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On Dec 18, 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 soft top-line performance in the last two quarters.

Why the Neutral Recommendation?

Kellogg’s top line has been sluggish for the past two quarters due to weakness in the U.S. cereal and snacks businesses, its two largest businesses.

Kellogg’s mainstay U.S. cereal business has been relatively slow due to sluggish category growth. Persistent weakness within adult varieties is weighing on category results. The U.S Morning Foods business declined 2.2% in the third quarter and 3.3% in the second quarter of 2013. Though the company is trying to re-invigorate this segment by innovation and aggressive marketing campaigns, these activities are yet to show results.

The U.S. snacks organic revenues declined in all the quarters of 2013 due to weakness in crackers and cookies. Weaker-than-expected sales in the U.S snacks and cereals businesses in the past two quarters and expectations for weaker developed market sales compelled Kellogg to squeeze its 2013 earnings and sales guidance. Estimates for the fourth quarter and fiscal 2013 were largely revised downwards following the guidance cut.

However, Kellogg’s profits have been decent thanks to its aggressive cost savings and productivity improvement efforts. Kellogg’s third-quarter adjusted earnings of 95 cents per share beat the Zacks Consensus Estimate by 6.7% and prior-year quarter’s earnings by 2.2% as the softer top-line performance was offset by overhead cost savings and lower taxes and lower-than-expected currency headwinds.

Overall, we believe that Kellogg has strong fundamentals with its solid brand positioning, geographic diversity and significant investments in innovation, marketing and supply-chain initiatives. We are also encouraged by the growth potential, diversification and international presence that the Pringles deal provides.

Moreover, the new cost savings plan, Project K, will free up funds for brand building, innovation and overall growth. However, the plan could easily take a couple of years before it delivers substantial results.

Other Stocks to Consider

Kellogg carries a Zacks Rank #3 (Hold). Other better-ranked stocks in the food industry include The Hain Celestial Group, Inc. (HAIN - Analyst Report), Green Mountain Coffee Roasters, Inc. (GMCR - Analyst Report) and United Natural Foods, Inc. (UNFI - Analyst Report). All the three companies carry a Zacks Rank #2 (Buy).

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