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On Jul 2, we maintained a Neutral recommendation on Kellogg Company (K - Analyst Report). While the cereal and snack company’s long-term fundamentals appear solid, we remain sidelined due to its lower-than-expected first-quarter results.

Why the Neutral Recommendation?

On May 2, 2013, Kellogg announced its first-quarter 2013 results. Kellogg’s first-quarter  earnings of 99 cents per share missed the Zacks Consensus Estimate by 2.9%. Earnings declined 8.3% from the prior-year quarter due to higher commodity cost inflation and lower-than-expected sales. Revenues missed the Zacks Consensus Estimate and rose only 2.2% organically due to lower volumes and sluggishness in the U.S. snacks and Asia Pacific businesses. Gross margin declined 330 basis points (bps) in the quarter largely due to a 200 bps headwind from commodity cost inflation.

While the second quarter will also be tough due to continued softness in the snacks segment and cost inflation, results are expected to improve in the next half of the year on the back of higher cost savings and commodity cost deflation.

We are optimistic about Kellogg’s solid brand positioning, its geographic diversity and significant investments behind innovation, marketing and supply-chain initiatives. Moreover, we are encouraged by the growth potential, diversification and international presence that the Pringles deal provides.

However, the challenged cereal business, pressures in Europe and the rising input costs keep us on the sidelines. Kellogg’s mainstay U.S. cereal business has witnessed a relatively slow business due to sluggish category growth. Though improving trends have been noticed in the past two quarters, we would like to see a broader and sustained growth in the category. The European business has been sluggish of late, though some improvement is being seen in the U.K. and France. Increasing prices of raw materials have hurt the company’s margins significantly in 2011 and 2012. In 2013, Kellogg expects $80 million of commodity cost inflation which will further hurt margins.

Other Stocks to Consider

Kellogg carries a Zacks Rank #3 (Hold). Other stocks in the food industry that are currently performing well and have a bright outlook include Flower Foods Inc. (FLO - Snapshot Report), Omega Protein Corp. and B&G Foods Inc. (BGS - Snapshot Report), all carrying a Zacks Rank #1 (Strong Buy).

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