Kellogg Company K could not sustain the first-half momentum in the second as the third-quarter sales missed our forecast due to the absence of improved cereal trends. Moreover, currency fluctuations pulled down revenues.
Shares of the world’s largest cereal maker declined 3.3% in pre-market trading.
Earnings Beat
Third-quarter adjusted earnings of 85 cents per share declined 9.6% year over year due to significant currency headwinds.
However, earnings beat the Zacks Consensus Estimate of 83 cents by 2.4%. Excluding currency headwinds of 11 cents, earnings increased 2.1% year over year as Project K savings, pricing gains and lower taxes partially offset weak volumes and the resetting of incentive compensation.
Adjusted earnings exclude charges related to re-measurement of the Venezuelan business, acquisition-related integration costs, costs associated with Project K, a mark-to-market loss and certain other items. Including these items, reported earnings were 58 cents per share, down 6.5% year over year.
Revenues Soft
Kellogg reported revenues of $3.33 billion which declined 8.5% year over year due to significant currency headwinds.
As Kellogg generates around 40% of net sales outside the U.S., a strong dollar lowered the value of international sales. With almost all foreign currencies deteriorating compared with the U.S. dollar, currency translations are posing a significant headwind in 2015, thereby limiting revenue growth.
Currency hurt sales by 9.8%. Acquisitions and dispositions had a positive impact of 0.3%. Accordingly, organic revenues (excluding the impact of acquisitions, dispositions and foreign exchange) improved 1%.
Organic sales increase was better than an improvement of 0.1% seen in the previous quarter as price/mix gains offset lower volumes. Volumes declined 1.6% worse than 0.4% shortfall in the second quarter. On the other hand, price/mix added 2.6% to sales, better than 0.5% in the last quarter.
Revenues missed the Zacks Consensus Estimate of $3.440 billion by 3.2%.
After a difficult 2014, Kellogg witnessed improved sales trends, mainly in the U.S. business, in the first half of 2015 backed by renovation, innovation, and brand support funded by savings from Project K. However, the improved sales trends in the U.S. could not be sustained in the third quarter. Organic sales, however, improved in Latin America and Asia Pacific.
Profits Down
Kellogg’s adjusted operating profit declined 2.3% to $518 million on a currency neutral basis due to the impact of resetting incentive compensation which hurt profits by 8%.
Profits declined in North America and Asia/Pacific, but improved in Europe and Latin America.
Segment Discussion
North America: North America sales declined 2.7% (down 1.4% organically) year over year to $2.26 billion as lower volumes offset price/mix gains. While volumes declined 2.4%, price/mix rose 1%.
Organically, the U.S. Morning Foods business, which includes cereals such as Corn Flakes and Special K, went down 2.6%.
Kellogg’s U.S. cereal business has slowed down since 2012 due to sluggish category growth resulting from lower demand. Competitive pressures from alternatives such as yogurt, eggs, bread and peanut butter are lowering the demand for cereals. Moreover, shift in consumer attitude from dieting to health and wellness is hurting the sales of Kellogg’s weight management cereal brands, like Special K
To improve sales performance, Kellogg has launched campaigns supporting the breakfast occasion. The company is also investing in in-store capabilities, product and packaging innovation as well as reformulation of many existing products to drive demand.
Specifically, the company is completely redesigning the Special K brand (cereals and snacks) with plans to re-launch it as a healthy lifestyle brand in line with the changing consumer trends. In this regard, the company launched a protein and a gluten-free version of Special K, while improving some of the existing products like Special K Red Berries and Special K Vanilla Almond.
Though these initiatives improved cereal results in the first half, it could not be sustained in the second as third-quarter organic sales decline in the segment was wider than 2.3% in the previous quarter.
The U.S. Snacks businesses — struggling since 2013 due to weak volumes — declined 1.5%. The U.S. Specialty Channels business grew 6.2% organically, while the North America Other business went down 3.4%.
Adjusted operating profit declined 3% in North America due to lower sales and impact of resetting the incentive compensation.
International: During the quarter, revenues in Europe declined 2.1% organically to $628 million. Asia Pacific increased 2.2% organically to $235 million helped by growth in the Asian business. Latin America also improved 23.9% to $202 million.
Adjusted operating profit (constant currency) grew 3.4% in Europe and 15.1% in Latin America but declined 20% in Asia Pacific.
2015 Guidance Re-Affirmed
Kellogg maintained the full-year guidance. Organic revenue growth is expected to remain flat in 2015. Also, adjusted operating profit is likely to decline between 2% and 4% on a constant currency basis.
Adjusted earnings per share are expected in the range $3.74–$3.82, representing growth range of negative 2% to flat. The adjusted earnings guidance excludes the impact of currency as well as an extra week in 2014.
Both operating profit and earnings per share guidance, however, include a negative impact of 3–4 percentage points related to the changes in its incentive-based compensation plan for 2015.
The company expects cash flow for the year to be approximately $1.1 billion, higher than $1 billion projected previously.
2016 Outlook
Kellogg still expects to achieve its long-term targets for sales and operating profit growth in 2016 — 1% to 3% in organic sales growth and 4% to 6% improvement in adjusted operating profit.
However, the company expects constant currency adjusted earnings to grow in the range of 6% to 8%, which is slightly less that the long term target of 7% to 9%.
Stocks to Consider
Kellogg currently carries a Zacks Rank #3 (Hold). Some better-ranked stocks in the broader food and beverage sector are B&G Foods Inc. BGS, Cal-Maine Foods, Inc. CALM and Campbell Soup Company CPB. All the three stocks have a Zacks Rank #2 (Buy).
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