Innovation Key To Future Performance As Kellogg Remains Challenged In Short Term

Aug.27.14 | About: Kellogg Company (K)

Summary

Top line growth remains weak due to slow growth in the cereal category.

Product innovation initiatives and brand-building efforts will portend well for growth in the future.

Performance might be challenged due to changes in consumer preferences and competition in the industry in the short term.

Kellogg (NYSE:K) is among the leading cereal companies of the world; the company's performance in the recent past has been adversely affected by weak consumer spending. Also, K's top line growth has faced challenges in the recent past due to changes in eating preferences of consumers. Although the company's multi-year cost-saving plan, Project-K, is well on track to delivering cost savings, the weak top line growth and increased investment in brand-building initiatives have weakened its margins. Owing to its weak top line growth and also due to the prevailing headwinds in the cereal category, the company has lowered its 2014 guidance. However, I believe the accelerated level of brand-building initiatives of K and cost savings through Project K will portend well for the company's margins and bottom line growth.

Sluggish Cereal sales = Pressurized Top Line

In the recent past, K's top line growth has remained weak due to the sluggish sales growth of the cereal business within the U.S. owing to the changes in consumer preferences; consumers are now focusing more on healthy foods. In an attempt to cater to the changes in consumer preferences and tastes, the company has been consistently working on product innovation and has been coming up with new products like instant hot cereals.

I believe the company's product innovation efforts will portend well for its top line growth and its market share in the long term. In the recent past, the company has been consistently reporting weak top line results, as shown in the chart below. The company reported a YoY revenue drop of 0.8% in Q2'14.

Click to enlarge
Source: Company's Earnings Data

The company needs innovation for its cereal category in order to capitalize on the changing trends in the market. K's competitor in the cereal category, General Mills (NYSE:GIS), seems to have sensed the potential of the cereal business, as the company has ramped up its innovations in the cereal category. To serve health-conscious customers, GIS has launched a protein-rich oats Cheerios protein. And the company is constantly expanding the family of its gluten-free cereals to satisfy those who are looking to avoid gluten in their diet. I believe that in the long run, GIS' innovations will pose a threat to the struggling cereal sales of K. However, through its innovations, K will be able to address the competition. K's management affirmed in the recent-quarter earnings conference call that it will continue to focus on innovation to strengthen its position in the market.

Also, K has been spending on brand-building initiatives by increasing marketing and advertisement spending. The brand-building initiatives will help the company strengthen the positions of its existing brands, as well as support new product innovation.

Project K and Cash Return

The company's Project K, a four-year productivity enhancement program, is well on track. As the company's top line growth stays weak, it has been working to reduce costs to fuel its bottom line growth. The company has plans to shut down the excess capacity of some of its cereals and snacks business to lower down 7% of jobs. Also, the company plans to achieve cost savings of $425-$475 million by the end of 2018. The cost savings will help the company support its margins and bottom line growth in the future, as its top line growth remains weak.

Also, the company offers rich cash returns to its shareholders through dividends and share repurchases. The company currently offers a dividend yield of 3.20%. Also, the company repurchased more than $300 million worth of common share in 1H2014. The share repurchases, along with costs savings under project K will portend well for the company's EPS growth. The following table shows analysts' earnings growth expectations for the next five years for K, Kraft Foods (KRFT) and GIS.

Company

Earnings Growth Rate

K

6.43%

KRFT

7.96%

GIS

7.74%

Click to enlarge

Source: Nasdaq.com

Acquisition

As growth for the company's cereal segment remains weak, it has been making efforts to strengthen its product portfolio through strategic efforts. The company's acquisition of Pringles back in 2012 has increased the company's footing in emerging markets, and positively affected its top line. In Q2'14, the company witnessed a double-digit net sales growth for the Pringles business. I believe that going forward, the Pringles business will continue to add towards the company's top line, with its broader outreach in emerging markets.

The positive results from the Pringles acquisition have boosted the company's confidence to consider more acquisition options in order to regain top-line growth. In this regard, the company has been eyeing another acquisition in the snacks category. The company has shown a keen interest in buying United Biscuits, a British biscuit and cracker manufacturing company, for $3.4 billion. If the company is successful in acquiring United Biscuits, it will strengthen its product portfolio.

Conclusion

The company's top line growth remains weak due to slow growth in the cereal category as a result of changes in consumer preferences. Also, the company has been facing competition from peers like GIS. As the company's top line growth remains weak, its product innovation initiatives and brand-building efforts will portend well for its growth in the future. Also, the company's cost-saving efforts will support its margins and earnings growth, as its top line growth remains weak. In the current situation, K needs consistent product innovation efforts to strengthen its position, which will portend well in the long term. However, in the short term, the company's performance might be challenged due to changes in consumer preferences and competition in the industry.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.