Will Kellogg (K) Gain From Productivity & Innovation Plans?

Sales for Kellogg Company (NYSE:K) have remained subdued in recent quarters due to persistent weakness in North American and Europe. Kellogg’s shares have declined approximately 12.2% so far this year, trading below the industry it belongs to. Nonetheless, the company is leaving no stone unturned to reinvigorate investors’ confidence and regain its footing by cost-saving initiatives, innovations and diversifications.

Although the company’s shares have been trading below the industry year to date, earnings estimates for the current year have moved 1.3% up in the last 30 days, reflecting analysts’ optimism.

Cost Savings Have Been Driving Profits

Kellogg posted better-than-expected third-quarter 2017 results. Cost-saving initiatives as well as higher demand for its frozen foods and Kashi snacks helped the company offset the industry-wide soft consumption trends for packaged food items. The company’s earnings have increased 9.4% year over year in the quarter banking on higher operating margin that offset a higher tax rate.

Kellogg’s adjusted operating margin was 17.6% in the quarter, reflecting an improvement of 280 basis points (bps) year over year, as the company benefited from strong productivity savings related to the Project K restructuring program, particularly this year's exit from its U.S. Snacks segment's Direct Store Delivery (DSD) system and its related elimination of overhead during the quarter.

The company also remains on track to reach a 17-18% currency-neutral comparable operating profit margin by 2020. During 2016-2018, Kellogg expects adjusted operating profit margin to increase by approximately 350 basis points from 2015 levels, reaching approximately 18% by 2018. This is driven by the expansion of zero-based budgeting initiative in North America and internationally along with stronger price realization via better revenue-growth management.

Other Growth Drivers

Apart from aggressive cost-saving initiatives, Kellogg is also making significant efforts to improve its food. It is channeling funds toward product and packaging innovation as well as reformulation of many existing products to meet the rapidly changing views of consumers regarding health and wellness.

Kellogg’s recent agreement to acquire protein bar maker, Chicago Bar Company, is a classic example to this effort. Chicago Bar Company makes RXBAR, which is considered the fastest growing nutrition bar brand in the United States. The addition of “clean-label, high-protein” RXBAR can be expected to revive Kellogg’s wholesome snacks business, which has been weak over the past few quarters.

Challenges

Kellogg has been struggling to increase sales over the past two years primarily due to weak performance in its developed market cereals and U.S. snacks businesses as a result of lower demand. In the first nine months of 2017, net sales declined 2% (down 3.4% organically) with volumes down 4.1% as a result of soft consumption trends across most categories during the period.

Specifically, North America core sales declined 2.9% in the first nine months of 2017 due to soft U.S. cereals and snack sales. Europe’s net sales also declined 7.9% in the period.

Kellogg’s mainstay U.S. cereal business, which accounts for 40-45% of the sales, has been performing poorly since 2012 due to sluggish category growth. Revenues at the U.S. Morning Foods segment, which includes cereals, slipped 5.3% in the first nine months of 2017.

Nonetheless, the company has chalked out several initiatives for the Cereal category that is expected to revive sales growth in future.

Zacks Rank & Key Picks

Kellogg current carries a Zacks Rank #3 (Hold). A few better-ranked stocks in the same space are B&G Foods, Inc. (NYSE:BGS) , Flowers Foods, Inc. (NYSE:FLO) and Medifast, Inc. (NYSE:MED) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

B&G Foods’ current-quarter earnings are expected to grow 101.7%.

Flowers Foods’ current-year earnings estimates have moved 1.2% up in the last seven days.

Medifast is expected to witness 14.8% growth in earnings this year.

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