Kellogg last week announced mixed second-quarter results, with growth in underlying operating profit above analyst expectations but reported revenue missing forecasts on Wall Street and underlying sales declining. However, the Special K and Pringles maker lifted its forecast for underlying earnings per share for 2016 – and raised its target for underlying operating margin for 2017/18. Its shares closed up on the day. just-food provides the most important talking points from what was a detailed announcement.
Mixed Q2 numbers
In a detailed release, Kellogg reported comparable operating profit – with “comparable” excluding factors like M&A costs and charges from its Project K restructuring programme – that was above expectations on Wall Street. Stripping out the impact of exchange rates, currency neutral comparable EBIT was up by 10.6%, helped by better-than-expected profits in North America and in an inflationary Venezuelan market.
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By GlobalDataHowever, on a reported basis, Kellogg’s net revenue declined more than analysts expected, while in North America, the company’s like-for-like sales came in under Wall Street estimates. “North America like-for-like sales declined for the 13th quarter in a row in 2Q16,” Pablo Zuanic, an analyst at US investment and trading firm Susquehanna International Group, said.
Kellogg saw some improvement in its business in Europe, with sales and profit improving compared to the first quarter. Kellogg’s Pringles business grew at a double-digit rate in Europe, although the performance of its cereal business was mixed. Bryant pointed to “double-digit” growth in Russia and “sequential improvement” northern and southern Europe but admitted results from the company’s cereal business in the UK were “disappointing”.
He said: “As we look to the second half, we continue to expect sequential improvement in Europe in sales and profit, which will require progress in stabilising UK cereal.”
What’s the latest on Kellogg’s core US cereal business?
Kellogg’s US cereal arm has been under pressure for some time. Comparable sales for the company’s US Morning Foods division, of which breakfast cereal makes up the bulk of sales, have fallen in each of the last three years.
The Special K maker has not been alone in finding the going tough in the US cereal market, as more consumers switch alternative dishes for breakfast.
In the first quarter of 2016, currency-neutral, comparable sales from US Morning Foods fell 1.2% year-on-year, although Kellogg claimed its namesake-branded sales made some gains when measuring their market share.
On Thursday, Kellogg reported another fall in currency-neutral, comparable sales from US Morning Foods in the second quarter. It said its “six core cereal brands” (without naming them) “held all-channel share”.
Speaking to analysts after the second-quarter results were published, Kellogg president and CEO John Bryant said the division’s total share in cereal was “off slightly” but said there were “encouraging” signs for the category as a whole. “The category came back to flat after down Q1,” he said.
Bryant said a number of times on the conference call with analysts that Kellogg’s US cereal business had “stabilised”. However, there is some concern among analysts about the performance of that side of the business. “It is worrying that the turnaround in sales growth in US cereals still hasn’t come through, despite best efforts since early 2015,” Sanford Bernstein analyst Alexia Howard wrote last week.
And, in a longer note today (11 August), Howard suggested sales in the US cereal category were sliding. “Ready-to-eat cereal category results in measured channels still seem to be down modestly – clocking -1.7% YoY in the latest quarter, which is actually a slight deterioration versus -1.4% over the past year,” she said.
However, Howard did see one positive sign. “In 2016, total points of distribution for the RTE cereal category now seem to be in decline, as retailers have presumably finally started to reallocate shelf space into faster-growing parts of the category. The good news is that velocities are improving for those brands that remain on-shelf, which can only be a good thing for category profitability for both the retailers and manufacturers.”
Kellogg’s new targets prompt questions over sales outlook
Alongside Kellogg’s results for the second quarter and first half of 2016, the company lifted its forecast for underlying earnings per share for 2016 – and raised its target for underlying operating margin through to 2018.
Kellogg believes it can achieve an improvement worth 350 basis points by the end of 2018 – a revision on a previous target of 2020. It pointed to its plans to extend the zero-based budgeting programmes the company has started to implement in recent months. The Pringles owner also said “a more disciplined approach to revenue growth management” would be a factor.
However, Kellogg’s forecast for net sales to be flat through to 2018 sparked questions for management. John Bryant, Kellogg’s chairman and CEO, said the forecast was “cautious” and insisted the Special K and Pringles maker would “shoot to do better than that”.
Asked about the split between volumes and price/mix, Bryant added: “Clearly, within a flat sales guidance, you would expect volume to be down a little bit and price/mix providing some benefit. And again, let me reiterate, internally, we’ll chase better numbers than that, but we don’t want to promise those numbers. Clearly, we want to deliver them, though, when the time comes.”
Forecasting flat sales may seem unexciting to some but is perhaps a sign of the challenging conditions in some of Kellogg’s key sectors, such as breakfast cereal in the US and the UK – and Bryant described the latter country as “a work in progress” for the company.
Above all, Kellogg’s CEO insisted the company was putting the building blocks in place for a more robust business. “As we do drive for more price realization, as we do de-emphasise some lower profit elements of the portfolio, we might see some drag on the top-line, but it’s a drag that I wouldn’t be concerned about, because we’re building a stronger core business over time with a better growth profile.”
Kellogg latest company to flag zero-based budgeting…
Zero-based budgeting has become a common strategy among companies in the food sector to tackle costs since the entry of private-equity firm 3G Capital into the industry through its acquisition of HJ Heinz and the subsequent merger with Kraft Foods Group.
Kellogg claimed it had already seen the benefit of zero-based budgeting in North America, citing the practice as a factor in an 110 basis point improvement in operating margin in the market in the second quarter of the year.
The company plans to roll out zero-based budgeting and said the expectation of a positive impact from extending the practice wider was a reason for it lifting its earnings per share forecast for 2016. CFO Ron Dissinger said Kellogg expects to eke out $150-180m in savings from zero-based budgeting in 2016. Between the start of 2016 and the end of 2018, the company forecast total savings of $450-500m from implementing zero-based budgeting across North America and internationally, he added.
Alongside zero-based budgeting, Kellogg continues to look for productivity improvements through its Project K programme. On the call, Sanford Bernstein’s Howard asked how Kellogg’s efforts to cut costs compared to a move in 2010 for savings dubbed “the billion-dollar cost challenge”, which she suggested caused problems with morale and cultural upheaval within the business. Dissinger said: “Zero-based budgeting is really just a refreshing way to look at our cost structure and ensure that the investments that we have are prioritised and aligned with our strategy, so it’s nothing more than that. We’re being very thoughtful on how we take costs out of our business and make sure that the investments we’re making are aligned with our priorities and strategy.”
… and latest to “manage” revenue growth
Revenue growth management is also becoming a tactic we are seeing more and more among some of the major names in the sector, as companies seek to optimise promotional spending and price points to improve margins. Mondelez International, for one, has identified it as a strategy it is following. The strategy also came up on Kraft Heinz’s second-quarter results conference call yesterday.
Bryant said Kellogg was putting “a greater focus” on revenue growth management to have “the right price, on the right pack, for the right occasion”. He added: “We’re finding there’s opportunities in some other areas, such as price/pack architecture, and, of course, continue to drive a focus on mix,” he said.
Deanie Elsner, president of Kellogg’s US snacks business, was also on the call. She cited Kellogg’s recent work with its Cheez-It brand as an example.
“The opportunity for Kellogg is greater price realisation across all three levers of revenue growth management,” she explained. In Cheez-It, we assessed our portfolio pricing across all of our channels. We expanded our formats to meet the needs of consumers by channel and that included large sizes and On-the-Go and smaller sizes, in addition to opening price points. The format’s changed by channel.
“Year-to-date consumption is up 5%, led by volume and strong price/mix. Base sales, up 7.6% and we’ve increased distribution more than 7% behind an expansion of our price/pack architecture. The brand also posted improved profit margin.”
