Kellogg Turns A Corner In Q3 2017
Summary
- The market for processed and packaged goods is evolving.
- Kellogg's third quarter net sales increased after ten quarters of negative growth.
- Kellogg will acquire RXBAR for $600 million by end of 2017 and release a new breakfast cereal.
By Jillian Falduto of Ursinus Finance Scholars.
It’s been a quarter of change for the longtime consumer goods staple Kellogg (NYSE:K). Kellogg’s stock closed at 58.87- down 17.95% on a YTD basis- the evening before the third quarter earnings release. In the same time frame, the S&P 500 was up 13.95%. But on Halloween morning, quite appropriately, the sugary cereal company’s third quarter financial results signified signs of a turnaround. In the first two quarters of 2017, Kellogg’s net sales were down 4.15% and 2.48%, respectively. However, with new CEO Steve Cahillane, in the third quarter of 2017, K reported a net sales increase of 0.6%, which marks the first quarter of positive growth in two and half years.
Over the past two years, Kellogg has been cutting costs in attempts to combat hits to revenue, and thus, the company has consistently improved EBITDA and net income margins. In the third quarter of 2017, Kellogg Company discontinued shipping through its direct store distribution system, reduced its workforce, and cut expenses even further. This time around, expense management was complemented by a net sales increase, and Kellogg reported a 13.1% increase in operating margin and 3.7% growth in earnings per share.
Industry Changes
The demand for consumer and packaged goods isn’t what it used to be, and subsequently, Kellogg products haven’t quite met the interests of health-conscious consumers and a developing retail market.
Most obviously, Amazon’s (AMZN) acquisition of Whole Foods and the continuation of the grocery price war have already pushed grocery store stocks down with the expectation that Amazon will lower Whole Foods prices. However, Amazon has yet to deliver on that promise. On average, Whole Foods prices have dropped less than 1% since the acquisition. Meanwhile, Amazon’s competitors are not backing down. Wal-Mart, who accounted for approximately 20% of Kellogg’s 2016 consolidated net sales, is projecting its e-commerce to grow sales by roughly 40% in 2019 through the addition of 1,000 online grocery pickup locations. Wal-Mart’s (WMT) stock is up 25.72% YTD with a 60% increase in online sales in the first half, and WMT just announced a $20 million buyback, which tells a much more optimistic story for Kellogg, for Wal-Mart is one of its main product distributors. Similarly, Kroger’s (KR) announcement of its “restock” plan for a more convenient shopping experience recently pushed KR’s stock up 7.1%.
On top of industry structure changes, consumer trends have shifted from sugary staples to organic, wholesome foods. Kellogg Company is combatting the decline in demand for traditional consumer and packaged goods with new products, rebranding, and marketing techniques, and K is starting to reap the benefits. Thus far, Kellogg has removed artificial ingredients from EGGO waffles and developed new Kashi and Special K bars. At the end of the third quarter of 2017, Kellogg reported that the U.S. Frozen Foods, Kashi, and Canadian businesses led the revenue increase with 3% sales growth and a 38% increase in operating profit.
The Acquisition of The Chicago Bar Company
Kellogg hopes to further its nutritious changes with a $600 million acquisition of the producer of the popular health bar, RXBAR. As a segment of Kellogg, The Chicago Bar Company will continue to operate independently. Net of tax benefit, this $400 million purchase aims to improve K’s top line in the long run. Although financials on the acquisition of the private company have not been released, press releases indicate that RXBAR's net sales are projected to be approximately $120 million in 2017, and Kellogg is expecting triple-digit growth for the brand.
Chocolate Frosted Flakes
Even with the new healthy market, Kellogg cannot afford to abandon its roots. On top of health-conscious changes, Kellogg is remaining loyal to sugary cereals with its newest addition: Chocolate Frosted Flakes. Breakfast foods account for more than 40% of Kellogg's bottom line, and in 2016, K reported the six core cereal brands collectively gained 20 basis points of share- one of those six being Frosted Flakes. In the third quarter of 2017, Kellogg reported that morning foods sales fell 3%, but the addition of Chocolate Frosted Flakes and new marketing techniques are likely to improve this number in the fourth quarter.
Conclusion
It’s not over yet for the longtime consumer goods staple. While months of less than favorable performance don’t bode well for the brand, new products, restructure, and acquisitions are keeping Kellogg alive. It’s a long road ahead to capitalize on these ventures, and while the acquisition of basement startup RXBAR and the creation of Chocolate Frosted Flakes alone are unlikely to save Kellogg altogether, they are steps in the right direction.
K’s management displays a thorough understanding of industry changes and demand. While the overall trend is down on a YTD basis, Kellogg could see RXBAR and e-commerce push growth up again in early 2018 and into 2019. Earnings per share have increased 13.3% YTD, and in all, Kellogg has shown great ability to manage net income and adapt throughout its life. The once cereal brand has kept up with an ever-changing market, and with RXBAR growth, the right strategy for e-commerce, and probably a little bit more innovation, Kellogg has the potential to grow once again. Though K’s stock won’t jump up Amazon-style, investors willing to weather the industry changes will likely see return in time. Meanwhile, K rewards patient investors with a 3.5% dividend yield backed by a payout that has increased each year well in excess of inflation. In a broad market of stocks all facing the same challenges as Kellogg, K offers a sense of consistency and control, with eyes on a more prosperous future.
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