Kellogg finds top-line growth challenging

Kellogg finds top-line growth challenging

US-based cereal giant Kellogg disappointed the market this week when fourth quarter sales and earnings failed to hit analyst estimates. While management subsequently shrugged-off falling volumes and insisted that the group is well-positioned going into 2010, Katy Humphries suggests that the results highlight some of the limitations of Kellogg's current strategic direction.

Kellogg yesterday (4 February) missed Wall Street expectations when it posted a 1.7% drop in fourth-quarter earnings, which slid to US$176m, or $0.46 per share – three cents less than consensus estimates.

Fourth-quarter revenue fell 1% to $2.9bn, below the average $2.94bn estimate, on the back of a 1.4% decline in volumes.

Speaking during a conference call following the earnings release, Kellogg management suggested that the declining volumes were down to two factors: production issues at the company's Eggo frozen waffle business and changes in product mix at Kellogg's operations in China and Russia.

Chief executive and president David Mackay insisted that Kellogg's disappointing end to 2009 does not undermine the group's strategic direction or its position at the high-end of the cereal category, which has proved relatively resilient in the face of the global economic downturn.

Kellogg has invested heavily in advertising and marketing activity globally in order to safeguard the value of its brand and avoid some of the pressures to cut prices and increase promotional activity in an increasingly competitive space.

“Strong advertising and brand building is a fundamental part of our beliefs that underpins our ability to drive sustainable and dependable performance, so that's something you're going to see every year,” Mackay reiterated.

Nevertheless, the international picture was a familiar one. Kellogg said that sales in North American and Europe dropped 1% and 2% respectively. Meanwhile, the emerging markets of Latin America and Asia Pacific each saw sales jump 7%.

Growth rates in the developed – and highly competitive – European and American markets are unlikely to show significant growth any time soon.

And, no matter how much Kellogg pours into advertising, it seems unlikely that the company will be able to drive sustainable, long-term growth through either pricing or market share gains in these regions.

For 2010, the company raised its outlook to $3.51 to $3.57 in EPS, excluding currency effects, an increase of 11% to 13%. The company said it expects net sales growth of just 2-3%. Analysts had, on average, been expecting earnings of about $3.62 per share, or about 15% growth.

So, while advertising investments might mean Kellogg can offer a “sustainable” and “dependable” performance, if the company is to do more than tread water it must look further afield, driving expansion into high-growth emerging markets to drive top-line growth.

However, it is here that the US company has hit a snag.

As Mackay said at the group's investor meeting in November, Kellogg is unwilling to enter emerging markets unless such a venture would generate quick returns for investors.

"We have been talking for a number of years about our desire to compete in emerging markets, as long as we can find an entry vehicle that will start returning to shareholders in a short space of time... If we can participate in emerging markets in cereal and snacks in a way that is going to give good returns to shareholders we will do that," he said.

In a bid to boost its operations in Russia and China, Kellogg has begun the slow process of shifting its portfolio to higher-margin, premium packaged foods from lower-margin or bulk business. However, this hardly represents a step-change in strategy.

With Kellogg yet to identify acquisition targets that would significantly boost its presence in emerging markets, it seems that we could see the company's top line continue to stagnate for some time to come.