Kellogg's 2005 results may have been unspectacular but take into account difficult market conditions, adverse currency effects and a shorter shipping year and the cereal maker's performance is more creditable than it first appears. Chris Brook-Carter reports.

Kellogg executives have had reason to feel a little aggrieved with the stock market in the last week. Having reported stronger than expected fourth quarter and full-year earnings and upped its forecasts for 2006, the cereal company watched as its share price slid in the hours after its results presentation.

Certainly, there was nothing spectacular about Kellogg's results. Fourth-quarter earnings rose only 3% and sales were flat at US$2.39bn. However, dig a little deeper and it is understandable why one analyst referred to the US-based cereal maker as "a bastion of stability and predictability" last week - far more of a compliment in these difficult times than one might at first assume.

At the very least, Kellogg's 2005 included one fewer shipping week for the cereal maker, which was also hit by an unfavourable foreign-currency translation. Internal net sales growth, which excludes the effect of foreign-currency translation and the reduced number of shipping days, was 6% for the full year and 6% in the fourth quarter. Moreover, reported net earnings for the full 2005 year were US$980.4m, representing a 10% increase from last year's US$890.6m and slightly ahead of the general market consensus.

There were some justified concerns from investors that the cereal maker had failed to give guidance on the first quarter of 2006, when it is up against some tough comparisons from last year. "They've had such monster first quarters for the last couple of years, so that has created a difficult comparison," one analyst told Reuters last week.

But these are tough times for the food industry. Few food manufacturers have performed with any sort of lustre on the stock market while most have combined modest top-line growth with climbing costs to produce a concerning outlook for the sector. Nowhere has this been better demonstrated in the last week than by Kraft's announcement that it would be embarking on a second restructuring, a move that will slash 8,000 jobs, or 8% of the food giant's total workforce.

And yet against this backdrop, Kellogg has steadily gone about its business. Spectacular the cereal company has not been, but in such a difficult time, slow and steady can be equally sexy.

Kellogg North America reported net sales growth of 7% in 2005, and 2% in the fourth quarter, also affected by 2004's extra week. Internal sales growth was an even more impressive 8% in 2005, which built on strong growth of 5% in 2004; internal sales growth in the fourth quarter was also 8%.

Even more encouraging, however, was the performance overseas, given Kraft's troubles in the highly competitive European retail environment. Kellogg International reported net sales growth of 4% in 2005, and a sales decrease of 4% in the fourth quarter. Internal sales growth was 4% for the full year, even after 5% growth in 2004. Internal sales growth in the fourth quarter was 3%.

To be fair Kellogg's performance has not gone completely unnoticed. Credit Suisse analyst David Nelson has upgraded his rating on shares of Kellogg Co. to "outperform" from "neutral," citing the breakfast cereal maker's "good chance of exceeding its earnings guidance for 2006."

This success has been built on the twin policy of brand building and consistent cost management - both long-term strategies for the group which are not always easy to deliver on when reporting to a market fixated by quarterly results

Announcing the full-year performance CEO Jim Jenness said: "The excellent results that the company has achieved over the last four years are a testament to the longevity of our strategy and operating principles and our executional capabilities. Our focus and realistic targets allow us to make the right decisions for the long term and make significant investments in brand building and innovation, which we recognise are the drivers of industry growth."

Speaking on a conference call after the presentation he added that the company preferred to approach cost-cutting on a "continual, smooth basis" rather than having to undertake a major restructuring.

Importantly, the control on costs has allowed Kellogg to continue with its brand building strategy. And, despite raising its 2006 earnings expectations - at a time when industry operating costs are also projected to rise - the company also anticipates that it will increase its investment in brand building at a rate greater than sales growth in 2006 and execute additional cost-saving initiatives. Kellogg anticipates that these up-front costs will total approximately US$90m for the full year.

This investment in its brands couldn't come at a better time, when struggling rivals will find it harder to capitalise on the benefits to the cereal market of increasingly health-conscious consumers. "Brand building has been a hallmark in recent quarters and continued internal growth indicates the model's success," said Wachovia Securities analyst Jonathan Feeney in a research note.

Perhaps investors would do well to take note as another year of rising costs and changing consumption patterns looms for the industry. As the investment website Motley Fool said last week: "Granting that the year-over-year numbers don't look great, I'm still a fan of this company and its stock. The return on invested capital is very good, as is the free cash-flow yield, and I believe the company's slow-but-steady approach to the business is the correct one."