Kellogg reported a second quarter of declining profits and sales but on a conference call with investors yesterday, the management team insisted it is taking the right steps to position itself for long-term growth. Here is just-food's take on the latest numbers, recent performance and outlook for the business.
1. Cereal recovery
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The improvement in its North American cereal business that started emerging in the first quarter carried through to the second quarter. The firm said its focus on the "four critical elements" – wellness; investing in foods; engaging with consumers in new ways and "dialling up the fun" – to return cereal to growth had paid off. "Over the past nine months, we have made good progress on the agenda we set out and have seen a stabilisation of our Kellogg's branded business. This is illustrated by our improving top-line performance and Kellogg's branded share being up year-to-date," said Paul Norman, senior VP and president, Kellogg North America.
2. The bid to revive Special K
Within cereal itself, Kellogg had committed to pulling Special K out of the "diet brand" spotlight and has started to reposition it as a wellness brand. Over the past few months it has launched a new protein offering and introduced a gluten-free version of the Special K cereal in the US. Norman said the moves have resulted in a "steady improvement in performance" and, according to the latest public data, consumption increased by 2.4%.
3. Wellness focus
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By GlobalDataAs part of its migration to "wellness" Kellogg launched Origins earlier in the year for which it says "early acceptance has been good". Going forward, it plans to renovate its core offerings to cater to the nutritional needs of today's consumer. This fiscal year the firm launched Froot Loops and Apple Jacks with lower sugar. Going forward, new offerings will include added protein, gluten-free options and simpler ingredient panels. "We know consumers are looking for foods with simpler ingredients and work is well underway to answer that call. Already in North America, 75% of our cereals are made without artificial colours and more than half are made without artificial flavours. Further, we have been working to remove artificial colours and flavours across Kellogg's branded cereals and a variety of Kellogg's branded snack bars as well as Eggo frozen foods. Our goal is to complete this transition by the end of 2018," said Norman.
4. The Kashi lag
Kashi is still presenting Kellogg with a string of challenges. Last August, CEO John Bryant pointed to Kellogg's lack of "ability to execute quickly enough in the evolving world of natural and organic food" adding that Kashi had not been focused enough on "progressive nutrition." The company has also faced legal challenges over "natural" claims associated with Kashi products. Sales of the Kashi business fell in the second quarter which led to a decline in the total "North America other" segment revenue of about 1.3%. But Kellogg said it is seeing distribution losses subside and velocities begin to stabilise. "The team is making good progress on renovation and innovation plans, and we expect to see the fruits of these efforts begin to come through in improving trends over the coming months and as we enter 2016," said Norman. "As you know, we've made a significant investment in the Kashi team and organisation. And we believe we have the right structure in place."
5. Snack unhappy
Over the past ten years Kellogg had made moves to reduce its reliance on the cereal aisle, acquiring snack brands like Keebler and Pringles. This quarter however, snacks demonstrated mixed results. Sales fell 1.8% in the US and, while Pringles sales grew and consumption in crackers and cookies improved, wholesome snacks is where Kellogg felt a bit of a chill. "Distribution losses on prior innovation have impacted our businesses this year. We are committed to improving the performance of US snacks, and this will be an area of focus for me in coming months," said Norman.
Alexia Howard, analyst at Sanford Bernstein, suggested that one way for Kellogg to bolster its US snack performance could be through M&A. "Given a robust Pringles platform, it seems possible that Kellogg could seek a way out of its current predicament by leading a roll-up of the US snacking segment – perhaps starting with Diamond Foods and potentially supporting this with smaller acquisitions of emerging challenger brands. Snacks are inherently stronger categories than cereals and this could work if executed well," she said.
6. Project K
Project K costs weighed heavy on Kellogg's second quarter bottom line. Operating profit fell 11.6% to $412m. Comparable operating profit dropped 10.5% to $507m. But chairman and CEO, John Bryant, insisted the benefits far outweigh the costs. "We expect it to continue to build momentum into the second half of the year," he asserted. Savings realised have provided the firm with the funds to invest in Kashi, new sales forces in the US and its coverage of high frequency stores in emerging markets. "These investments have already had an impact and will help to drive even better results next year," he said.
7. Europe
The region experienced a fall in comparable net sales of 2.5% during the second quarter, on the back of continued pressure in cereals. Kellogg hopes to recover this with a re-staging of its Special K cereals. New Special K cereals are being launched across the continent in the second half and mueslis have just been introduced in Germany with plans to roll these out across other parts of the region. Pringles performed well for Europe with mid-single digit currency-neutral comparable sales growth. Wholesome Snacks experienced improved consumption.
8. Latin America
Total currency-neutral comparable net sales in the region increased by 14.5% in the second quarter driven by growth in both cereal and snacks. Bryant said sales in cereal were "ahead of expectations" with good growth in kids' cereals and a benefit from the parent brand products it has launched this year. Sales in the snack business increased at a high-single digit rate. Investment into high-frequency stores in the region is seeing early distribution gains and sales growth. "We see significant opportunity for further gains as we expand our efforts. The team in Latin America has done a great job with new products, investing in growth and executing the plans. The results this quarter reflect all this effort," said Bryant.
9. Asia Pacific
Currency-neutral comparable net sales in Asia and Sub-Saharan Africa increased at a double-digit rate. India benefited from new packaging initiatives while the Japanese business experienced "continued popularity" of granolas and All-Bran. New advertising and innovation helped drive sales of Special K brand up in South Korea. But sales in Australia fell. Bryant said the Australian environment was expected to "remain challenging" but plans for improvement were underway including new product introductions, support which stresses the nutritional benefits of Kellogg's food and a focus on increasing distribution.
10. Outlook
While Kellogg expects full-year 2015 currency-neutral comparable operating profit to decrease at a rate between 2% and 4%, Andrew Lazar, analyst at Barclays said ultimately it is a "reinvestment year" and what was being looked for in the quarter was "signs of improvement" particularly since General Mills recent earnings results implying that ready-to-eat cereal category trends are less challenged.
Kellogg is, however, banking on long-term growth recovery. It said "due to continued strong productivity, progress with Project K and zero-based budgeting, and the year-over-year sales momentum seen in 2015" it expects that it will achieve its long-term targets for currency-neutral comparable net sales and operating profit growth in 2016.
"What we're essentially doing is letting investors know that we expect to be on our long-term top-line and operating profit growth goals for 2016. We're building momentum in 2015 and we see that continuing into 2016. You're seeing it with continued strong Pringles growth around the world. You're seeing it with the larger cereal businesses starting to perform better, particularly in the US and Canada so far. You're seeing also very strong emerging market growth. We grew cereal double digits across Latin America and Asia," said Bryant.
Howard said even if sales growth is lower than management's expectations, Project K savings and zero-based budgeting cost cutting efforts could give management the flexibility to achieve its FY16 operating income and EPS growth targets. "It will be important to cut costs surgically to not repeat the 2010 billion-dollar challenge fiasco, which led to morale and quality-control issues across the US manufacturing base due to the company's tight timeframe to achieve cuts; the company ended up having to reinvest to rebuild these capabilities."
