Pressure in cereal category prompts rating's downgrade for Kellogg

by Eric Schroeder
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Kellogg cereal
Credit Suisse said consensus estimates for Kellogg’s revenue growth and e.p.s. need to go lower to reflect continued challenges for the cereal.

NEW YORK — Credit Suisse on Dec. 7 downgraded its rating’s outlook for Kellogg Co. to “neutral” from “outperform” and lowered its target price for the Battle Creek, Mich.-based company to $77 per share from $84.

Robert Moskow, Credit Suisse
Robert Moskow, research analyst with Credit Suisse

“As we had hoped for when we upgraded the stock last year, the management team took on a greater sense of urgency to accelerate its margin targets and cost savings programs to adapt to a slower growth environment and perhaps pre-empt an unwelcome bid from a strategic acquirer,” Robert Moskow, a research analyst with Credit Suisse, wrote in the Dec. 7 report. “However, the company’s revenue growth rate continued to under-punch its peers due to ongoing pressure in the breakfast cereal category (45% of sales) and company-specific problems in wholesome snacks (about 7% of sales).”

Mr. Moskow said Credit Suisse now believes that consensus estimates for Kellogg’s revenue growth and e.p.s. need to go lower to reflect continued challenges for the cereal and wholesome snacks businesses as well as currency headwinds that the rating’s agency estimated at 11c per share. He said Credit Suisse expects Kellogg’s stock to perform in-line with its peer group in 2017 with only 6% e.p.s. growth and a continued valuation discount relative to consumer peers.

Kellogg granola
To appeal to millennials, Kellogg has offered more granolas, but the efforts “have not fully stabilized the business.”

An area that may not be having as much of an impact as expected has been Kellogg’s effort to reengage millennials. Mr. Moskow said Kellogg has offered more granolas, mueslis and “fashion-forward” ingredients, but the efforts “have not fully stabilized the business.”

“According to our tracking data, Kellogg’s U.S. cereal slipped back to a 2% decline in the fourth quarter as consumers continued to seek alternative breakfast solutions,” he said. “Western European cereal showed modest progress sequentially but remains down 5% versus the prior year. As a result, we view the guidance for ‘stable’ breakfast cereal sales in 2017 as a best case scenario rather than conservative, and we have lowered our target for organic sales growth to -1%.”

Despite lowering its outlook for Kellogg, Credit Suisse acknowledged the company has taken several positive steps to deliver stronger gross margin expansion in 2017. Specifically, the rating's agency lauded the “volume-to-value” approach now in place that generated success for Kellogg in the early 2000s.

Kellogg Special K Nourish cereal
Kellogg’s U.S. cereal slipped back to a 2% decline in fourth quarter as consumers continued to seek alternative breakfast solutions.

“Price realization should go higher as the company makes bigger investments in product quality, puts more discipline into price-pack architecture decisions and improves its returns on trade spending,” Mr. Moskow said. “However, it is unclear to us whether the benefits from these efforts will be enough to materially offset the negative impact on mix from the declining wholesome snacks business (particularly Special K) and the weak volume.”

Credit Suisse has forecast Kellogg’s net income at $1,311 million in fiscal 2016 and $1,372 million in fiscal 2017, up from $1,259 million in fiscal 2015 and compared with $1,398 million in fiscal 2014. Net revenues are forecast at $12,955.4 million in fiscal 2016 and $12,831.3 million in fiscal 2017, which compared with $13,528 million in fiscal 2015 and $14,580 million in fiscal 2014. 
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