The report, written by Consumer Edge analysts Robert Dickerson and Sean King, notes that Kellogg has outperformed competitors in cold cereals this year “partly due to increased innovation, but also due to easier year-on-year comparisons [it recalled several breakfast cereals in 2010 due to off-flavors from packaging liners]".
But it added: “Over the past two months, however, Kellogg has once again drifted below private label and General Mills in dollar and volume sales growth terms [according to IRI data for US food, drug and mass merchandise channels excluding Walmart].”
On its third quarter earnings call last month, Kellogg chief executive John Bryant faced tough questions about his recent admission that bosses had cut too many staff in the US plants and sweated assets too hard.
But aggressive cost cutting and buying back more shares in a bid to manage earnings growth “were the effects of weakening fundamentals, not the cause”, claimed the Consumer Edge analysts.
“Basically, try to circumvent cash flow growth deceleration due to long-term weakness in the business by cutting costs, keeping capex low, and buying back shares, is a strategy that can lead to higher earnings per share growth, but usually doesn’t end well.”
Cold cereals category continues to underperform
Meanwhile, the cold cereal category that Kellogg dominates has continued to underperform relative to the overall US food retail market, and more specifically compared with the frozen breakfast, yogurt, and snack bar categories, they added.
“With North American cereal accounting for about 35% of North American and 25% of total-company revenue and Kellogg being the category’s captain, we find the pressure in the category to be a key driver in Kellogg’s weakness over the past three years.”
Moreover, while Kellogg had been steadily cutting stock keeping units to give more space to its top sellers, its big brands were not growing fast enough, they claimed.
“Kellogg has to innovate more, as its legacy brands aren’t growing and other smaller brands are being rationalized.”
To add to the challenges, the brands that were proving more successful were typically the more sugary varieties that were being targeted by health lobby groups and government crackdowns on marketing towards kids, they noted.
However, other commentators are more positive about Kellogg’s prospects, with Tim Begany, a contributor to financial research and publishing firm StreetAuthority yesterday urging investors to take a second look at Kellogg stock.
Recent moves into emerging markets through the acquisition of Chinese cookie maker Zhenghang Food Co and Russian snacks and cereals firm United Bakers Group were particularly encouraging, he said.
“I find it very encouraging that Kellogg has been getting into emerging markets, since most economists will tell you that's where the real growth opportunities are.”
Q3 results: ‘The more rocks that are turned over, there’s more ugly stuff underneath’
Kellogg boss John Bryant faced a grilling from analysts on the Q3 earnings call last month, with Deutsche Bank analyst Eric R. Katzman observing that “it seems like the more rocks that are turned over, there's more ugly stuff underneath… it's amazing that a company like Kellogg with its reputation is actually going through this.”
Bryant agreed mistakes had been made - “we did cut too many people from our facilities… and we probably worked the assets a bit too hard” – but said he remained confident about the firm’s prospects in the US cold cereals sector.
Bryant: Long term growth prospects
He added: “There are lots of reasons to believe that [the US cereals] category can continue to grow. There's an aging population trend here and older people eat more cereal than younger people.
"There's an opportunity to drive cereal consumption outside the breakfast occasion. And some of the trends right now, like Greek yogurt… can be complementary to cereal....”
Kashi could be more of a growth engine
Asked about the performance of the Kashi cereal brand, he said: “I think Kashi has an opportunity to get back to be more of an engine. I think we need to pick up the rate of innovation on the Kashi business."