Comment: 2011 will be a challenge for cautious Kellogg
It was a cautious Kellogg management team that addressed investors and analysts in the US yesterday (2 November).
The cereal giant has had a difficult 2010. A significant product recall has dented sales and Kellogg has faced weak cereal markets at home and abroad (notably the US). Both of these elements continued to affect the business at it moved through the third quarter of the year, three months in which earnings fell 6% on the year and sales slid 4%.
CEO Dave Mackay said 2010 was "disappointing for all of us" and said the recall, supply-chain issues, less innovation and falling prices in Kellogg's core cereal markets had taken the business "off course".
As well as publishing third-quarter numbers, Kellogg gave its guidance for 2011, and, after the year the company has had, it was little surprise that Mackay set out conservative targets for 2011.
Next year, Kellogg expects internal net sales to grow in the "low single-digits", in-line with its long-term growth targets.
However, the company said internal operating profit is expected to be flat or, at worst, down 2%, reflecting its need "to reset incentive compensation levels". Kellogg is also targeting 2011 earnings per share on a currency-neutral basis are expected to grow by low single-digits. The forecasts took a bite out of the breakfast maker's shares and left analysts digesting targets that were below some estimates.
Mackay acknowledged it would take "time, focus and effort to regain our momentum" and admitted: "We believe we can do all this but it will not be done overnight."
That said, Mackay and COO John Bryant were keen to look ahead to 2011 with optimism, pointing to the new products Kellogg would launch and improved trading conditions in the US cereal market (less promotional activity and the prospect of price increases) as two key drivers of improvement in 2011. Pointing to the product lined up for the US market, Bryant said: "We expect it to be one of the strongest years of innovation."
Nonetheless, Kellogg's tone during the conference call with analysts was one of caution. For all the upbeat noises about, for instance, new products adding 25% to sales in the US next year and for all the belief that the worst of the promotional dogfight in US cereal was over, there was the recognition that business on both sides of the Atlantic would remain difficult.
Mackay warned that trading conditions would remain tough next year in both the US and Europe, with unemployment remaining high. "We're not anticipating any massive change as we look at 2011 at this point," he admitted.
A downturn should benefit cereal makers. Eating a bowl of cereal at home provides more value than, say, grabbing a croissant and a coffee from Starbucks on the way to work. Cereal makers like Kellogg did benefit from that trend in 2009. However, during 2010, certainly in the US and the UK, something of a price war developed in the cereal category and that, combined with less product launches from Kellogg, hit the business.
Rising commodity costs suggests the deflationary spiral seen in cereal is set to stop. Indeed, in the US, General Mills has upped its list prices on a quarter of its volume. However, even if retailers accept price rises, with consumer confidence still fragile, will shoppers switch to paying more for their cereal?
"Increased promotional spending throughout the industry is conditioning consumers to expect lower prices, and in the absence of product innovation that resonates with consumers, weaning them from lower prices could prove challenging, particularly as unemployment levels remain elevated," Morningstar analyst Erin Swanson said yesterday.
Kellogg is promising more innovation and its planned strategy for the US - to take brands successful in one market and launch in another - has had success in the UK in the last year (think the launch of the French Tresor brand as Krave in the UK). However, that strategy, as with any product launch, is inherent with risk and the company has had its misses on NPD in recent months (think Nature's Pleasure in the UK).
A more rational pricing environment will bolster Kellogg's top line but competition for cash-strapped consumers will remain fierce - particularly from General Mills in the US and Cereal Partners Worldwide (General Mills' venture with Nestle) elsewhere. Kellogg's margins, already facing a squeeze from higher incentive compensation, will remain under pressure.
"In our view, input cost inflation will persist, reflecting increased demand for commodities in emerging and developing markets. In addition, we anticipate that increased promotional spending will be necessary, as consumers continue to seek out value," Swanson said.
Given the year Kellogg has had, it is no wonder management was careful with its guidance for the year ahead. It is just that 2011 also promises to be challenging.
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