much, Andy. This morning, I'm going to discuss with you our long-term growth targets. Also, our operating principles, sustainable growth and manage for cash. And I'm going to come a little bit near end and talk about our guidance for 2013. We've got a number of moving parts so I'll go through that. And I'll end on cash flow and returning cash to our shareowners.
First, we're committed to our long-term targets and growing our business in this fashion over time. Our internal sales growth expectation is in the range of 3% to 4%. And these targets are very consistent with what we've communicated to you previously. Underlying operating profit is expected to grow in the range of 4% to 6%, and underlying earnings per share in the range of 7% to 9%.
Now you'll notice this year, we use the term underlying, very similar to what we've communicated to you previously, but now we've changed our pension accounting and we've talked about moving to mark-to-market on commodities. So underlying simply excludes those onetime adjustments that might flow to the quarter to the year-end performance.
We participate in some great center store categories. John talked about the opportunities to grow our Cereal business and how we're reframing the Cereal category. And also, the opportunities in Snacks and the catalyst that Pringles becomes for our domestic business and as well our international business. We have a fantastic Frozen Foods business that is growing fast, and we're growing in our emerging markets and Andy shared with you some of the opportunities we have in our emerging markets.
Fundamental to the way that we run our business and foundational to the way we run our business are operating principles, sustainable growth and manage for cash. And you've seen these operating principles previously. Sustainable growth is about investing in our brands at the rate of sales growth or perhaps faster. Innovating behind our brands as well, driving sales growth at the rate of 3% to 4%, and over time, a good balance between volume and price and mix improvements. We'll remain disciplined on our cost structure and continue to expect productivity improvements in the range of 3% to 4%. Clearly, we're at the high end of that in 2013 business. And we'll also remain disciplined on overhead and grow that at a lower rate than sales growth, trying to create some operating leverage. All of that creates a virtuous cycle for us to grow our business, investing in our brands, growing our top line and reinvesting back in the business. And that should allow us to deliver operating profit growth in the range of 4% to 6%.
Effective management of our cost of debt and also effective tax planning as well should allow us to grow our earnings at the mid-single-digit rate. On working capital, we do remain disciplined in this area though it is true over the past couple of years, our working capital has come up a little bit as a percent of sales. Now we still have very low levels of working capital as a percent of sales, but we continue to identify opportunities in this area and we'll continue to execute against those opportunities for continuous improvement.
We'll also make sure we're prioritizing our capital expenditures. Long-term expectation is to be in the range of 3% to 4%. We've been a little bit higher than that over the past couple of years as we've invested in our infrastructure, particularly in North America, and as we're investing in capacity behind the Pringles business and other international markets as well. But long term, we'll want to be in that 3% to 4% range. We also want to maintain a strong liquidity position. In 2012 and '13, that means paying down debt associated with the Pringles transaction. The principles of sustainable growth and what you see here on manage for cash should allow us to improve our return on invested capital over time.
Now let's move a little bit near end and talk about our 2013 guidance. We're reaffirming the guidance that we recently communicated to you on our fourth quarter call. We still expect reported sales to be approximately 7%. And remember, this includes approximately 5 points of growth related to having Pringles through the extra 5 months in 2013. We've got about a 1 point currency headwind so our internal sales growth is approximately 3%, at the low end of our long-term targets. Our reported earnings per share is excepted to be in the range of 5% to 7%. Now note that, that does include a $0.02 currency headwind. So our currency neutral earnings per share, obviously, is growing faster than the 5% to 7%, and we expect our cash flow to be in the range of $1.1 billion to $1.2 billion.
Now let me give you a little bit more color on our 2013 earnings outlook. But first, we do expect operating profit to grow faster than our earnings per share and that does include growth in our base business operating profit. It also includes increased accretion from the Pringles business. So we're moving from about $0.17 in 2012 to $0.30 to $0.32 in 2013. In addition to that, our synergies are increasing in association with the Pringles business. So we've communicated previously, 2012 was about $15 million to $20 million worth of synergies. We've communicated also a range of Pringles synergies of $50 million to $75 million. In 2013, we expect we'll be towards the low end of that range. And then as we move to 2014 and future, towards the high end of that range. And honestly, we're going for every synergy dollar we possibly can in association with the acquisition.
In addition to that, our integration costs, very consistent when we announced the deal. Our integration costs are stepping down in 2013. So we have approximately $0.16 of integration costs in 2012 that moves to $0.12 to $0.14 in 2013.
The next item I want to highlight, and I talked about this on the fourth quarter earnings call, is yes, we are lapping a limited recall on many weeks in the third quarter of 2012. But based on our performance in 2012, we will reset our incentive compensation back to targets and essentially, those 2 items are relatively offsetting within our profit and loss statement.
We have a number of things moving around below the line as well. The first item, lapping tax and foreign exchange benefits specifically related to the Pringles acquisition. These occurred in the second quarter. This is the $0.07 that we've consistently discussed of benefit that occurred. I mentioned we've got about $0.02 of translational currency headwind as well.
In addition to that, remember, we pulled back on our share repurchase program in 2012. Once we announced the deal, we essentially bought no more shares back from that point in time. So we do see a little bit of dilution from higher shares as we move into 2013 business and it's about 1 point of impact adverse to our earnings per share. Partially offsetting that is lower interest expense. And I had mentioned this at the Investor Day. So we had some higher cost debt term out at the end of 2012 and also some in 2013. We replaced that with lower cost debt. We expect our interest expense to be in the range of $230 million to $240 million in 2013 business.
Another item that I want to point out is our Q1 outlook. We have discussed this on the fourth quarter call. So we do expect solid sales growth in the first quarter. But as John was mentioning, the first quarter is our highest inflation quarter of the year. We have net around 4 points of inflation in that quarter. Remember, John mentioned, over the course of the year, we have about 1 point of net inflation. So essentially, the way to look at it is that largely all of our inflation is happening in the first quarter of the year, and we've got good visibility to our inflation expectations and also to our savings expectations as we move into 2013. And we are a bit more hedged at this point in time in terms of our commodities in 2013 than where we were last year at this time for 2012.
As a result of that, we do expect our operating profit to be down slightly in the first quarter. In addition to that, we're lapping about $0.05 of benefit that we received in the first quarter of 2012 in association with the Pringles debt. We've had some interest rate hedges that were positive for us, $0.05 in the first quarter and then that flipped around in the second quarter. So we essentially have a $0.05 headwind in the first quarter of 2013 and we'll have a $0.05 tailwind in the second quarter of 2013.
The other item, as most of you are aware, the Venezuela currency has devalued. Now we communicated on our fourth quarter call that we had taken that into account, where we had an estimate embedded within our 2013 outlook. Clearly, that all falls in to the first quarter of the year, for the most part. There's a bit of translational impact that will occur over the next few quarters. So we're seeing about $0.03 to $0.04 of impact below the line from the Venezuela currency devaluation. Now as we've looked at some of the external estimates for our first quarter, we do find that those are a bit higher than where we had always planned to land our first quarter consistent with our guidance for the full year.
This next page, I won't go into a lot of detail. These are our operating principles, sustainable growth and manage for cash and specifically, looking at 2013. And essentially, the key message here is we are getting back on our operating model as you feel around the wheels and look at our performance. So we feel very comfortable and confident in getting back on that operating model and delivering against our sustainable growth objectives and manage for cash objectives.
Next, on cash flow. From 2002 to 2012 and '13, we have increased our cash flow significantly. Now it is clear that over the past 3 to 5 years, our cash flow has flattened out a little bit. It's been a function of our earnings, as well as our investments and capital spending and expense associated with our supply chain. We've guided to about $1.1 billion to $1.2 billion in 2013. And we did deliver $1.2 billion in 2012, but remember, that included a onetime benefit associated with the Pringles acquisition. And that benefit was in working capital. So our underlying cash flow was a little less than $1.1 billion in 2012. So we're growing our cash flow consistent with our earnings growth, and over time, we would expect to do just that.
And what do we do with that cash flow? Well, our objective over time is to return our cash to our shareowners. And over the past 5 years, we've returned nearly $6 billion of cash to our shareowners, including 2012 where we pulled back on our share repurchase program to pay down our debt. In terms of our dividend, we'll continue to work within the 40% to 50% payout ratio. Now we are towards the high end of that ratio at this time, but with our earnings growth, there is room for growth in our dividend as well.
And we've got a very attractive and competitive yield on our dividend also. In terms of our share repurchases, as I mentioned, we pulled back in 2012 and expectation is to pull back in 2013 as well, very consistent with what we've communicated to you that we may repurchase shares to the extent of options proceeds to manage dilution.
In addition to that, we're always out looking at acquisitions, joint ventures, strategic alliances that fit with our strategic objectives and our categories. And these are examples of acquisitions or joint ventures that we have done over the past several years. And John talked a little bit about the Wilmar joint venture that provides us with promising opportunities to grow our business in China as well. Our intent will be to continue to look at small, bolt-on acquisitions that fit in our strategic space.
So just in summary, we are committed to our operating principles and getting back on our long-term targets as well, and we are getting back on our operating model also. In the near term, we're going to use our excess cash to pay down debt associated with the Pringles transaction and strengthen our liquidity position and our balance sheet. But over the long term, our expectation would be to return our cash to shareowners through our dividend program and share repurchases.
With that, I'll turn it back over to John for some closing remarks.
John A. Bryant
Great. Thank you, Ron. So in summary, we have an exciting growth strategy. We've organized ourselves to make that a reality. We are getting back on our sustainable growth model. We're getting back on our operating principles that wheel is starting to turn in the right direction and our goal as we go through 2013 is to accelerate the rates we've set, that wheel is turning. So we have increasing visibility into our business.
And with that, I'd like to turn it over for some Q&A. [indiscernible], you want to take the Q&A?
Yes, Rob? Give it to him.
I think, Ron, you were giving a little more color on first quarter just now, saying operating income would be down. I have sales up 14%, 15% first quarter. So I guess, I was a little surprised, especially given that the presentation seems to indicate that the momentum is back on the business and Pringles is extraordinarily doing very well and Cereal is doing well in the U.S. Can you give us a little more color on why?
Ronald L. Dissinger
It's really a function of that net inflation that we discussed, Rob. And if you think about that net inflation for the year, virtually, in its entirety being situated in the first quarter, that's creating the adverse impact to our operating profit performance. So it's really driven by the cost inflation. We see that being a headwind in the first quarter, a slight headwind in the second quarter and then a tailwind as we move into the second half of the 2013 business.
We had said on Q4 -- on the Q4 call, we did say OP [ph] was going to be down slightly.
John A. Bryant
No, that's very consistent with what we communicated previously, Rob [ph].
Yes, Brian [ph]?
A question for Andy. If you could talk a little bit about the Pringles integration and maybe more specifically, the transition out of Procter & Gamble, especially on selling and distribution, how that's going, and especially, particularly the markets where you're having to recruit new distributors or new distributions, just how that process is played out.
Yes. We are -- as I have said, most of our major talks are now behind us. But we are in the middle of the last big one, which is transitioning our IP back office and our customer services from P&G to Kellogg. We completed the Asian switchover of the IT set up earlier this month with no issues whatsoever, and we will complete the European switchover in the last few days of this month. So we are very close to completing that switchover in the back office work. It's been hard work. We have had, I think, 800 people trained in Europe over the last couple of weeks. So we're getting those systems up and running. But we're very confident that we're in good shape to do that. Certainly, from a European perspective, we don't have anywhere where we're now putting in place new distributors. We're basically capitalizing on the Kellogg in-market operations in all of those regions where they exist, and we have distributors set up and running in distributor markets, both for Pringles and for Kellogg. So, so far, I would say they're good.
John A. Bryant
Just to add to that, in Asia-Pacific, we are changing distributors. We've done that in Japan in the fourth quarter. We're doing that through 2013. We'll have some slight disruptions as we go through that process.
We should go to Eric.
Two questions. First, you didn't really quantify yet revenue synergies in terms of snacks globally with the Pringles platform. I've always wonder why, for example, Rice Krispies treats aren't all over Asia. What could this mean for the business top line? And then two, I think you said at one point that you were going to use this integration to try to, let's say, redo Europe. And Europe's margins have gone from probably 18%, 19%, 4, 5, 6 years ago, now down to low double digits. And what will allow those margins to get back up? Or is there something structurally that's impaired?
John A. Bryant
I think on revenue synergies, we see a lot of revenue synergy potential. We've talked about leveraging the U.S. innovation pipeline more aggressively internationally. You've seen that already with Special K Cracker Chips being launched in the U.K. here in early 2013, as well as Mexico at the end of last year. We have not quantified that and quite frankly, it's very difficult to quantify that. But we think that they are significant and on top of our acquisition model expectations. In terms of Europe and the operating margin, Europe has been a very difficult region for us for a number of years. We believe that reorganizing Europe, putting ourselves in more of a cereals, snacks platform and accelerating the rate of innovation, will help us drive the top line that will help us drive the bottom line. And as we said, in 2013, we expect both top and bottom line growth for the European business.
If we can move forward to Alexia.
Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division
Can I ask about the strategy in emerging markets? It seems to me that a few years ago the focus was much more on developed market opportunities, particularly in Continental Europe, and now we're hearing a lot more about China and Russia and Central Europe and so on. As you think about building out your presence in these new markets, first of all, has that actually changed, in your mind, the strategy? Secondly, if you think about building out your business in these new markets, do you expect margins to come down or remain fairly flat as you go through this investment phase?
John A. Bryant
Clearly, building a stronger platform in the emerging markets is critical to the long-term future of the company. We've known that for a period of time. I think we've become more comfortable using different ways of opening up the emerging markets, so the Ülker joint-venture, now the Wilmar joint venture. So I think you'll see us doing more of that sort of activity going forward. Where we are doing organic investment like Brazil, it could have an adverse impact on margins. Where we do joint ventures, it would not necessarily have an impact on margins. So it depends very much country by country as to the impact.
With the commodity prices' pressure coming down a little bit, can you talk about the promotional spending activity, both in the U.S. and Europe, please?
John A. Bryant
I think, in terms of promotional activity in the U.S., let's take the Cereal category for example, we actually saw price per pound in the category growth $0.03 or $0.04 in the fourth quarter of last year. In the first month of this year, it looks a little bit more promotional, but quite frankly, I think that's because of the comparable. So in January last year, we increased our promoted price points on Special K, and quite frankly, that promotional strategy failed. So as we went into January this year, we went back to our more normal promotional price points and the result is it looks like more promotional activity, but it's actually just the comp. It's a bad comp. So we operate in intensely competitive categories. They're always competitive. I don't think we're seeing a shift change in the level of merchandising across the categories from a U.S. perspective. Obviously, in Europe, the consumers are under even more pressure. There's a little bit more focus on getting to the right price points, whether it be 1 Euro packs, 2 Euro packs, 3 Euro packs. So that's probably a little bit more aggressive an environment.
John, just a bigger picture question. You spent the 2000s, back in the volume to value days, really mixing this portfolio upward, not only in just in Cereal but in Snacks. If, in fact, we are now, or in the future, getting back to a better economic environment globally, first of all, in the current economic environment, do you see the potential for -- what mix factor, independent of inflation, do you think is possible as far as your internal net sales growth algorithm? And secondly, if we are in fact getting in a better economic environment, do you see the potential for -- in developed and developing markets to return to a period of volume to value, if you will.
John A. Bryant
I think, John, in that category, it's particularly in the more developed economies. Mix is a very important driver of that business. Our normal long-term aspiration will be to grow, say, around 3% of the top line and break that down 1/3 price, 1/3 mix, 1/3 volume. And we're not very far away from that algorithm as you think about our 2013 guidance. So we expect to continue to drive mix in 2013. Some of the reasons why, if look at the Cereal category. We think adult consumption is where the growth opportunity is in Cereal and adult brands seem to have a higher mix than, say, some of the kid brands. So there's some demographic reasons as well as business reasons why we want to keep driving that mix. The emerging market is a slightly different world where mix is obviously important, but driving just fundamental consumption is where we need to be and make sure we have the right price points, affordability and availability. So I don't think we're going to take developed market metrics and apply them to an emerging market business model so the business model is slightly different. But at a consolidated level, we see mix is very important and something that we can continue to drive as we go through the next several years the same way as we did back in the 2000s at a consolidated level.
We'll do last one, I guess, from Chris.
Christopher R. Growe - Stifel, Nicolaus & Co., Inc., Research Division
John, I had a question for you on revenue growth overall. And as I think about the last couple years where you've had a pretty solid increase in marketing, you've kind of kept that going, much higher levels of innovation and now a larger emerging market business. I just was curious, with 3% base revenue growth, could that be better? Or better said, what it -- is it just more marketing and more innovation that gets it moving? or is it a function of developed markets or -- just curious on your perspective there.
John A. Bryant
Our long-term growth aspiration is 3% to 4% organic sales growth. Our 10-year CAGR is actually 4%. We think, in running a food business, the best way to do that is to set realistic goals. And if you beat them, you beat them. But if you set aspirational goals and then you're forced to drive up the top line, you can make some poor decisions deeper in your P&L. So we prefer that 3% to 4% growth as a more appropriate realistic goal for the company.
Okay. With that, we'll take it to the breakout. Please join me in, again, thanking Kellogg for breakfast and for their presentation.
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