Our long-term recommendation for Kellogg (NYSE:K) is Neutral, which means the stock will perform mostly in-line with the market.
The company has functioned on two operating principles (“Volume to Value” and “Manage for Cash”) over the past five years. 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, especially by consolidating capacity in the U.S.
Kellogg continues to market 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. The company’s products, such as Rice Krispies and Special K cereals, are seen by many as a cheap meal and continue to be eaten at home to save money.
Although 2010 was a difficult year for Kellogg, the company has taken actions to revive momentum in fiscal 2011. Management at Kellogg believes that the company can achieve its objectives through increased innovation and investments in brand building initiatives. Kellogg has over a 100-year heritage of strong brands. Therefore, In combination with an attractive dividend yield, the company’s business model is expected to provide a strong return to its shareholders.
However, the common headwind for all food companies does not spare Kellogg either. Kellogg uses a number of raw materials such as corn, wheat, soy bean oil, sugar and cocoa, all of which are witnessing dramatic rises in costs. Therefore, the higher commodity prices are bound to impact the company’s margins.
In addition, cereal processing ovens at domestic and international facilities are fuelled by natural gas or propane, which are obtained from local utilities or other local suppliers. Short-term stand-by propane storage exists at several plants for use in case of interruption in natural gas supplies. Oil is also used to fuel certain operations at various plants.
In addition, considerable amounts of diesel fuel are used in connection with the distribution of Kellogg’s products. The cost of fuel, which is also on the rise, further is expected to reduce profitability. Added to these risks, the company also has a highly leveraged balance sheet, with a debt to capitalization ratio of 73%.
In conclusion, the earthquake and tsunami that hit Japan will have an impact on consumer spending and the overall economy of the country, which remains home to many luxury goods.
The company currently has a Zacks rank#3 which translates into short term “Hold” rating.