K – Adding to Best Ideas Short

Consumer Trends Work Against Portfolio. More Than Cost Savings Needed


Kellogg’s has taken so many blows to the head that it’s curious it is still standing. Despite the leg down the stock has taken today following a disaster of a Q2 report, we’re adding Kellogg’s as a Hedgeye Best Idea on the short side.

 

What’s clear is the company is working against some pretty powerful consumer trends that demand healthier, protein based foods for breakfast (think Greek yogurt and Eggs & bacon) and not cereal with milk. Add on a competitive landscape in snack foods and cereal bars (GIS and MDLZ), the struggles to get cereal and breakfast food adoption across global geographies, and the economically weakened consumer (in the US and abroad), and the macro headwinds on the business are quickly apparent. 

 

In the quarter, K’s top-line missed consensus ($3.69B vs $3.71B) and diluted EPS of $0.82 decreased -15% Y/Y!  The company lowered its FY 2014 internal sale growth guidance to -1% to -2% (versus previous +1%); cut internal operating profit growth to -1% to -3% (vs prior 0% to +2%); and lowered its EPS guidance to $3.91-3.99 (vs prior $3.97- 4.05). Ouch!


Our greatest worry is that Kellogg’s management believes it can turn around the cereal category and consumer trends based on a new marketing message; in CEO John Bryant’s words “we need to communicate how cereal can be a better option for them.”  The cereal category is expected to be down -5% this year and K is underperforming the category – we frankly are not of the camp that cereal sees a turn around, and in fact we believe that its glory days are firmly past. 

 

Recent quarters have shown that Project K, a four year program design to create and enhance global efficiencies across supply chains and business units has not delivered.  The resulting costs savings to re-invested and grow its core Kellogg’s brand, global snack brands (in particular Pringles), and emerging market presence, is not working as planned. The revision to guidance this quarter and the broader underperformance we’re seeing across business units is confirmation that the strategy is off track.

 

We look forward to sharing with you why we think Kellogg’s will continue to underperform expectations in an upcoming Best Idea presentation.

 

Select commentary in the quarter:

  • U.S. Morning Foods (includes cereal) – operating profit down -20.9%, citing the underperformance of Kashi. The company announced a renewed focus on returning the message of progressive nutrition to Kashi and name a new CEO of the brand that is expect to become an autonomous business and return to its roots in La Jolla, CA.  CEO Bryant called turning around cereal a “multi-year program”.
  • U.S. Snacks – operating profit down -0.4% and underperformance in the category. Co. cited the struggle with 100 calorie packs and decision to reduce SKUs, and expectation for the “segment to be challenged for the remainder of the year”.  Reaffirms strong Pringles sales trends.
  • N. American, Other (includes US frozen and Canada) –operating profit down -20.4%. Frozen down on difficult comparisons (the launch of flatbread sandwiches last year) and the Eggo brand is below expectations (focusing on marketing in 2H behind the business). Canada – strong Pringles sales and 2H optimism on more product activity.
  • Europe –operating profit down -29.7%. Snacking strong (Pringles sales up DD) but renewed efforts on campaign called Origins, to make the connection between food and its origins.
  • Latin America –operating profit 9.5% on strong results across the region. Venezuela currency issues remain a threat to FY earnings.
  • Asia –operating profit -90.2% on weakness in Australia, only partially offset by growth in India after weakness earlier in the year.

 

Howard Penney

Managing Director

 

Matt Hedrick

Associate

 

Fred Masotta

Analyst


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