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K AT A GLANCE

P/E ► 16.5 AVG EV/EBITDA ► 11.1 AVG ROA ► 12.7% AVG ROE ► 52.2% VERY HIGH Debt to Equity ► 4.68 HIGH Current Ratio ► 1.06 LOW Interest Coverage Ratio ► 7.17 AVG

 

 

 

 

 

 

With 2008 sales of nearly $13 billion, Kellogg is the world’s leading producer of cereal and one of the largest producers of convenience foods^[1]. With sales in over 180 countries, Kellogg's produces some of the world's most iconic and easily recognizable brands including: Keebler , Pop-Tarts, Eggo and Rice Krispies. As of FY 2007, the company booked 66% percent of its revenues in North America, 20% in Europe and the remainder in Latin America and Asia Pacific regions.

Today, Kellogg faces the most difficult operating environment it has experienced in many years. Prime among the challenges confronting Kellogg are rapidly rising prices for several of the key inputs for its cereal and snack foods, including corn and wheat. Rising energy prices exacerbate high input prices by increasing the cost of transportation and delivery to Kellogg's distributors. Finally, Kellogg faces intense competition from General Mills and Kraft in its core U.S. market where a slowdown in consumer spending threatens to hurt sales. Despite these hurdles, Kellogg has posted strong performance with sales growth of 8% in 2007 and 3% growth in operating profit with a mix product innovation, price increases and increased advertising.

Business Overview

Kellogg's business is separated into two operating segments: Kellogg North America and Kellogg International. Kellogg generates the majority (66%^[2]) of it's revenue in North America which consists of the United States and Canada. The company's North American division is further subdivided by product type including cereal (25% of 2006 sales), snacks (30%), and frozen and specialty categories (12%). Kellogg International generates the remaining 34%^[3] of sales and consists of three regional operating segments: Europe (20%^[4]), Latin America (8%^[5]) and Asia Pacific (6%^[6]).

Quarterly Earnings

1Q09 In the first quarter of 2009, Kellogg posted revenues of $3.17 billion, a decrease of 2.7% from 1Q2008 figures; net income remained nearly unchanged at $321 million.^[7] The decrease in revenues is predominantly due to unfavorable foreign exchange fluctuations which had a negative 7.7% impact on the company during the quarter. This was partially mitigated by net pricing increases which raised revenues by 4.2%.^[8] The increase in net income is a result of Kellogg's ability to maintain costs and operating expenses as prices increased, contributing to a higher margin.

2Q09 In the second quarter of 2009, Kellogg posted revenues of $3.23 billion, a 3.5% decrease from 2Q2008 figures; net income grew 13.5% to $354 million.^[9] In terms of volume, the company fared relatively well, losing only .5% across its operating divisions. A net pricing increase of 3.1%, however, was negated by a 6.4% adverse shift in foreign currency translation. Ignoring these currency fluctuations, the company's international divisions mostly grew revenue, 8% in Latin America and 3% in Asia Pacific, while Europe fell 1% due to challenging negotiations with local retailers. The increase in net income was due to lower input costs as well as a 7% decrease in Selling, General & Administrative Expenses (SG&A) as a result of the company's cost reduction initiative.^[9]

Segments

*Note that corporate operating expenses are not allocated to individual segments, so operating income will add to more than 100%.

North America (66% of Sales, 74% of Operating Income)^[10]

Kellogg makes the majority of its sales in North America. Within the segment, the company reports revenues from its three primary product groups.

Cereals (23.7% of Sales)^[10]

Kellogg's is the number one player in the multi-billion dollar ready-to-eat U.S. cereal market with a 2007 market share of over 34%^[11]. The company markets many of the United States' most recognizable cereal brands including Apple Jacks, Cocoa Krispies, Kellogg’s Corn Flakes, Rice Krispies, Smart Start and Special K^[12]. Kellogg relies on a combination of product innovation and marketing strategies to drive growth in the mature U.S. cereal market. In fiscal 2007, Kellogg introduced several successful new products such as Special K Chocolatey Delight as well as child focused products like Fruit Loops Smoothie and Corn Pops Peanut Butter^[13]. The company also benefited from new advertising campaigns for its Raisin Bran Crunch, Special K and Rice Krispies brands^[14].

Snacks (30.9% of Sales)^[10]

North American Retail snacks which consists of cookies, cracker, fruit-flavored snacks and toaster pastries is Kellogg's single largest product category. Kellogg's Snack category includes familiar brands like Cheez-it, All-Bran, wholesome snacks such as Nutri-Grain and Special K bar as well as Pop-Tarts toaster pastry which holds a 86% category market share. ^[15]. Kellogg's snack business also includes the Keebler Foods cookie line which the company acquired for $3.8B in 2000^[16]. With the acquisition, Kellogg obtained Keebler's direct-store/door-delivery system (DSD) which lowers delivery costs and allows the company to target its product innovations and obtain prime shelf space. Product innovation and marketing also drive growth in Kellogg's snack category. In fiscal 2007, the company increased advertising at a double-digit rate^[17] and introduced several new product extensions such as Cheez-It Stix, All-Bran crackers, Keebler Dipping Delights and new Special K Honey Nut bars^[18]. Particularly successful were new portion-controlled packs such as 100 Calorie Right Bites Cheez-It packs^[19] which appeal to increasingly health conscious consumers.

Frozen/Specialty (11.4% of Sales)^[10]

Kellogg's frozen and specialty channels consist primarily of frozen breakfast and dinner products. The company's marquee brand in this segment are the ubiquitous Eggo Waffles- key to Kellogg's leading market share in the frozen breakfast category. Kellogg saw its breakfast market share grow in 2007 because of strong innovation with products such as Eggo Blueberry pancakes and Eggo Stuffed French Toaster Sticks^[20]. Kellogg's Morningstar Farms brand also produces vegetarian selections such as its newly introduced Mushroom Mozzarella Veggie Bites and Gardenburger' veggie foods^[21].

International (34% of Sales, 35.4% of Operating Profit)^[10]

With sales in over 180 countries around the world, Kellogg International is an important and promising segment of the company's business. Europe accounts for approximately 20% of total sales with the U.K. representing Kellogg's second largest market. Southern Europe (Spain, Italy), where per capita cereal consumption lags Northern Europe, enjoyed the strongest growth in the area over 2007^[22]. Kellogg also has a relatively small presence in central and eastern Europe which presents a promising opportunity for expansion^[23]. Latin America accounts for 8% of Kellogg's sales and is the company's single fastest growing regional market with a 6.5% increase in volume over 2007; Mexico is now the company's third largest market after the U.S. and the U.K. The Asia Pacific region accounts for 6% of sales and holds particular promise for Kellogg due to potentially huge consumer markets in developing countries like India and [[Rise of China's Middle Class|China].^[24] Despite challenging dynamics that arise with the introduction of traditionally western cereal and snack foods in eastern markets, low per capita consumption in the Asia Pacific region presents an exciting expansion opportunity.^[25]

Marketing and Innovation

Marketing and innovation are central to driving sales and profit growth at Kellogg. Indeed, Kellogg has had a strong commitment to advertising since 1929, when W.K. Kellogg doubled its advertising costs after the stock market crashed. In 2007, Kellogg spent $1,063 million on advertising and $179 million on research and development^[26]. Marketing innovation and product differentiation help keep consumers interested and translate directly into higher revenues. Over the past three years, Kellogg's revamped R&D department has helped the company claim 50% of industry sales of new product launches in cereal. In 200 bm gh hjy yuj rtytynj y7, 17% (or $2 billion) of the company's sales were from products launched within the past three years^[27].

Trends and Factors

U.S. Consumer Slowdown a Mixed Bag for Kellogg

Soaring food and energy prices^[28], the housing slump^[29] and a weakening job market^[30] are putting a drag on consumer spending in the U.S. where Kellogg generates the bulk of its sales. As a consumer staples business, Kellogg is somewhat insulated for a slowdown in consumer spending (people continue to eat during recession) and may even benefit from the spending slowdown as consumers opt to eat at home instead of going out to restaurants.

Rising Food & Energy Costs Pressure Margins

Kellogg purchases large quantities of agricultural commodities including cereal grains, corn products, wheat, cocoa and dairy products. Increases in the prices of such raw materials increases production costs and crimps margins. Kellogg is also more vulnerable to fluctuation in oil prices compared to its competitors due to its direct-store/door-delivery (DSD) system. Oil prices, along with plastic prices, affect production costs and packaging as well. Furthermore, Kellogg's competitive environment its ability to pass rising costs along to consumers. To mitigate the risk of commodity cost inflation, the company purchases commodities in advance using futures contracts and hedges the risks associated with buying commodities.

Supermarket Consolidation Reduces Bargaining Power

A steady trend toward supermarket consolidation is concentrating the buying power of Kellogg's largest customers. Kellogg's largest customer is Wal-Mart Stores. Wal-Mart made up 19 percent of consolidated net sales in 2007^[31]. Although no other company made up more than 10 percent of sales, the company claims that its five largest customers during 2007 accounted for approximately 32% of consolidated net sales and 40% of U.S. net sales.^[32]. Because these large customers are so important to sales, Kellogg has less bargaining power when determining wholesale prices.

Healthy Products Draw Newly Health Conscious Consumers

The focus on obesity and health & wellness has become a major factor in the food industry. Kellogg has capitalized on this trend with new adult-oriented cereals, directed toward the middle aged and the aging baby boomber generation. Three particularly successful health focused products include the Smart Start line which lowers blood pressure and cholesterol, All-Bran which aids digestion, and the Special K which aid with weight reduction and maintenance weight watching. Since Special K's introduction, it has been one of the fastest growing brands in the world, showing the impact of the healthy consumer. Kellogg has also become a player in the organic food business with its very successful Kashi brand of organic foods, purchased in 2000^[33]. Kellogg has also benefited from portion-control of its snack products which puts a healthy spin on some of its less healthy products offerings.

Competitors

Kellogg's primary competitors are General Mills and Kraft. Kraft generates triple the revenues that General Mills and Kellogg produce, and Kraft's leading segment is snacks which accounts for about $10 billion in revenue. Kellogg and General Mills, on the other hand, receive a large amount of their revenue from the cereal segment. Snacks and cereal are the common sectors to these three companies. In terms of risk, they are all susceptible to commodity, oil, and plastic prices.

Kellogg is the leader in the U.S. cereal market. Over the last few years, despite increasing competition, Kellogg has slowly increased its market share. Kellogg now controls about one-third of the market, followed by General Mills with 31 percent and Quaker (a division of PepsiCo) and Post (a division of Kraft Foods). Kellogg has also launched more cereals than General Mills recently. Kellogg controls 50% of the market for new cereals in the United States. New cereals are particularly important since manufacturers generally charge higher prices for them than for older products.

References

1. ↑ 2008 10-K p. 1
2. ↑ Kellogg 2007 10-K Item 7. Results of Operations
3. ↑ Kellogg 2007 10-K Item 7. Results of Operations
4. ↑ Kellogg 2007 10-K Item 7. Results of Operations
5. ↑ Kellogg 2007 10-K Item 7. Results of Operations
6. ↑ Kellogg 2007 10-K Item 7. Results of Operations
7. ↑ k 2009 10-Q  
8. ↑ k 2009 10-Q  
9. ↑ ^{9.0 9.1 9.2} K 2009 8-K  
10. ↑ ^{10.0 10.1 10.2 10.3 10.4 10.5} [ K 2008 10-K]  
11. ↑ Kellogg 2007 10-K Letter to Shareholders
12. ↑ Kellogg 2007 10-K Item 1. Business
13. ↑ Kellogg 2007 10-K Letter to Shareholders
14. ↑ Kellogg 2007 10-K Letter to Shareholders
15. ↑ Kellogg 2007 10-K Letter to Shareholders
16. ↑ NY Times- Kellogg Agrees to Buy Keebler Foods
17. ↑ Kellogg 2007 10-K Letter to Shareholders
18. ↑ Kellogg 2007 10-K Letter to Shareholders
19. ↑ Kellogg 2007 10-K Letter to Shareholders
20. ↑ Kellogg 2007 10-K Letter to Shareholders
21. ↑ Kellogg 2007 10-K Letter to Shareholders
22. ↑ Kellogg 2007 10-K Letter to Shareholders
23. ↑ Kellogg Investor Relations Presentations- 2007 Annual Meeting Printable Slides 2 of 2
24. ↑ Kellogg Investor Relations Presentations- 2007 Annual Meeting Printable Slides 2 of 2
25. ↑ Kellogg Investor Relations Presentations- 2007 Annual Meeting Printable Slides 2 of 2
26. ↑ Kellogg 2007 10-K Item 6. Selected Financial Data
27. ↑ Kellogg Investor Relations Presentations- 2008 CAGNY Printable Slides
28. ↑ The Boston Globe- Surging costs of groceries hit home
29. ↑ Bloomberg Case-Shiller Index Falls
30. ↑ NYTimes Unemployment Rising
31. ↑ Kellogg 2007 10-K Item 1. Customers
32. ↑ Kellogg 2007 10-K Item 1. Customers
33. ↑ Kellogg Acquires Kashi